Four Kinds of Cap Rates

A new essay is up at NetGain Real Estate. It tackles the question of cap rates and how companies calculate them.

Recently I had a conversation with the manager of a large pension fund. He proudly announced that he had purchased a trophy piece of real estate in a prime location at a six-plus capitalization rate. I congratulated him, and then I asked, “On what basis was the capitalization rate computed?” He returned my question with a blank stare.

The purchase was large, involving a great deal of money, and the key to determining the purchase price was the capitalization rate. Yet this pension fund manager didn't know the assumptions behind his six-plus capitalization rate.

His stare went from blank to worried when I told him that the same property could have four or more capitalization rates. They are all valid; it just depends on the retirement program's needs and financial objectives to determine which is appropriate to use.

Read the full essay.