Don’t repeat the same mistake that investors made over the past 5 years. Commercial real estate investors were betting on the come–that the next investor would pay a lower cap rate–and as cap rates decompressed, or increased, values declined and investors who based their projections on a lower terminal or exit cap rate, were caught holding the hot potato.
As you acquire commercial property in this market, pay attention to your fundamentals. Cash flow performance makes up a large part of your return on investment, while those who are betting that the next investor will pay a lower cap rate than you did should be careful, it may not happen.
Institutional investors are focused on performing cap rates today. In the past, they projected 3-5 year holding periods. Now they’re looking at 5-8 or even 10 years. And instead of counting on a lower cap rate to boost their internal rate of return forecasts today, they’re planning on cap rates increasing as much as 50 basis points. They believe:
- Interest rates will increase during their holding period;
- Annual operating fundamentals and cash flow performance are paramount;
- Properties should support leverage and be sustainable through market fluctuations over a longer holding period.
Be careful. If you’re making promises or acquisition decisions on an uncertain future, it makes sense to be safe rather than sorry. The worst that can happen is that you hit your numbers, and if we’re all wrong and cap rates decrease again, you’ll just make that much more money.
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About the Author: Jeremy Cyrier, CCIM is the founder/principal of MANSARD Commercial Properties and member of the CCIM Institute faculty. He delivers thoughtful, large scale commercial real estate solutions to the individual challenges owners and tenants face. Jeremy Cyrier, CCIM was elected by Banker & Tradesman as one of its New Leaders in 2009. You may reach Jeremy at Jeremy@Mansardcre.com.