Determining an appropriate reversion value

[Anonymous]

Hi Spencer,

When I was building my model, I couldn’t help but wonder how uncertain it is to predict anything 10 years down the road, especially a property’s value at disposition.

Considering that we use the direct cap method, a property’s value is simply Net Operating Income/Cap Rate. In the case of 10000 Fitness Way, given that we know our single tenant is signed to a long-term lease, and at disposition, we can assume that market rate is going to be higher than in-place rates, I think we can be relatively confident predicting the NOI portion of the direct cap method, though this kind of certainty is not always guaranteed too I imagine?

And the cap rate seems to be even more of a long-shot. I know we played it safe by bumping our acquisition cap rate by 50 bps to get the reversion cap rate, but in reality, is there any real way to predict where market cap rates are going to be in 10 years? I know in this forum post, Michael alludes to linking cap rates to federal reserve rates, but even that seems like developing a strong specialization in economics is needed to predict it.

My overall question is how is this kind of uncertainty approached in the reality of the industry? I would think this is quite an important estimate to get right given that majority of the cash proceeds used in our return calculations come from the exit sale. And after an acquisition deal is executed, do you typically re-visit the model every year and update where you think the NOI and Cap rate is going as you get closer to reversion? Or am I just overthinking this?

Thanks, and hope the July 4th celebrations went well!

Josh

[Author]

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