Cap Rates 101
A capitalization (cap) rate, in simple terms, refers to the net return expected from an investment. A going-concern storage business is worth what someone is willing to pay for it (or sell it for), based upon its perceived (higher) future net income earning capacity and value in the buyer’s ownership, and the risks involved in getting to that point.
The net operating income (NOI) is established by subtracting all operational and management expenses from the gross income generated by the property. Cap rates are determined by analyzing in detail sales of similar going concern self storage properties, and being aware of how the general market is reacting to current economic issues in more traditional investment asset classes.
Put simply, if a storage property is sold for $1,000,000 with a net income of $100,000 per annum, the cap rate is 10% (i.e. the sale price / NOI produces a multiplier of 10. 100 / 10 is 10%). If the property sold for $1,250,000, the cap rate is 8% (the multiplier is 12.5. 100 / 12.5 is 8%).
The higher the cap rate, the lower the value. The lower the cap rate, the higher the value. Self storage valuation is an inexact science. It does however require a detailed understanding of storage occupancy and operational issues, knowledge of market evidence and experience, to know about, find, analyse and use the appropriate cap rate.
Merry Christmas to all and a happy (return to lower cap rates) New Year!