4 . Relying on a Cap Rate with an unstable market condition is difficult . Using market rents may become suspect because higher rates of foreclosures , tenants default much more frequently , vacancy rates go up , and replacement tenants will ask for higher rent concessions , thereby bringing the market rents down . Additionally , owner operating expenses may become constrained .
5 . Calculating forecasting future income streams involves a high degree of professional judgment , and therefore subject to variation .
6 . Professional judgment is subject to subjective vs . objective interpretations about expectations of future benefits .
7 . The method may result in miscalculations when estimating the cost of capital outlay for upgrades to bring the property up to current standards . All subsets of the job have a cost , time and frustration allocation , including municipal approvals , reconstructing the building , modern materials , safety , zoning , environmental , and social equity requirements .
8 . Property amenities , parking , easements , recorded encumbrances , and compliance with building and zoning regulations require a complex analysis .
9 . The leaseup period is only an estimate and may not be correct .
10 . Alleged appraiser and lender biases for racially segregated neighborhoods have been known to exist .
Types include :
1 ) Fixedterm tenancy is a tenancy with a rental agreement that ends on a specific date . Fixed terms have a start date and an ending date . According to the written lease document , time terms may be short or long such as ten years with multiple extensions .
A landlord can ’ t raise rents or change lease terms because the terms are codified in a written agreement . A key advantage for a landlord is to receive today ’ s market rents . A key for a tenant is to lock in a longterm lease where the rents are or become below market over time .
A tenant ’ s company ’ s profits are enhanced if they pay substantial under market rents . On the other hand , if a tenant ’ s company is making a good profit with rents substantially below market and a lease is coming due soon , the increased or negotiated upward lease rate may wipe out some or all the profits .
2 ) Periodic tenancy is a tenancy that has a set ending date . The term automatically renews into successive periods until the tenant gives the landlord notification that he wants to end the tenancy . Monthtomonth tenancies are the most common .
The strength of the tenancies from national credit with longterm leases and corporate guarantees down to mom & pops monthtomonth tenancies will result in a substantially different Capitalization Rate . National credit tenants with corporate guarantees have a considerably lower Cap Rate . Mom and pop tenancies will reflect a higher Cap Rate because they inherently have more risk .
The lower the market Cap Rate , the lower the perceived risks of property ownership . The higher the market Cap Rate , the higher the perceived risks . An exception would be where the national credit tenant locks in a lease rate that does not increase as the market dictates or anticipates increases . Eventually , over time , this tenant will reflect belowmarket rents .
A momandpop tenant could be converted to a market rent more quickly because the term is usually shorter .
Market rents are obtained by surveying local brokers and appraisal databases of local market rents .
3 ) Tenancyatsufferance ( or holdover tenancy ). This form of tenancy is created when a tenant wrongfully holds over past the end of the duration of period of the tenancy .
Tenancies : A landlord and tenant may enter into four types of rental or lease agreements . The type depends upon the agreedupon terms and conditions of the tenancy . All rental amounts and terms of a lease will be reflected in the capitalization evaluation .
Image by Gerd Altmann from Pixabay
The lower the market Cap Rate , the lower the perceived risks of property ownership .
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