CAP rates for Aspen commercial real estate | Aspen Daily News ...

As the Aspen commercial real estate market emerges from its four year slump, one of the primary questions on the minds of owners, investors and appraisers is what is a reasonable capitalization rate (?CAP rate?) in today?s investment market for Aspen commercial real estate? For those not familiar with the terminology, a CAP rate is the net operating income (NOI) of an investment real estate property divided by the price of the property. Most commercial properties in downtown Aspen operate on net leases where the tenants pay the building?s operating expenses, real estate taxes, insurance and property management costs; and the landlord receives a net rent as compensation for owning the building.

The initial CAP rate an investor is willing to pay for an investment property is related to the investor?s view of what the building will likely produce in future cash flow and the probability of receiving that cash flow, otherwise known as the risk factor. The higher the investor?s expectation of future NOI and their confidence in the certainty of actually receiving the cash flow, the lower the CAP rate the investor will pay for the investment. The lower the investor?s expectation of future NOI and the higher the risk of receiving the future cash flow, the higher the CAP rate the investor will demand. Over the past 12 years, national CAP rates on the sale of retail properties have ranged from 100 to 500 basis points over the 10-year Treasury bill which presently yields about 2.01 percent. Currently, the national average CAP rate for retail properties is 7.81 percent as reported by CBRE Valuation and Advisory Services.

Over the past four years, Aspen?s commercial rents dropped approximately 30-50 percent depending on the location and building quality, a decline that was as much if not greater than the national average drop in commercial rents. The degree that commercial rents declined in Aspen was probably a surprise to investors who willing paid as low as 4.0 percent cap rates for Aspen commercial properties back in the mid-term of the last decade when Aspen had a virtual zero commercial vacancy rate.

This past experience should lead investors to think that Aspen?s commercial property should trade at cap rates similar to the national average for retail properties. However, when you consider the fact that Aspen has a finite supply of commercial space which generally results in historically low vacancy rates, you could make the argument that Aspen?s commercial properties should trade at a premium of perhaps 750 basis points or about a 7 percent cap rate for the average commercial property in today?s market.

Another way to check this assumption is to run an analysis based on a typical property acquired using market rate acquisition financing of say a 6.0 percent interest rate, 1:25 debt coverage ratio, 75 percent loan-to-value and a 20 year amortization schedule. Using this analysis, an investors could purchase a property in Aspen at an approximately 7.0 percent CAP rate and realize approximately the same rate of investment return over 10 years as an investor purchasing a retail investment property in another part of the country at a 7.8 percent CAP rate.

Although real estate investments are influenced by a number of factors, such as tenant mix, lease terms, age and condition of property, lease rental rates versus market rental rates and opportunities to add value, a 7.0 percent CAP rate would seem to be a reasonable mean CAP rate to determine a properties current value from which the CAP rate could be adjusted up or down depending on property location, quality of tenants and term of leases.

Thi opinion piece provided byWilliam Small, JD, CCIM, Managing Director of Frias Commercial Real Estate, a division of Frias Properties of Aspen.

Source: http://www.aspendailynews.com/section/home/152039

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