What is a good cap rate???

7 Replies

My 2018 goal is to purchase a triplex or quad in the Philadelphia area. For the past 4 months I have been listening to podcasts and reading books about real estate. I keep hearing different rulings regarding a good Cap rate. What do you think is a good cap rate for a Multi-Family home?

@Yasmin Mohamed , some might say: the lower the cap rate (eg. 4%), the better!

Others will say: the higher the cap rate (eg. 10%+), the better!

Who's right? Well maybe, depending on their circumstances/goals, they're BOTH right!

And if their circumstances/goals were different, they could also - both be wrong! 

Can you do a bit of research to see why I came to those conclusions? Here endeth your first lesson.

By the way, for triplexes and quads, cap rate is NOT used to determine value anyway! Tell us: what is? Cheers...

Totally depends on your location and what kind of property you’re looking for. What you should focus on is actual cash on cash return and you should find a deal that has a cash on cash return over 15%.

I believe that cap rate only determines value when dealing with commercial. For residential properties you use sales comps.

@Yasmin Mohamed

As @Brent Coombs and @Cody Evans said you do not use cap rate for a triplex. Philadelphia is the city of neighborhoods. And if you are trying to go by cap rate you should look for a specific area not whole Philadelphia area. You can have cap rate 4% in center city and 20% somewhere in D areas. 

@Yasmin Mohamed

There is really nothing called a "good" cap rate. Let's say someone comes to me to tell me about an 8-cap property for sale. While that allows me to make certain assumptions about the property, I can't really decide whether it's a good deal just based on the information alone. For example, an 8-cap property in Manhattan, NYC is most likely going to be a steal. An 8-cap property in Wilkes-Barre, PA is probably going to be overpriced (not always but probably). 

Long story short, you need to compare the cap rate for the property with the market cap rate. You also need to make sure that you are comparing cap rates for the same type of property (e.g. the market cap rate for shopping malls may differ than the market cap rate for apartments). Without such information, it's hard to make use of the cap rate. 

One other thought: many of the other posters are correct that appraisers don't use caprates to determine the value for small multi-families (2 to 4 units). That said, the price for these small multi-families can sometimes closely track the market cap rate in some markets. Why that's the case is a bit complicated topic. It basically has to do with the level of competition that investors face from regular home buyers for these small multi-families.  

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information.

Cap rate is a useless number. A 100 unit vacant brand new condo-quality building overlooking Central Park in Manhattan will have a cap rate of 0%. A fully occupied slum tenement in Detroit might be a 50% cap rate. 

Cap rates don't tell you anything because you'll likely operate the property differently than the current owners. I get sent at least 3 deals a day that claim to be 7 caps which are actually 5.5 caps because nobody in NYC has a building where it costs $300/door for repairs.

And if the market cap rate is 7%, but your seller will only make a deal if you can pay a 5 cap, that's not necessarily a terrible deal. Maybe you buy it at a 5 but can turn it into a 15, then it doesn't look so bad. I wouldn't use market cap rates as much more than a gauge if you're looking to just buy and hold, then you'd be wise to pay the market rate for those type properties.

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