Cap Rate Selection for a Contaminated Comparable Set
You are appraising a 60,000 sq ft grocery-anchored strip center for a lender. You have five comparables:
- Comp A: sold 4 months ago, 7.1% cap, but the anchor vacated two weeks after closing.
- Comp B: sold 9 months ago, 6.4% cap, 15-year NNN lease to an investment-grade tenant.
- Comp C: sold 2 months ago, 8.3% cap, seller was a distressed fund in receivership.
- Comp D: sold 6 months ago, 7.6% cap, similar vintage and occupancy to the subject.
- Comp E: sold 3 months ago, 6.9% cap, but 40% of NOI is a below-market lease expiring in 18 months.
The subject has 91% occupancy, a grocery anchor with 7 years remaining, and in-place rents 8% below market. The lender wants a conservative value.
1. Adjust or reject each comparable and derive a supported cap rate range.
Read the worked answer
Go comp by comp:
- A (7.1%): reject or heavily adjust. The anchor vacancy is a post-closing event that the 7.1% cap did not price; using it would understate risk. If used, adjust upward materially.
- B (6.4%): the 15-yr IG lease is a quality the subject lacks (7 yrs, non-IG anchor). Adjust up for lease term and credit.
- C (8.3%): distressed sale; adjust down toward market, but it signals the ceiling of what a forced seller accepts.
- D (7.6%): the cleanest comp - similar vintage/occupancy. Weight heavily.
- E (6.9%): below-market lease rolling in 18 months is a positive reversion, so its low cap partly reflects upside the subject also has (8% below market). Somewhat comparable but adjust for timing of rollover.
A defensible range clusters around 7.3%-7.7%, anchored by D at 7.6% with modest downward pull from E's mark-to-market story and upward pressure from B's superior lease profile.
Key point: the lender wants conservative, so select the upper half of the range (7.5-7.7%) and document why A and C were not relied upon.
2. The borrower argues the subject deserves a lower cap rate than Comp D because in-place rents are 8% below market. How do you respond, and does it change the lender's value?
Read the worked answer
The borrower is half right and half wrong.
Right: below-market rents create mark-to-market upside that a buyer will pay something for, which can compress the cap rate modestly.
Wrong to over-credit it: (1) capturing that upside requires leases to roll, which takes years and costs TI/LC and downtime; (2) the anchor has only 7 years left - renewal risk offsets rent upside; (3) a lender's value should reflect as-is income, with upside treated as a sensitivity, not baked into the going-in cap.
Response: acknowledge the mark-to-market and reflect it as a small adjustment (perhaps 10-20 bps off D), but keep the concluded cap in the conservative band. Show the lender a sensitivity: value at 7.6% vs 7.4% vs 7.8%, and note that the loan sizing should use the higher cap (lower value) if the lender is risk-averse. The borrower's argument is a negotiating point, not a valuation conclusion.