Tricks & Traps Part I

When considering an investment property, it is important to look at more than the just the cap rate (or terminal cap rate). Investors and sometimes institutions will often buy based on a property’s income without further examination of the market and therefore look mostly at the last or present year’s net operating income for the property. 

One trick sellers engage in is to bump lease rates in later years when they are selling. This may be due to concessions in the early years to help a start-up business in exchange for bigger bumps in later years that will resulted in an above average rental rate and one above the weighted average of rents through the holding period compared to stabilized or market rates. Other times an inflated rental rate may be due to tenant improvements that have been made by the owners for the benefit of the tenant and are re-paid through lease bumps and higher rents. Capitalizing such income will naturally result in a higher value. One that may not truly reflect the market.