Risk & Business Magazine CEO/CFO Business Today Magazine Summer 2018 | Page 30
INVESTMENT PROPERTIES
BY: BRIAN E. HALL
VICE PRESIDENT, CORPORATE
BANKING, OHIO VALLEY BANK
Cap Rates for Investment Properties:
C
apitalization Rates (Cap Rates),
the standard-bearer and
primary valuation concept
and tool for evaluating
investment properties, remains
one of the most difficult and often
times misrepresented value assessment
processes. Everyone involved — including
bankers, realtors, investment property
owners, professionals, and even appraisers
— has a mixed set of standards and
perspectives, which can result in wide
variations of opinion about a property’s
value.
This article seeks to share a common-
sense approach to the use of this
most valuable tool in the evaluation
process, placing greater emphasis on the
understanding that it is just that — a
tool. A piece of the puzzle in evaluating
properties as investment opportunities.
The practical methodology suggested here
is a function of my experience over many
years of reviewing properties, sometimes
the same property, with multiple owners,
covering fairly significant changes in
local and national economic conditions.
This extended view — meshing the often
divergent influences of investor, lender,
and appraiser, and the variability between
local economic conditions overlaid with
a more regionalized conceptualization
of cap rate tendencies — can provide a
valuable, more homogenous perspective
that usually results in a better final
assessment leading to more realistic
investment results.
I argue that equal emphasis must be
placed on the core factors that are used
in the cap rate model. Specifically, market
conditions locally, revenues and their
durability over time, and expenses and
their potential future influences.
30
The Forest, The Trees,
and All That’s In Between
THE FOREST
The landscape that is Cap Rates
is littered with misconceptions,
generalizations, over-simplifications, and
misrepresentations. One of the primary
factors negatively influencing cap rates
as a valuation tool is the mind-set that
seeks to obtain an absolute factor for a
given property. Principal amongst these
is the baseline exercise of establishing
a range or average cap rate given the
property type almost always as a function
of regionalized data often well beyond the
geography of southeastern Ohio.
This can be dangerous and overly
optimistic given the long-term nature of
the more generally depressed economic
conditions in our communities. This
urban/rural tension must be balanced
by local factors. Understanding these
local influences is central to a proper
balancing of regionalized cap data as an
influence on local market conditions. This
is particularly evident and a concern in
the appraisal process, as often times the
lack of local certified general appraisers
results in assignments given to appraisers
from urban/metro markets as far away
as Columbus and Cincinnati. It can be
difficult for these appraisers to fully grasp
the local market dynamics influences by
varying degrees of depressed economic
conditions offset by an insulated,
inventory-driven demand with proprietary
underpinnings. These influences are
often misunderstood and understated
in our area. An “average” of regionalized
cap rates is invariably used with little or
no consideration of these local market
influences—both positive and negative.
Generally, the loss of homeownership and
resultant strong increase in rental housing
in urban markets, as a function of the
great recession of 2008–10, has served
to create what is likely an unsustainable
bubble in cap rates for residential rental
properties. It is not unusual to see
cap rates as low as 5 for these types of
properties, and this should be a point of
emphasis given that cap rates for similarly
constituted properties was as high as
11–12 in the last 10 years.
The regional urban/metro data
extrapolated from this phenomenon is
dangerous and could have the unintended
consequence of value fluctuations over
time that make real estate markets behave
more like Wall Street investments, with
their inherent and often unsubstantiated
value fluctuations. Past experience in the
sha