7% Cap Rate On Self Storage
I have an opportunity to buy a 500 plus unit, 95% occupied self storage unit.
The guy is asking $9 million and the net return has been $600k plus for the past 2 years.
The property also includes 3 acres so there exists room for expansion or an additional revenue source.
This is my first foray into self storage units, thoughts on whether this is good?
Anyone out there done self storage units?
Thanks
Will you be able to get a commercial loan for less than 7%?
If so, please let me know where-
Chris
I was under the impression the cap rate is the ratio between NOI and purchase price. To calculate the cap rate, take the NOI and divide it by the purchase price.
600k / 9mil = 0.07 I believe what Chris is refering to is known as Cash on Cash return aka "return on investment". cash-on-cash return is the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage
Thanx, Don
fh4,
ypochris hit the nail on the head. You are correct about cap being NOI/Price. This relationship is derived from the concept of a perpetuity cash flow stream. The cap rate is the discount rate associated with this discounted cash flow stream.
For example, if you were to receive $1 per year forever, and your opportunity cost was 10%, then the you would be willing to pay 1/.1 = $10 for this cash flow stream. This basic realationship appears in many areas of finance, and is also applied to real estate. Instead of receiving $1 per year forever, we assume that you receive $NOI every year forever. Since we know the NOI, and we often know the price, then we can back out the discount rate (or CAP when we are speaking about real estate).
Intuition tells us that if your return on investment does not exceed the cost of capital, you lose money. In this context, your return is the CAP, and your cost of capital is the rate the lender charges on the loan.
To use the example $1 perpetuity example, if you want to find out how much you will bleed by having your borrowing costs too high, simply look at this relationship:
[$1/APR on Loan] - [$1/CAP]
So, lets say you have a 10% cap, and a 12% borrow rate. Then, you will lose $8.33 - $10 = -$1.67 over the life of this investment. To be clear, by having borrowing costs that are 2% greater than your return, you will have a negative 16.7% return. (ouch!).
All you have to do is substitute NOI for the $1, and you can see the result.
I know it sounds textbook, but fundamental valuation is fundamental valuation.
Two points: 1. If your borrow rate exceeds your cap, you will be "bleeding" money. 2. All of these methods assume that everything is constant. Some people like to take bets (and others HUGE bets), that if they walk into a deal like this, and they improve NOI by a large enough margin, then they will get ahead. This formula can tell us an awful lot. If you increase NOI you are better off, if you reduce borrowing costs you are better off, or if you sell at a higher price you are better off. We already knew this. But, these formulas can give you an idea of "how much" to expect from each of these changes.[ Edited by SF_Economist on Date 05/05/2006 ]