Just received an OM where the future sale cap is 1 point higher than the listed cap for a stabilized asset. Is this what the top feels like?
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[{"id": "h9yrnr8", "text": "So they're underwriting 75bp of cap rate expansion?", "replies": [{"id": "h9z8vp6", "text": "A lot of institutional capital isn\u2019t underwriting any cap rate expansion on their current acquisitions. Seems crazy to me.", "replies": [{"id": "ha0c7fe", "text": "Sorry this is just not true, the spreads have thinned but definitely not to 0", "replies": [{"id": "ha0tw21", "text": "Ok I guess they are lying to me \ud83e\udd37\u200d\u2642\ufe0f.", "replies": [{"id": "ha1izhi", "text": "If it was a broker, they were probably brokering or exaggerating.  If they were in the business in the 80's, 25-50bps is basically 0 to them lmao", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}, {"id": "h9zczzf", "text": "Yes. 3 year timeframe. This is a 100% stabilized, market rate asset.", "replies": [{"id": "h9zn7ep", "text": "I\u2019m not understanding how this is a sign of the top. Underwriting a higher cap rate at exit is standard procedure. It means the exit value will be lower (I.e. due to higher vacancy as the asset ages, deterioration , etc)", "replies": [{"id": "h9znuys", "text": "I guess that\u2019s fair.", "replies": [], "depth": 4}, {"id": "ha15s5t", "text": "Not just that, but we are at all time lows. Expansion is the responsible thing to underwrite.", "replies": [], "depth": 4}], "depth": 3}, {"id": "ha0qcie", "text": "I started in this industry 10 years ago underwriting 100 bps of expansion. In that time period, my market has seen 250-300 bps of compression. Underwriting 75bps of expansion on 6 handles doesn't give me any pause.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "h9yrpoy", "text": "Doesn\u2019t mean we\u2019re at the top. I assume it\u2019s selling with a lot of term left? The future sale is just anticipating a deal with less term but a higher NOI.", "replies": [], "depth": 1}, {"id": "h9z5f19", "text": "You have it backwards. A higher cap rate means a lower price for a given amount of income. Cap rates are supposed to widen over time.", "replies": [{"id": "h9zo301", "text": "Cap rates have compressed significantly over the last year", "replies": [{"id": "ha0t5e3", "text": "No but on a given asset when you're projecting it forward, you project that it will widen. \n\nIf you buy a $100 thing at a 5% cap for $2,000, and plan to pocket the NOI and sell it 5 years from then, you should project to sell it at a 6% cap (for $1,666) not a 4% cap (for $2,500) because it will be older and more depreciated/worn down/need more maintenance, etc.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "h9z67n8", "text": "I guess taking note of conservative underwriting practices to be something strange is a signal of a top", "replies": [{"id": "h9zo0t1", "text": "To me, I figured it meant they were saying \u201cwe\u2019re listing it at a far higher rate than you can sell it for\u201d", "replies": [{"id": "h9zvwmq", "text": "What about changes to risk profile over the hold period?", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "h9z80qz", "text": "This isn\u2019t anything other than them understanding when you sell it it\u2019s going to be worth less than original because the term will be much shorter implying vacancy risk.", "replies": [{"id": "h9znwm6", "text": "The term?", "replies": [{"id": "h9zs2jm", "text": "\u2026\u2026.\n\nPlease don\u2019t act on any OM before you understand the vocabulary.\n\nA \u201cterm\u201d would be the total amount of time a lease is for. They come in two main flavors: primary and extension.\n\nSo a lease might read like this:\n\nPrimary term 10 years, option for early termination at year 7, rent escalation of 10% at month 60. Two extensions of 5 years with 10% rent escalation at the start of each extension.\n\nLease gets underwritten as a 7yr lease with each extension a 5yr. \n\nSo say you buy it new with the 10yr term and sell it at year 8 with two years remaining it will sell at a higher cap (lower total price) reflecting the possible vacancy risk they assume when buying.", "replies": [{"id": "h9zvq5s", "text": "Thanks for looking out, however I\u2019m not dealing with long tenured commercial tenants - this is self storage.", "replies": [{"id": "ha1yxro", "text": "Self storage the likely risk would be a newer facility pulling tenants.", "replies": [], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "h9zcbu8", "text": "Just echoing some others but this is rather typical. Adding 20-50bps onto going cap to account for degradation of bldg and the market requiring greater nominal returns 10 yrs down the road.", "replies": [], "depth": 1}, {"id": "h9zn1cq", "text": "Speaking from the tristate area. What\u2019s a 7.5 cap!? It\u2019s like a unicorn.", "replies": [], "depth": 1}, {"id": "h9zrmap", "text": "We always assume a higher cap rate on the exit. If you have to rely on cap rate compression for a deal to pencil then there\u2019s too little room for error. If a deal works at the higher cap rate, and you do get cap rate compression, then that\u2019s a home run.", "replies": [], "depth": 1}, {"id": "ha0d2wl", "text": "I'm guessing this is the first DCF analysis you've ever seen. It works differently from direct caps.  You underwrite higher cap rates in the future and underwrite inflation because over the years you are assuming growth in market rents and expenses that ultimately lead to higher NOI's (there's exceptions).  A very nerdy metric to look for is the CAGR of the sale price to the exit sale price, it's usually something pretty palatable if the underwriting checks out.", "replies": [], "depth": 1}]