Comments on: Worshiping At the Altar of Cap Rates? You Could Be the Next Sacrifice

By: Jeff Brown

Jeff Brown — Mon, 19 Sep 2011 20:10:21 +0000

Hey Dave — You’ve made my day. Happy to have confirmed what was already your gut feel.

By: Dave L

Dave L — Mon, 19 Sep 2011 17:06:33 +0000

Jeff,
Your article just helped me make my decision on a 26 unit property I was considering
I own 3 buildings in a good part of town that I maybe paid a little more for, but have good quality tenants and lower operating costs. This particular property comes witha high cap rate and huge roi but with a cost to that as tenants are of the lowest quality, property needs capital improvements and is located on the wrong side of the tracks, which I am not used to. Your article basically reaffirmed my suspicion as I will go with my better judgement and wait for a more quality deal. Thanks again!

By: Jack

Jack — Thu, 03 Mar 2011 13:55:00 +0000

Hi Daniil,

Where are you finding 20-25% unlevered returns right now? I know your post is a year old but does this still apply?

Thanks!

By: Personal Financial Planning this Week | Personal Investment Management and Financial Planning Blog Directory

Fri, 05 Mar 2010 07:38:49 +0000

[...] Dorkin presents Worshiping At the Altar of Cap Rates? You Could Be the Next Sacrifice posted at Real Estate Investing For Real, saying, “Using cap rates to buy properties is like [...]

By: BawldGuy Talking

BawldGuy Talking — Tue, 02 Mar 2010 22:28:32 +0000

Hey Mark — We’re pretty much on the same page — you’re preachin’ to the choir.

When the request for the ol’ Schedule E comes out, folks begin makin’ excuses, don’t they? That’s when the cap rate, as you so correctly commented, falls.

Again, cap rate is good, but under these conditions.

1. The ‘analyst’ actually knows what a cap rate is.

2. The income, vacancy, and expenses are real, as is the income. Duh

3. The properties being compared are in roughly the same area — apples & apples and all that.

With hen’s teeth exceptions, our clients generally generate 5-8% cash on cash even when they’re basis for investing is for growth. Thanks again.

By: Mark

Mark — Mon, 01 Mar 2010 17:46:45 +0000

(continued from above)
If something that you buy has a regular monthly return/profit, it can rightfully be called an “investment.” If whatever you buy has no regular monthly return/profit, and it has to be sold to realize a profit, then that is speculation, not investing (like buying stocks that do not pay dividends). To avoid this, the REAL cap rate (not the BS “pro forma” one provided by sellers and their Realtors) is crucial. The real cap rate tells you how much real money you should have every month to cover the mortgage payments and provide the profits that make it a real investment. And you get the real cap rate by looking at the seller’s real Schedule E for that property, provided directly to you (in writing) by their CPA.

Cash is king. If you’re not getting spendable cash every month from your rentals, you’re not “investing” and you’re not “wealthy” — no matter how much you think you’re worth “on paper.” Many paper millionaires in real estate have ended up in foreclosure and bankruptcy because they lacked the positive cash flow to hold on to their property during rough times. (This is now happening all over the country.) Don’t make this mistake!

By: Mark

Mark — Mon, 01 Mar 2010 17:34:29 +0000

I’ve been a full-time investor for over 8 years now, supporting my family with the positive cash flow from my rental properties. Some of them were foreclosures and short sale properties lost by “investors” who were really speculators.

I agree with most of your advice about bad areas, bad tenants, etc. (I wouldn’t buy in East LA either.) However, if someone borrows tons of money to buy rental property that just barely “breaks even,” they face two huge risks: 1. Unexpected problems (like falling rents, too many repairs and/or vacancies) can literally force them into foreclosure if they do not have deep pockets. 2. There is no guarantee that the property will appreciate fast enough to bail them out of an “investment” that has no regular monthy profits (example: California real estate, down 30-50% since 2006). So cap rates are very important because if they’re too low, your “investment” will turn into a life-sucking money pit. But the cap rates need to be real, not estimated or “pro forma” (that means “made up”).

By: Daniil

Daniil — Sun, 28 Feb 2010 23:25:38 +0000

Jeff – good article. I think it’s important that cap rates are compared to each other when analyzing similar properties.

Personally, I’ve been shooting for a mix of high-cap but lower-income and lower-quality areas and lower-cap properties in more desirable location. And, admittedly, some of these high-cap properties are hard to resist – 20-25% unlevered returns leave a lot of room for mistakes and put a nice chunk of cash in your pocket. In an environment where we may not see appreciation for a a very long time, cashflow is just about all i am prepared to bank on.

By: Mitch

Mitch — Sun, 28 Feb 2010 22:51:05 +0000

Great article! I’ve been a landlord for over 10 years, but just recently heard of this thing called Cap Rate. I’m not comfortable with any single “one-stop-shop” metric for evaluating anything, whether it be Cap Rate for an investment property, P/E Ratio for a stock, or height/age/weight for a mate!

By: laurie

laurie — Sun, 28 Feb 2010 20:22:55 +0000

I definitely think we are on the same page. And I’m glad I could provide at least one person a laugh!

Thanks for the article – looking forward to reading more of what you have to say.

Laurie

By: BawldGuy Talking

BawldGuy Talking — Wed, 24 Feb 2010 19:13:01 +0000

Laurie — ‘In context’ is obviously the key phrase. We’re on the same page. Comparing apples to apples via cap rates generally, as you said, is another worthy tool. It’s when investors compare Beverly Hills cap rates to units located in economically depressed areas that they get tripped up. If I’m choosing between half a dozen properties in a tight and more or less homogenous area, cap rate will at least be somewhat of an indicator. As I’m sure you already know, the reconstruction of income & expenses are mandatory when doing that sort of comparative analysis so that the various NOIs have more credibility.

Thanks for the catch on the spelling. You already made one of my client’s day.

By: Laurie

Laurie — Wed, 24 Feb 2010 18:04:57 +0000

Seems to me that cap rate is a useful measure if considered in context — i.e., in the context of the market you’re looking at — and with other metrics that are equally important. It’s not so much that one shouldn’t “worship” the cap rate, it’s that it should be considered alongside other, equally useful analytical measures.

[BTW, on an unrelated note, you might want to edit "poopooing" to "pooh-poohing," which means dismissing/discreditng, versus "poopoo" which is something else entirely and not actually a verb! ]