Cap Rates can run in a very wide range. In very general terms, a buyer wants to pay the lowest price possible so he or she will want to acquire property at the highest possible Cap Rate. Cap rates will vary due to a wide range of factors impacting a given property. Location, strength of tenants, vacancy rate, condition of property, existing demand etc., etc. However, while Cap Rates are an easy guide to use when sorting through alternative deals, they pretty much go out the window when the buyer brings financing alternatives into play. Internal Rate of Return calculations that take into account multi-year income and expense figures become much more meaningful. The due diligence process for vetting alternative investments can also be very complex. You want to be able to determine what the "actual" net operating income is for the property and then determine the potential for it to continue or improve. Often times I see Cap Rates advertised which are based on "Projections" or on numbers that aren't very detailed in nature. Thus, you want to be able to verify all the expense and income numbers. If the owner isn't showing that he is spending money making repairs and maintaining the property he is either neglecting the property, doing work himself and not billing the property for it, or he is conveniently "forgetting" about some expense items so his Net Income looks better.
Oct 22, 2010