Who in the World is Buying Class C Apartment Buildings at a 7% Cap Rate?
Finding good apartment building deals is tough right now – almost anywhere in the country. I was curious to find out what kind of investor is actually buying these over-priced deals and so I polled my network of commercial real estate brokers.
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When I say it’s tough to find good deals on apartment buildings, I’m not talking about the super-nice, Class A type properties, which normally command lower cap rates anyway. I’m talking about the Class C type properties in perhaps not-so-nice areas that have typically delivered higher returns.
Not any more. Now these properties, when stabilized, are commanding cap rates of 8% or even lower on both coasts, and not that much higher in the middle of the country.
What’s up with that?
I wanted to find out what kind of buyer is willing to overpay and put up with these rather paltry returns. I asked this question to my commercial real estate brokers, and they told me there were primarily 4 types of buyers right now willing to put up with lower returns, which is driving up prices.
Buyer # 1: Newbies
Ah yes, the newbie. Eager to do their first deal. Ignorance coupled with unbridled optimism. Lax underwriting. Well, you get the picture. They’re out there, and they’re overpaying. Don’t be that newbie.
Buyer # 2: Buyers with their Own Money
There is a TON of cash on the sidelines as investors are still uncertain about the stock market. People like the reliability of commercial real estate, and that’s where many people with money are investing their capital.
If you’re syndicating deals (like me) and you need to find deals to achieve acceptable returns for your investors AND leave some left over for you, competing with people that DON’T have investors is tough. Where YOU might need a deal with a 10% cash on cash return so that your investors get 8% and you get 2%, the investor who is using his own cash might just need a plain old 8% return and can therefore afford to pay more than you.
Buyer # 3: Foreign Buyers
There appears to be a lot of foreign money chasing U.S. deals. Some of it is coming from countries where wealthy individuals are concerned about the country’s stability and are looking to simply preserve capital. For them, getting a 4-5% return in return for stability is a good deal.
Buyer # 4: Buyers with Related Business
The fourth buyer is one that has a business that is related to the underlying real estate. For example, commercial construction or property management companies are able to make money from their related business as well as the real estate. That combination allows them to pay a little extra for the real estate if they can make up the difference with their property management or construction companies.
While I normally try to answer the question “So What? How does this affect my life and what can I learn from all this?”, I don’t have a good “lesson learned”. I just wanted to share with you my findings to the question “What kind of &%#@! buyer is willing to pay that much for this building?” In case you, too, were curious, now you know -;)
OK, OK … I can’t resist, maybe a few lessons learned:
- Continue looking for that good deal. Stay persistent. Grow your network, talk to more brokers or send more letters. Consider investing out of your own area.
- Don’t relax your underwriting requirements and talk your way into a deal.
- Be patient. It might take a while to get that next deal, that’s OK.