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Guys, loved the class thanks so much for your time that you invested in this.
Quick question about CAP Rates in development models- I know a lot of uncontrollable variables go into determining the cap rate but is there any way of determining the rate for a development property? In the examples through the class relying on the broker was used multiple times, but is there any other way to pin down a cap rate or accurate estimate yourself?
Hunter – Spencer here, responding for Michael as he’s out of the country this week.
This is an interesting question. The answer is far less nuanced than you might think, especially when you’re NOT coming at it from an academic perspective. In grad school, we learned various “methods” for deriving a cap rate. Everything from comparative analysis (i.e. looking at cap rates on sales of comparable properties) to building an imputed cap rate by adding together tranches of risk (e.g. risk free rate + illiquidity risk + market risk + volatility risk + etc). I remember we even used a method of deriving an imputed cap rate by calculating the weighted average cost of capital and then subtracting out a long-term growth rate.
However, this program is about teaching how concepts are actually used in industry. And in industry, cap rates are much more simple than what you learn in academia/school. There’s not some special formula you can use to come up with the right cap rate. In the real world, a cap rate is simply an assumption, the denominator in your direct cap (i.e. NOI/Cap Rate) formula, used to forecast the value of a stabilized property. And like any other assumption in your model, the cap rate assumption is arrived at by looking at what is actually being achieved at similar properties and using that information to support your assumption.
So to your question, “is there any way of determining the rate for a development property?”. The answer is Yes. By looking at what cap rates other newly developed and stabilized properties are trading for in your market. You get that data either through personal experience and knowledge of trades in your market, data providers such as CoStar/REIS, or through broker contacts. Real estate research firms also put out market cap rate analysis that provides high-level cap rate information (e.g. CBRE Cap Rate Survey), but in industry cap rates are supported (i.e. justified to an investment committee) by actual sales of comparable properties.
Happy to answer any follow up questions to this!
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