How can the outbreak of a virus affect world markets? Will it affect U.S. Commercial Real Estate?

A basic overview of preferred equity, and how it is used.

When I was in graduate school at Johns Hopkins, our analysis professor, a successful commercial real estate developer in Baltimore, railed against cap rates. He believed that internal rate of return (IRR) was the only viable way to look at an asset's performance and we were told to stay away from the dreaded cap rate. However, cap rates are too prevalent in the industry to ignore, so it's important to understand what they mean and how they're calculated. A cap rate is, at its simplest, the ratio between net operating income and value of the property. It really is just a snapshot of the unleveraged rate of return on an investment for a single period in time. However, there are many variations of the cap rate. Most of the time, brokers and investors look at the "entry" cap at acquisition and the "exit" cap at sale, but you can also look at building, equity, mortgage, and land cap rates. However, cap rates are not all calculated in the same manner and do not account for certain important variables. For example, taking a cap rate from current rental income (relatively less risk) and extrapolating it to future income (more risk) may result in an artificially inflated value. Some analysts include replacement reserves and some do not. It also may not be accurate to compare the cap rate from a higher risk property (without ample reserves, solid management) with that of a lower risk property. The bottom line is when comparing cap rates, it is important to understand how the cap rate was calculated. It is good practice to consistently apply the same protocol internally when looking at cap rates to determine what adjustments may be necessary, and whether cap rates were calculated using similar methodologies.

Become familiar with the "holy grail" of office leases, and why investors like them so much in our first post.