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Cap Rates When You Are Debt Free

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dougm

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I apologize if this question seems beneath the level expertise of 99% of you. We are privately held with no debt on our commercial properties. We were approached by an entity that wanted to buy a piece of our portfolio. Naturally, they wanted NOI statements and they used market area cap rates. But we are debt free, so would our cap rate for our property be lower than market? thus, should we expect a substantial premium for giving up a debt free property?
Thank you,
Doug Marcus
 

Gobears81

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Illinois
Doug- What property type is this? I am pretty confident in answering this question but wanted to make sure that it isn't something that necessarily implies transfer of debt to a prospective purchaser.
 

dougm

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Doug- What property type is this? I am pretty confident in answering this question but wanted to make sure that it isn't something that necessarily implies transfer of debt to a prospective purchaser.

class b commercial office property. property was acquired for 100% cash. any debt would be originating with the buyer and not transferring from us.
 

Gobears81

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class b commercial office property. property was acquired for 100% cash. any debt would be originating with the buyer and not transferring from us.
A short answer would be that it really has no effect as the prospective buyer's net income will not be affected after the sale goes through, regardless of whether you have no debt or a mortgage worth 90% of the value of the property. Maybe the property is worth more to you because you have no debt, but from a market value standpoint, this isn't really a significant issue.
 

dougm

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A short answer would be that it really has no effect as the prospective buyer's net income will not be affected after the sale goes through, regardless of whether you have no debt or a mortgage worth 90% of the value of the property. Maybe the property is worth more to you because you have no debt, but from a market value standpoint, this isn't really a significant issue.

that is what I figured. the only way I could convert our NOI's to the buyer's valuation was reduce the cap rate substantially. the band of investment method would have equity @ 100% * annual income growth + debt @ 0% * annual mortgage constant.
 

dougm

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No, there are many investors that acquire property from a cash basis this is not unique
but your exit price might be higher if you do not have mortgage risk. thus, he lacks the urgency to sell without a premium.
 

Thomas Holding

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Jan 22, 2004
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Certified General Appraiser
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North Carolina
What type of financing would a typical market participant utilize? Typically, most purchasers have to borrow money from a bank. You can estimate what a cap rate would be by surveying local banks as to what terms and rates they would charge when lending on a property like yours. Search for Band of Investment technique. You can find a bunch of websites with good explanations and spreadsheets that will show you the formulas.
 

Howard Klahr

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Certified General Appraiser
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Florida
Typically, most purchasers have to borrow money from a bank.
What purchasers? REITs, Pension Funds, Family Offices purchase without financing all the time and comprise a significant portion of the market.

but your exit price might be higher if you do not have mortgage risk.
That reflects investment value not market value. What mortgage risk does the seller have anyway? Unless you are suggesting that sellers are upside down.
 
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