Tuesday, April 10, 2007
There is more risk - as the market suggests - in non-credit rated tenants. The mom and pop nail salon seems more risky than the Quizno's. A retail center of Quizno-quality name brands will sell at a lower cap rate than a center made up of neighborhood service providers. The difference in costs also is evident in financing. 5.9% vs. 6.78% is the difference in 10 year fixed money from credit to non-credit tenants as quoted from one lender's rate sheet today. Fair, yes. Higher risk/reward center will also command higher cost of capital. I suggest that the higher upside would be in a neighborhood center that can be converted to name brand tenants over time.
What is the cap rate on your rental house? Annual income less expenses over current market value, right? The "less expenses" part is the nebulous part of the analysis. Needed items to include are major capital improvements that don't happen yearly. Roof replacements, new kitchens, bathroom remodels, landscaping, painting - all of these should be prorated every year to give a more fair cap rate. Don't be surprised if you get a 2.3% cap rate as I just did on my rental house. So, does that 4% cap rate apartment building look better? Maybe... That's another discussion.