Thank you guys, you all raise very good points. I also got another response on this matter from another expert that I’d like to share with you. Here it goes:
Leases from income properties with national credit type lessees when compared to leases with smaller sized businesses are typically: longer in duration, with less frequent and more modest rental increases. Consequently, income properties with this type of lessee provide a more stable income with minimal increases, and a reasonable possibility of negligible capital appreciation.
Leases from income properties with local type businesses when compared to leases with larger sized businesses are typically: shorter in duration, with more frequent and substantial rental increases. Consequently, income properties with this type of lessee provide a less stable income with substantial increases, and a possibility of significant capital appreciation.
Conclusion
The market is willing to accept a lower initial yield from income property with a lessee that is smaller in size financially, when compared to an income property with a lessee that is a national credit tenant.
Hi. I’ve been searching in Los Angeles area for a good commercial real estate investment. I’ve noticed that the higher the price the better the cap rate for example a 2mil dollar property with a “post office” or “denny’s” as its tennant has a good lease in place and offers 7-8% cap rate, while smaller properties have worse lease terms with about 4-6% cap rates. Aren’t the cap rates for smaller, riskier properties suppose to be higher? since you stand to loose more by having short term leases or event half vacant properties…but for some reason it’s the other way around. Can anyone explain this phenomena?
Posted by D.McGehee.sf on September 09, 2009 at 23:52:19:
Scott raises a good point. Often there is simply more demand at the lower levels ~$500k-3mil.
Especially in a down cycle, many of the major players are sitting on the sidelines. The potential, and more importantly capable buyers for larger properties is much smaller than in 07 which is one of the reasons why caps on larger properties are higher.
Additionally, financing for larger projects is much tougher than the mid range projects which is putting more stress & downward pressure on property values above $5 mil.
There is no single answer but I’d say the two above factors I mentioned above are definitely two of the more influential.
If these smaller properties are in good locations, then it could be justified. Length of lease and strength of tenant are secondary to Location, Location, Location.
My understanding was that caps have been climbing steadily since 2007 and now are in the 8 - 10 range although LA could be different from national average. It would seem logical to me that smaller properties with more risky tenants should trade at higher caps.