Yield Isn’t That Important!
When we examine investment properties for investors we often find that buyers often place too much attention on the marketed “cap rate” of a property. The sophisticated investor knows that the marketed yield of investment property is just one barometer and that it is far more important to focus on the underlying underwriting assumptions rather than just a simple cap rate. I would rather have yield based upon reasonable underwriting assumptions rather than a higher ‘face value’ cap rate or yield.
It is pretty common for sellers to set the value of their properties based upon their incomes at that exact point in time when their building is 100% full. Others base the cap rate a projected income at full occupancy, something that may or may not be achieved anytime soon. Even great properties with long track records don’t maintain 100% occupancy day in and day out. There is always a little turnover, it is only natural. With turnover comes added costs for leasing commission, and tenant improvements to ready the space for the next occupant. Then of course there is always some down time between tenancies.
When you take these into account the proper underwriting will fit into five categories:
- The likelihood of the tenant not renewing their lease (or defaulting), thus the “roll”
- The new rental rate on the roll
- The leasing costs for the new tenant
- The tenant improvement cost likely required to attract a new lease
- The duration of time it will take to relet the space.
It is only after taking all of these items into account is it meaningful to starting thinking about minimum yield requirements. The financing or debt side of the acquisition will play a lot into this. There needs to be enough spread or differential between your reasonably predicted equity yield and the debt interest rate. That spread needs to take into account the amortization of the loan plus providing the investor with some enhanced return on his net investment. That’s where having a minimum level of yield makes sense.
So is yield important? Of course! But getting to the right yield based upon sound underwriting assumptions is the true answer.
For more information on this subject please contact Dougall McCorkle.
Dougall McCorkle
Premier Commercial Inc. – lic. Real estate brokers
239-860-3368
Dougall@premiermail.net