Why do cap rates on commercial investment properties remain so diverse?
A quick glance at commercial investment properties available on the MA real estate market today shows that among just a handful of listings with cap rates ranging between 5% to 10%, with even larger differences seen with a little more digging.
So why the huge disparity? What is a good capitalization rate or rate of return for commercial real estate investors shopping for opportunities in the Massachusetts market today?
What’s right for an individual investor is really a personal choice and relies on a combination of different factors. The reason advertised cap rates vary so widely depend on a wide number of factors.
10 Variables which Impact Massachusetts Cap Rates Include:
1. Property Taxes
Property taxes can vary widely by county and can put a big bite in net income and what rents can be charged.
2. Property Age
Property age can be a much bigger factor than most realize. Obviously long term cash flow seeking investors need to know if a property is nearing the end of its structural life or is at least going to require major repairs soon. However, recent market reports from the CCIM Institute also show that older properties can sometimes deliver better cap rates as they have proven track records, better occupancy and are in mature areas.
3. Class & Condition
There is a huge difference between what are considers Class A properties and everything else. This is especially true when it comes to obtaining financing from a lender.
4. Location, Location, Location
They say real estate investing is all about location, but the areas with the best cap rates in MA may not be where new investors expect. Many sophisticated global investors are now looking outside of Boston for better returns and growth opportunities.
5. Tenant Quality
This can actually go two ways. For many obvious reasons a large ‘national-credit’ tenant like a Walgreens or Burger King might be more appealing, but top end tenants certainly have power when it comes to negotiations and leveraging their brands too. Lesser known tenants on the other hand may be willing to pay more for the space.
Investors are obviously normally willing to pay more for a performing property with a good track record, but this has become trickier in the wake of the recent crises years.
7. Interest Rates
Interest rates directly impact cap rates. Right now they are great, but could returns could be hampered on the same properties if rates rise and investors drag their feet on buying or refinancing.
Risk (perceived or real) affects capitalization rates through the price being asked for properties.
9. Property Types
Cap rates tend to run in packs and can be found within similar ranges by commercial property sector, but there are no hard rules based upon whether you are looking at office, multifamily or retail investment property in Mass.
10. Market Direction
Current value and asking prices are also affected by the anticipated direction of the market. Are rents and property values expected to go up or down? What about volume of demand for housing or retail and office space?