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Risk, Cap Rates

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CVal

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Hello,

Debating risk, cap rates and NOI/SF for net leased industrial properties. Say you have a cap rate table of maybe ten sales. Some of my colleagues are saying that those sales which have higher NOI/SF have higher risk. For example, subject near $4.00 per square foot, comp near $6.00 is higher risk due to this factor.

Honestly, this does not ring true to me, only recently has anyone in my office begun to consider NOI/SF as a risk factor in cap rate analysis.

I welcome other thoughts on the matter, thanks.
 

Michael S

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Given two identical properties if one has a higher NOI/SF it could indicate higher risk, but only if the rent was above-market. If you have two similar distribution warehouses and one is right off the freeway with great access and the other is a mile away with poor access then you would expect the former to achieve higher rents than the latter. It wouldn't make the former more risky, in fact due to a better location it might be less risky as it would be easier to lease-up than the warehouse in a poor location. Comparing cap rates between industrial buildings that range from a bare bones storage warehouse to a flex space with a large office buildout isn't going to be that helpful. Of course sometimes that's the only data that's available. Bottom line I wouldn't consider a higher NOI/SF to inherently be indicative of higher risk. There are many other factors at play (lease term, escalations, credit strength of tenant, quality/condition of the building, location, above/below-market rent, etc.)
 

Gobears81

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Rents of $4 vs $6 per square foot do not, in itself, imply greater risk. But how much it deviates from the market does, particularly if it is a shorter-term lease. For example, I know of some warehouse sales with cap rates of 13% - 16%. Even though I'm in a higher cap rate market than many on this forum, the above market rents are the sole reason for those sales being that much higher. Perhaps not true in all cases, but my experience with industrial is that they are more sensitive to above or below-market rents than the national NNN market. Even if it is a longer-term lease, there is often greater risk associated with above-market rents in many cases, which may be attributed to the likelihood that it will revert to market after the lease or possibly even during the lease. Maybe risk isn't the best word, but rather the market pricing in a greater likelihood of a future decline in NOI (I distinguish between the two because one may not view it as risky per se, just highly unlikely to maintain current NOI). To answer your question, I would compare market rent to actuals. If the comp has market rent of $5/ SF but is leased at $6/ SF, that factor, in itself implies higher risk/ potential downside.
 

PL1957

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Oftentimes with single tenant buildings, the cap rate is driven by the credit and term of the tenant, regardless of how the rental rate compares to market.
 

Gobears81

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Oftentimes with single tenant buildings, the cap rate is driven by the credit and term of the tenant, regardless of how the rental rate compares to market.
Not sure what kind of industrial the OP is referring to, but I've found that the "dumb dentists" (a bit of a cavalier saying, but one that I remember hearing in my finance courses) often flock to the retail properties that could be leased 100% over market without more than a 1% difference in cap rates vs a property leased near market. On net leased manufacturing facilities, I would argue the market to be a bit savvier and very much noticing above or below market rents.
 

Terrel L. Shields

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In poultry farms although income may be identical between new and old, expenses tend higher in older barns, particularly energy cost and maintenance thus cap rates deteriorate over time until the barns get refurbished to a premium contract standard. Plots very nicely as an age-cap rate curve.
 

PL1957

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Not sure what kind of industrial the OP is referring to, but I've found that the "dumb dentists" (a bit of a cavalier saying, but one that I remember hearing in my finance courses) often flock to the retail properties that could be leased 100% over market without more than a 1% difference in cap rates vs a property leased near market. On net leased manufacturing facilities, I would argue the market to be a bit savvier and very much noticing above or below market rents.
A credit deal is a credit deal, regardless if it's retail, industrial or office. Retail deals tend to be smaller in $ making them accessible to a larger pool of buyers. Larger industrial credit deals are very appealing to institutional investors with sub-5 cap rates for the right buildings with the right tenants.
 

Michigan CG

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Larger industrial credit deals are very appealing to institutional investors with sub-5 cap rates for the right buildings with the right tenants.

I don't appraise large industrial, I was surprised at the sub-5 rate you mention.
 

CVal

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Illinois
Thanks for your feedback guys.
 

PL1957

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I don't appraise large industrial, I was surprised at the sub-5 rate you mention.
I can show you 50 sales over the last 12 months of industrial buildings over 100K sf that sold with sub-5 cap rates. Mostly on the coasts, mostly occupied by credit tenants. It's a frothy world out there ...
 
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