Is the 'CAP Rate' the most Important Factor When Considering an Investment?

After working with many investors, the conclusion is generally “no.”  While the Cap Rate, is an important barometer when evaluating options, there are other significant factors that investors must look at when making selections. 

Let’s look at several here:

1. Location 

2.  Building Characteristics/Features

3.  Credit worthiness & history of the tenant 

4.  Cost Basis and Market Rent

5. Upside Potential or Value-Add

READ THE BREAKDOWN OF EACH BELOW

Location

While all RE acquisitions hinge on “location, location, location,” for industrial property this has more to do with your current tenant than a buyer’s personal preference. 

(i) Is this a strategic or critical location to the current occupant? 

(ii) How many other businesses could utilize this location? 

(iii) How accessible are the transportation routes servicing this property? 

(iv) What are the demographics of the surrounding area? 

Most of these questions, as far as investors are concerned, revolve around “How likely is this tenant going to stay and/or if this tenant goes away how quickly will the investor be able to replace them at equal or better rent?”

 Building Characteristics/Features

If the property first checks the location box, then consider how easily someone could construct a property with similar amenities nearby?  Are the amenities that the building currently has compatible with a wide variety of users. Investors need to understand their competition, marketability to future tenants, and ability to increase rental income. Buying a property with good “bones” or key features not easily duplicated will help the owner protect its long-term value.  

Credit worthiness & history of the tenant

A critical factor for any investment property is the stability of the existing occupant. As re-tenanting a property, especially large properties, can be a lengthy and costly endeavor, most buyer’s want to acquire properties where the tenant is going to stay put for the long haul. Therefore, it is important to have someone on your team who can evaluate the tenant’s financials. Additionally, it is important to know if there have been any major operational changes in the core business or the executive team for those who are running the operation.

 Cost Basis and Market Rent

On paper the initial offering’s advertised Cap Rate may look very attractive, but to ensure that it is not unreasonably inflated, it must be checked against the fair market value of the current rent and/or price per square foot (PSF) of the building. This can be extremely important when considering a sale-leaseback acquisition, especially one where the seller is more interested in raising the sales value than keeping the monthly cost of occupancy low. It is not uncommon, however, for investors to absorb slight premiums in either price PSF or rental rate PSF, but these premiums must be within reason.  

Upside Potential or Value-Add

One final consideration is the sought after “value add” play, or “What type of upside potential does a property offer?” This is in contrast to the idea of paying a slight premium, as mentioned in our last point. Here, investors are looking for ways to either increase the current rent significantly or re-positioning the asset to increase the total sale price when they dispose of the property. These are generally harder to find and include a little more risk but can provide a great vehicle for building equity.

For further discussion on these points, or any questions you may have, please contact our team today. We look forward to hearing from you and being a trusted advisor in your real estate decisions.