When Market Conditions and Buyers Expectations Differ

[George Hatch]

We've talked about this before, but even with 2-4s the differences in rents between subject and comps can be used to contribution to developing adjustments. If two properties have the same/similar floorplan and unit mix but the condition is different the rents will also usually be different. If one sale has (2) 2bd units and another has 1bd+2bd, the difference in rent between the 1bd and the 2bd can be used to develop that adjustment factor. The GRM for that adjustment will generally be a lot lower than the GRM for the entire property because the latter includes the contributory of the land+improvements, so instead of using the 150x GRM from the sale the adjustment factor might only use a 70x GRM or a 50x GRM. But if the difference in rents is $800/mo x 50x GRM that still amounts to $40,000 for that bedroom. Not $20,000 as might apply to an SFR in that same neighborhood. Cross check with sensitivity analysis between the comps and it will often square up.

 

[Fernando]

Before Covid, I would look at commercial properties and different tenants with different cap rates.
For me I consider the tenant, lease terms, and the location and see if the income justify the risks.
Unlike residential properties in which buyers negotiate price. I'm not sure if other investors consider all these factors especially long term or just look at cap rate/income for short term.

 

[George Hatch]

If I am appraising a Main Street property and one of the sales has a corporate tenant then I don't even consider that property to be a comp for what I'm appraising. ESPECIALLY with restaurant and fast food units. I'm not even looking at the cap rate of a NNN investor because the typical buyer for an "orphan" restaurant or fast food unit will be an owner-user, not a rental-income oriented investor. And vice-versa; when appraising the investment grade properties only similar is actually similar.

A McDonalds is not a comp for the Tom's Burger #6 that's located on the opposing corner, even if the Toms was originally built out as a Burger King. The McD sale isn't even relevant enough to warrant mention in my analysis except as an explanation for why I don't consider it to be a comparable property.

 

[Fernando]

If I am appraising a Main Street property and one of the sales has a corporate tenant then I don't even consider that property to be a comp for what I'm appraising. ESPECIALLY with restaurant and fast food units. I'm not even looking at the cap rate of a NNN investor because the typical buyer for an "orphan" restaurant or fast food unit will be an owner-user, not a rental-income oriented investor.

A McDonalds is not a comp for the Tom's Burger #6 that's located on the opposing corner, even if the Toms was originally built out as a Burger King. The McD sale isn't even relevant enough to warrant mention in my analysis except as an explanation for why I don't consider it to be a comparable property.

McDonalds is a NNN tenant and has one of lowest cap rate in market. McDonalds rarely owns the real estate. They get low rents relative to the market because they can.
With higher minimum wages, we are seeing McDonalds closing some eateries. Thus, additional risks which investors need to consider.

Tom's Burger (Junk status) is even riskier than McDonalds. The two tenants have MAJOR difference in value of the property.

 

[George Hatch]

Different buyers, different expectations.

 

[Joe Flacco]

There are several ways to do it, but the one method I use the most is to extract them from the comparable sales data. Obviously to include the less directly comparable comps besides just the ones I present in my report.

Another variation that's common is that sometimes the brokers depict an unreasonably low expense ratio, or fail to include the new tax assessment that would be based on the current value. If all my comps are reporting expenses in the 35% range and one of them reports 20% then that will explain why the reported cap rate for that one is so low.

As well, if a property has vacant units, those will usually be projected at the market rate because that's how we expect the buyers to handle those units. That's another reason why we take rental surveys very seriously, even for 2-4s. Look at everything we can find, pick the most similar comps and look for the trends. I'm commonly looking in several databases for rental comparables because none of them have it all. I sometimes spend 2x longer looking for good rent comps than I spend looking for sales comps, and I spend a lot of time looking for sale comps.

What is the typical sales time frame considered for cap rate extraction? And what are some of the other ways to do it?

 

[TerryRohrer]

What is the typical sales time frame considered for cap rate extraction? And what are some of the other ways to do it?

In stable markets and for some assets, it could be fairly long, but with rapid changes in either prices or rents, which don't always move in concert, the most recent indications are the best measure of current market conditions.

 

[Terrel L. Shields]

Is it standard practice to round to 6%? Or is it more like 6.1% or 5.7%?

I do to the tenth of a percent

 

[Dublin ohio]

McDonalds is a NNN tenant and has one of lowest cap rate in market. McDonalds rarely owns the real estate. They get low rents relative to the market because they can.
With higher minimum wages, we are seeing McDonalds closing some eateries. Thus, additional risks which investors need to consider.

Tom's Burger (Junk status) is even riskier than McDonalds. The two tenants have MAJOR difference in value of the property.

Approx. 82% of McDonalds are owned by franchises. They don't typically have the deep pockets of company owned stores

 

[Joe Flacco]

In stable markets and for some assets, it could be fairly long, but with rapid changes in either prices or rents, which don't always move in concert, he most recent indications are the best measure of current market conditions.

Yeah obviously. When you say stable markets, are you saying stable sale prices? Stable rents? Stable cap rates?

With the sharp change in yields, would you say that only sales since 2023 would be reliable sales to extract cap rates today? Are yields and the trend in yields ever considered when developing cap rates?

I know it is a lot of questions. Just asking out of curiosity.