Those curious cap rate surveys

[Vernon Martin]

They seem to be the easy way out for appraisers who can't find cap rate data from real sales, but how real are these cap rates?

For instance, of the 8 golf courses I've appraised in the last 5 years, not one was profitable, and neither were the comparable sales. Yet I'm told that the cap rate surveys indicate that golf courses are now selling at cap rates of 9 to 11%. Where are these profitable golf courses?

I just read an appraisal of a distressed regional mall which reports that the surveys indicate cap rates of 5 to 9.5% for regional malls. Based on real distressed mall sales I've seen, it seems that the cap rates are closer to 12%.

Am I accidentally appraising on the wrong planet?

 

[dasantacroce]

No. You are on earth. Your experiences and mine are similar. Published cap rates are often nonsense and are based on investor expectations. I use band of investment technique which is based on real world data.

 

[Jerry Lieb]

Interesting discussion.

I generally have a higher "comfort level" using market-derived cap rates, rather than the Band of Investment method. Commercial loan rates depend on a lot of factors, not only the property itself, but the borrower and his influence with a particular lending institution. As a result, commercial loan rates vary widely and I find it difficult to zero in on a mortgage rate that can be well-supported, for use in the B of I calculations.

The main thing with market-derived rates is to carefully reconstruct the Operating Statement, since the way they appear in broker's listings is often laughable. Rarely do the listings give all of the expenses (when's the last time you saw Management Fees, Leasing Commissions, or Legal and Audit shown under Operating Expenses?). Vacancy rates, if shown at all, are typically unrealistic.

Another issue that must be considered is property taxes. Here in California, upon sale of a property, the taxes can take an enormous jump, particularly with properties that have not transferred in a long time. But, in property listings, the property tax amount shown is almost always the existing tax, and not what the taxes are likely to increase to upon sale of the property.

If I reconstruct enough operating statements from sales, I will usually see a "central tendency" emerging, thus have no problem using such a rate (or rate range) in my analysis.

Dasantacroce mentioned that published rates are useless. If you are referring to Korpacz, you've got to remember that these rates are for institutional quality properties. Most of us appraise properties that are far from institutional quality, and for those, yes - the Korpacz rates are pretty useless.

 

[Mountain Man]

I'm with you Vernon, I've yet to see a golf course that actually made $$$. Have many courses in my area, some owned by the same developer, going into foreclosure... and we are talking clubs where homes start at a million. Same for hotels. The last one I did, about 6 months ago, survey rates were below 10 when I saw real market rates 14+.

 

[dasantacroce]

I use warren Information Services for rate and term info on commercial loans and I am able to construct the debt side of the band. My relationships in the commercial market are a valuable data source for equity expectations on the equity side. Commercial brokers in exposure documents are also an excellent source for band of investment data as these professionals have an ethical and legal obligation to not misrepresent. Loop-Net is a valuable source for this data.

 

[PL1957]

You've got two separate topics here - golf courses and cap rate surveys. I'll give you my 2 cents on each.

Golf Courses - from what I've seen, there are very different dynamics for courses that were primarily conceived as an amenity to a residential development vs. golf courses built to make money from the golf operation. The "amenity" course often doesn't make economic sense and won't until its been taken back by the foolish lender and sold at a rational market price that is a fraction of the cost of construction. "Real" golf courses can still make money and do.

Investor Surveys - You have to look very carefully at the methodology of the surveys. Who are they surveying? One of the well known surveys keeps bugging me for responses - I tell them I'm not an investor, I'm an appraiser. They don't care, they just want a response. Garbage In, Garbage Out.

Some surveys really do go after investor expectations - you need to be very careful as to their definitions. As was stated earlier, Korpacz is designed for investment grade properties - see what their definition of "institutional" is. They also have a table with "non-institutional" rates - but that's usually only a page or two out of 100.

NCREIF uses "real data" - but the "real" is based on appraised value, as opposed to transactions.

All of the surveys are useful in their own way, but you should never rely on them solely in determining a cap rate.

As to Band of Investment - the next time I see an investor actually use it in their acquisition analysis, I'll be happy to start including it in my reports.

 

[Vernon Martin]

Korpacz is designed for investment grade properties - see what their definition of "institutional" is. They also have a table with "non-institutional" rates - but that's usually only a page or two out of 100.

I didn't mean to sound critical of Korpacz. I like and respect him. I think his surveys tend to be misused by people dealing in non-investment-grade properties, though, including lazy appraisers.

I recently reviewed an appraisal of a distressed equestrian center, for instance, in which the appraiser used a cap rate for "special purpose properties" that supposedly came from the Korpacz survey. That was the extent of his cap rate research. I would think that distressed properties would inherently be non-investment-grade, but that doesn't stop appraisers from using investment grade cap rates after forecasting a quick return to stabilized occupancy.

 

[ETex2]

No. You are on earth. Your experiences and mine are similar. Published cap rates are often nonsense and are based on investor expectations. I use band of investment technique which is based on real world data.

I don't tend to think of published cap rates as nonsense, as long as I believe they are realistic expectations of investors in my market who would consider the property I am appraising. I only use the band of investment technique as a backup or secondary method when actual and expected rates are weak. If the published rates are for "investment grade" only, adding a point or two for they fact that the subject is not, might be appropriate if local investors agree.

 

[dasantacroce]

For litigation purposes I have often requested of the various "cap rate" services if their data includes a recapture rate. They don't know; or they are not sure; or maybe sometimes. I have also asked if these rates are transactional??? what's that??? So I have taken to looking at the performance history of the rate services and have found NCREIF to be very good. With the condition of the current commercial market and its bloated operators on the verge of destruction I'd be very hesitant to accept some "investors" information such as their sanctoned use of "forward looking information" upon which no reliance is to be made which the real world calls baloney. In fact we probably should be somewhat restrictive in the information we solicit from investors. A look at the SEC filings for many of these investors can make some very interesting reading and be eye opening as well. Remember it is the "investors" who have created a commercial bubble that is due to hit the fan starting in 2010. I practice in the northeast and the extent of commercial retail, office and institutional vacancies is something I haven't seen since the S&L days.
Something has gone horrendously wrong and I think it has been a departure from common sense and an over reliance on data we can't put our hands on. Over the years I have looked at many operating statements with low cap rates based on an NOI that funded no reserves or depreciation but resulted in an attractive cash flow without consideration to the capital investment itself. So despite the method used it is incumbent on the appraiser to identify debt, equity, recapture and risk.

 

[H.B. Userman]

Compare the avg cap rate in realtyrates.com for Q3-07 to the avg cap rate now, all property types. It's a joke. I made the comparison a few months ago and decided to stop associating myself with that particular survey anymore.