Lease Duration
Lease Structure and Cap Rates
Unlike your home, investment properties trade at prices based primarily on capitalization rates (“cap rates”)—the average net operating income (“NOI”) that buyers expect to receive as a percentage of purchase price. Cap rates for any type of property change over time, a function of three important variables: interest rates, available market capital and perceived operating risk. If a specific building maintains a flat NOI, its future value is entirely dependent on how these forces move the applicable cap rate for such a property. Put another way, if prevailing cap rates go up, a property’s NOI must increase proportionally to maintain its value, notwithstanding transaction costs. To actually appreciate, a property’s NOI must outpace any upward trend in cap rates. For properties with long-term leases and contractually predetermined rental revenues, it may be algebraically impossible to achieve appreciation if cap rates rise during ownership. Therefore, investors should strongly consider where to invest along the spectrum of lease structures:
LONG-TERM, SINGLE TENANT LEASE
LONG-TERM, MULTI TENANT LEASE
MID-TERM, MULTI TENANT LEASE
SENIOR HOUSING
APARTMENT COMMUNITY
SELF-STORAGE
HOSPITALITY
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