Jim: Just because a cap rate is higher, does not necessarily mean more risk - although this is many time the case. It may also mean more involvement in the property or business. For example, if you were to buy a Walgreens with no landlord responsibilites, just the receipt of rent, then the cap rate would be low (maybe 7-8%) - a reflection of the landlord duties and the credit-worthiness of the tenant, Walgreens. On the other hand, if you bought a convenience store property with a non-national tenant, you should expect a much higher cap rate, say 10-15%, for the risk invloved there. What is the credit-worthiness of this tenant?
The actual cap rate is figured by dividing the NOI by the purchase price. The cap rate is only one way to view a property. There are many methods that people use. For example, with multi-family property, many people use a rent multiplier.
Cap rate is important, but you need to look deeper into a property before a decision can be made. Just getting to the real NOI can be a challange - are there reserves in the NOI?, etc. Right now, almost anything with a cap rate of 4.5 is not saleable - this is much too low. Even if there is room to move the rents up, why has the current owner not done that? Almost all properties are sold today on present numbers, not future.
Jul 8, 2010