Investment Price & CAP rates?

10 Replies

Hi everyone,

My name is Ian. I am new to biggerpockets and also to real estate investing. Nearly 40 and need to get serious for my retirement. Hoping to be able to make some good investments over the next 20 years.

I watched the video by Brandon Turner on the 50% rule and it seems I was lucky to do so as I may of made some big mistakes? I was planning to buy a multifamily home in my area but the CAP rate would be about 5% around here and it seems (I do not know if it is true) from his figures you can get up to 15% CAP rate around the US. In the UK where I am originally from in a good area with good rental ability the CAP rate is between 5-6%.

Now my question is as a novice investor what do I look for to best build a stable portfolio?
Do I start with 3 or 4 low value homes ($100,000 ish) out of NYC where I am from or is it best to invest locally where there may be more capital appreciation but where the CAP rates are lower and property prices are higher?

What CAP rate should I be aiming for if I don’t want to sell the houses and Just want to obtain a lasting income from them long term?
I appreciate the answers will be different as there probably will not be 1 perfect scenario but there may be things I should not do that everyone agrees on. Plus I would like to know what you would do if you were investing for the first time in 2014.

Thank you all for your help in advance

Cap rates only measure what the market is paying for NOI for a type of property in a specific market at a particular time. The higher the cap rate the less desirable that NOI is to the market. Lots of people here don't understand this and think it is like an interest rate.

Hey @Ian Radcliffe  welcome to the site!

 Like @Bob Bowling said, caps are really just a metric that shows the condition of the market in relation to what people are accepting in an investment.  There are areas around the country that can provide a 15% cap - but they are probably in Detroit and on the verge of being tore down ;)  If I had to guess, I'd say the US average would be 8, but that is going to depend on the type of property and such. And that's just a guess, really.

So, really, i think your question boils down to this: Cash flow vs. appreciation. Which is better?  Now that's an argument for the ages. Personally, I'd love to see both, but I vote cash flow in the end. (That doesn't necessarily mean cheap, or a high cap rate either.)

Not sure if that helps at all, but hopefully some! 

Originally posted by @Brandon Turner:

 

So, really, i think your question boils down to this: Cash flow vs. appreciation. Which is better?  Now that's an argument for the ages. Personally, I'd love to see both, but I vote cash flow in the end. (That doesn't necessarily mean cheap, or a high cap rate either.)

Not sure if that helps at all, but hopefully some! 

@Brandon Turner OK, I'm glad you're on board about cap rates ONLY being a metric in a specific area for a specific property type at a certain time period of what buyers are paying for NOI.

Now, cash flow vs. appreciation?  First, just like cap rates a majority of posters seem to have no idea what appreciation is or how to quantify it.  It's a BONUS, ICING ON THE CAKE, MAGICAL.  Appreciation rates are pretty predictable like your vacancy rate, expense rate, rent growth rate, OVER time.  AND, cash flow will follow appreciation.   

I agree, cap rates are in reality just a ratio if NOI to purchase price. And you will find that as you add value (hopefully) to the property and neighborhood your individual cap rate will increase, based on your purchase price.

I work in Manhattan and cap rates normally hover around 4% these days in the city. Some are higher, some are lower, but in general that's where they fall. Reason being: the rental market in the city is incredibly stable. On average landlords find their vacancy below 3% and the rents rise at predictable (and sometimes astronomical!) rates. Low cap rates means that the market is willing to pay a premium for the stability and comfort of low vacancy and consistent cash flow, even if it's less than in other markets. People want to live in NYC, bottom line.

As for appreciation, I don't think you can count on it in the New York market for a multi family. Unlike single family homes, multis are valued using the income approach and thus the value is based almost entirely on what the property produces. If I were pricing a multi family I would probably price it around a 3 or 3.5% cap rate and leave a little room to negotiate. So you're not going to be able to necessarily expect appreciation beyond the general increase of rents in your area and any value you add though renovations or destabilizing apartments.

Here in the city it's just a little harder to find the INCREDIBLE deals because there are so many huge, sophisticated investors and the market can be incredibly complicated. But if you're after consistent money and can afford to break into the market, you can do very well for a very long time here.

Just my two cents! - Matt

Originally posted by @Matt Payne:

I agree, cap rates are in reality just a ratio if NOI to purchase price. And you will find that as you add value (hopefully) to the property and neighborhood your individual cap rate will increase, based on your purchase price.

Just my two cents! - Matt

 The cap rate is set when a purchase price is agreed upon. 

1.  What is an individual cap rate and how do you manipulate it? 

2. Why would adding value to the property and the neighborhood increase the cap rate thereby making your NOI less desirable? Doesn't that seem self defeating?

3. Are you confusing increasing the NOI? That would make sense.

Thank you all for your responses. This is a very nice forum. I have been on forums before where people are just very rude & sarcastic to simple questions so it is great to not be afraid to ask anything. Great site too.

OK I think I have got it.

My friend bought a house here in Brooklyn in 2011 for 500,000 and rented for $3,000
So his CAP rate was 7.2%
Mortgage & Insurance = $2700
So Cash flow = $300

Now with $200,000 renovation, some good luck with this areas price increases over last few years it is valued at around $1,000,000
So now his CAP rate is now 3.6% but of course cash flow is still $300. So I see CAP rate is more like a marker. It now shows that his house is more desirable to rent than before and of
course it also shows he could possibly increase rents slightly too.

So if i'm correct I should first work out if the property will gain me cash flow then see what the CAP rate for me at that time would be and if its in the 5-7% region it will probably be able to be rented but if its suddenly turns out in my calculations to be 15% I should not jump up and down for joy but simply think the rent expectation is too high or I wont be able to rent it continuously at that desirability rate in the future.

Is this a better way of looking at it?

@Matt Payne   thank you for response. I know this is cheeky but would it be possible to come and speak with you over a coffee in person one day about pros & cons for someone like me buying here in NYC?
I live on the D-line so can get in any time that suited you, before work if you are an early bird or lunch time if you have a quiet day maybe. It doesn't have to be next week. 

Let me know. Thanks

Hi Bob,

You're right, I'm referring to increasing the NOI. I look at the cap rate as a simple ratio (NOI/Purchase Price, expressed as a percent) so for an "individual cap rate" for an investor, as NOI increases (and presumably your initial purchase price stays the same) your "individual" cap rate goes up. I suppose this could be considered your rate of return.

That's not going to be the same as the cap rate you would get were you to sell. That cap rate is set by the market you are in and, as you point out, how desirable your NOI is to the market.

Perhaps there's a better term for what I'm referring to as an "individual cap rate" but that's how I've always thought of it. -Matt

Ian,

I'd love to get together for coffee to discuss your options some more. Let's PM to coordinate a place and time.

As far as your friend's place, in those numbers there is no room for capital expenses, regular maintenance, utilities (in NY heat and hot water must be supplied by the landlord), or vacancy, so I wouldn't consider his cash flow to be $300/month. I would actually consider that a negative cash flow property probably, because those costs will eventually catch up with him.

Also, when calculating cap rates use the NOI (net operating income) which is gross income minus expenses. Using the numbers you've got there the NOI is $300/month or $3600/year (again, this is not counting any other expenses beside mortgage and insurance).

So his cap rate is really .72%. Depending on where he is in Brooklyn there may be room for increase in his rent which could help his improve the NOI on the property. Is this a single family home he's renting out or multi family?

Originally posted by @Matt Payne:

Perhaps there's a better term for what I'm referring to as an "individual cap rate" but that's how I've always thought of it. -Matt

 How about yield cap? 

http://incomepropertyanalytics.com/direct-capitalization-vs-yield-capitalization/

Sounds correct! Thanks for the libk!

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