Why do people invest in 6.5 to 7% cap rates?

Steubenville, OH · Member since 2015 · 10 posts · 1 vote

I live in midwest ohio which is supposed to have some of the highest cap rates in the country and I am consistently seeing low B grade multifamily properties selling for 7 percent cap rates, is the competition really this fierce?

At 7 percent there is no cash flow, for example (correct me if I'm wrong)

5,000,000 purchase price, 20% down, 4 percent 15 years fixed.

350,000 noi (7 percent)

So financing comes out to roughly 360,000$ a year!!! so this example has negative cash flow when you have to pay tax on the equity (after interest and depreciation) you're building (correct?)

Basically my question is why are people doing this?

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Chris Adams

Contractor · Valparaiso , IN · Member since 2013 · 604 posts · 327 votes

11y

Are you really talking about $5MM B class properties or did you use $5MM as an example. When you get into multi million $ properties its a different game. There is a considerable amount of speculation done by people in that market who know things others don't about an area.

Also Foreign money is investing in the US in the price range for other reasons beyond todays CAP rate.

Now if your not really talking about the lower price market, well then I just blame it on some nube that watched HGTV.

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Roy N.Pro Member
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
11y
@Account Closed
If the CAP is really 7%, then there is cash flow with a cash purchase. What you may be seeing are those situations where leverage can negatively gear the property.
There are areas up here where B properties are going at 5% CAP rates .... I just shake my head and wait for interest rates to bump up.
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Account Closed
OP
Steubenville, OH · Member since 2015 · 10 posts · 1 vote
11y
so my math is correct? and you have to pay income tax on the equity accumulated in the loan correct?
It seems to me that you can get better returns in REITS, or Fixed incomes with less work and headache.
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Chris Adams
Contractor · Valparaiso , IN · Member since 2013 · 604 posts · 327 votes
11y
Are you really talking about $5MM B class properties or did you use $5MM as an example. When you get into multi million $ properties its a different game. There is a considerable amount of speculation done by people in that market who know things others don't about an area.
Also Foreign money is investing in the US in the price range for other reasons beyond todays CAP rate.
Now if your not really talking about the lower price market, well then I just blame it on some nube that watched HGTV.
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Account Closed
OP
Steubenville, OH · Member since 2015 · 10 posts · 1 vote
11y
yes I'm really talking about 5mm class b properties, and yes the current market is 7-8 percent cap rate
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Roy N.Pro Member
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
11y
Originally posted by @Account Closed:

so my math is correct? and you have to pay income tax on the equity accumulated in the loan correct?
It seems to me that you can get better returns in REITS, or Fixed incomes with less work and headache.
Technically, you pay tax on your net operating income minus any permitted deductions (debt interest, capital cost allowance, etc) - known as Cash-Flow-Before-Taxes (CFBT) and not on the accumulated equity, though I think I understand your perception.
Sometimes you can get better returns lending to those folks buying 5 CAP properties.
A lot of the money flowing into larger multi-units is either corporate/institutional (ie Brookfield Properties or a REIT) or wealth individuals looking for wealth preservation rather than growth (if I already have 500 million, I am more interested in preserving it than growing it to 800 million).
For foreigners there are even scenarios where a small return, say 7% CAP, could be a solid investment. viz. We converted cash from CAD to USD back in 2013 when $1 CAD was about $1.04 USD. Today, $1 CAD is at $0.80 USD. If we had purchased a multi (all cash to keep it simple) in the U.S.A. that was returning 7% we would be repatriating that as an ~8.5% return today.
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David Begley
Investor · Atlanta, GA · Member since 2014 · 415 posts · 299 votes
11y
Originally posted by @Account Closed:

so my math is correct? and you have to pay income tax on the equity accumulated in the loan correct?
It seems to me that you can get better returns in REITS, or Fixed incomes with less work and headache.
Your math may be correct, but you didn't provide any detail on how you calculated NOI. I have been shown a ton of properties lately where the seller is indicating a 11% cap, for example, but when I conservatively calculate NOI using my own estimates for Vacancy/Credit losses and 50% or so for Operating Expenses, I get a much lower cap rate. Are you using the Seller's provided financials, or are you making conservative assumptions? If making assumptions, could the actual expenses be significantly less than your estimates?
You could just be in a 7% cap market. My last foray into looking for Nashville opportunities indicated caps of 4.5%-5.5%, so I know such markets exist. It's difficult to use leverage in those markets, unless you're less concerned about cash flow than appreciation.
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Account Closed
Real Estate Investor · San Antonio, TX · Member since 2014 · 785 posts · 190 votes
11y
We are doing 11-13% cap rates with cash purchases in my city, down a bit from a year ago but still good. I only buy cash, owner finance all houses. It works for me.
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Roy N.Pro Member
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
11y
Originally posted by @Account Closed:

We are doing 11-13% cap rates with cash purchases in my city, down a bit from a year ago but still good. I only buy cash, owner finance all houses. It works for me.
Joe:
CAP is not really a useful metric for SFRs as they are valued based upon comparative sales. Even with commercial properties, CAP is only a meaningful metric between similar cash-flows (properties) in the same location ... and then only if calculated using the same methodology. Furthermore, comparing the CAP rates of two identical properties, one in NYC and the other in Auston Texas, is meaningless.
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OP
Steubenville, OH · Member since 2015 · 10 posts · 1 vote
11y
as roy n stated, Im familiar with single family homes and I wouldn't really use cap. Yet I'm new to larger multi families and still trying to figure it all out
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
11y
@Roy N.
I love that term Negative Gear probably lost on most US investors. !!
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Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
11y
Part of what kills the cash flow in your example is the 15 year amortization. Make it interest only, and you cash flow better. Your example creates equity flow. You own it free and clear in 15 years. I like that deal.
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Tyson Cross
Investor · Portland, OR · Member since 2013 · 133 posts · 88 votes
11y
@Account Closedjust remember that CAP rate is a measure of the yield on an un-leveraged asset. It's also a function of the market and the perception of risk associated with it.
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
11y
Originally posted by @Jon Klaus:

Part of what kills the cash flow in your example is the 15 year amortization. Make it interest only, and you cash flow better. Your example creates equity flow. You own it free and clear in 15 years. I like that deal.
But then you have $5,000,000+ of 2015-2030 dollars trapped in a highly illiquid asset that is only receiving 2031 dollars.
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Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
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Yup, at some point exchange into the next property, or at least borrow against it to do more deals.
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
11y
Originally posted by @Jon Klaus:

Yup, at some point exchange into the next property, or at least borrow against it to do more deals.
Borrow BACK all the more expensive dollars you foolishly threw into the property? How many points on that money?
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Account Closed
OP
Steubenville, OH · Member since 2015 · 10 posts · 1 vote
11y
Originally posted by @Jon Klaus:

Part of what kills the cash flow in your example is the 15 year amortization. Make it interest only, and you cash flow better. Your example creates equity flow. You own it free and clear in 15 years. I like that deal.
equity flow, If I'm putting up a million dollars I would like something to work with today. it seems pretty unreasonable today when I could invest in fixed income mildly liquid securities relatively speaking and get freaking 7 percent cash on cash returns with the chance of principal appreciation in REITS
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Engelo RumoraBusiness Member
Investor · Toledo, OH · Member since 2013 · 4k+ posts · 2k+ votes
11y
Originally posted by @Account Closed:

I live in midwest ohio which is supposed to have some of the highest cap rates in the country and I am consistently seeing low B grade multifamily properties selling for 7 percent cap rates, is the competition really this fierce?
At 7 percent there is no cash flow, for example (correct me if I'm wrong)
5,000,000 purchase price, 20% down, 4 percent 15 years fixed.
350,000 noi (7 percent)
So financing comes out to roughly 360,000$ a year!!! so this example has negative cash flow when you have to pay tax on the equity (after interest and depreciation) you're building (correct?)
Basically my question is why are people doing this?
Hi Stefano,
lol
The whole market in Australia is based on "negative gearing."
Pretty much the money lost on investment properties can be offset against your income tax. Its a joke if you ask me.
Many there invest for even lower returns than 7%. I don't get it either lol
We are also based in Ohio and I like to joke around with 'I wouldn't get out of bed unless I am making 15% net minimum.
SFH, Multi, Commercial, etc....
Thanks
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Chris Winterhalter
Investor · Chicago, IL · Member since 2009 · 566 posts · 274 votes
11y
@Account Closed
Cap rates have indeed compressed across all CRE asset classes however if you can lock in solid non-recourse low interest 10 year fixed debt/30 am then that 5MM, B class (stable or growing) apartment complex, 7 cap deal is a solid deal. Interest rates will definitely affect cap rates, but so will inflation. It's tough to predict the future however if well managed the investment will provide solid returns.
Cap rates of 10+ don't really exist on multi-family of any size today. And single families with cap rates don't exist past that point either (if you think they do then truly do a 20 year analysis, have professional management in place or pay yourself for your time involved, & then calculate the return). Now the return on a single family might be strong because of appreciation growth but that's a whole different topic.
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David Begley
Investor · Atlanta, GA · Member since 2014 · 415 posts · 299 votes
11y
Originally posted by @Account Closed:

I live in midwest ohio which is supposed to have some of the highest cap rates in the country and I am consistently seeing low B grade multifamily properties selling for 7 percent cap rates, is the competition really this fierce?
At 7 percent there is no cash flow, for example (correct me if I'm wrong)
5,000,000 purchase price, 20% down, 4 percent 15 years fixed.
350,000 noi (7 percent)
So financing comes out to roughly 360,000$ a year!!! so this example has negative cash flow when you have to pay tax on the equity (after interest and depreciation) you're building (correct?)
Basically my question is why are people doing this?
People are doing this because they aren't trying to cash flow at 80% LTV with a 15-year fixed rate debt instrument. As you know, cap rates reflect cash purchases, and if you really think this looks like a good purchase, run the numbers with interest only or a 30 year mortgage - or pony up more down payment. Given your numbers, an interest only loan would cost roughly $160,000 rather than the $355,000 in your 15-year amortization example, or almost 19% cash-on-cash returns, before tax. With a 30 year amortization, the debt service would be approximately $229K p.a., or a 12% cash-on-cash return before taxes. You're shooting yourself in the foot trying to make it work with a 15 year mortgage.
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Daniel Mohnkern
Investor · Titusville, PA · Member since 2015 · 298 posts · 150 votes
11y
@David Begley That's exactly what I was thinking. Why would you put up that much cash if you have nothing to show for it. With the 15 year mortgage, you already have a negative cash flow before you even consider taxes or expenses. If you go to a 30 year fixed with the same interest, you have a $19,009.64 mortgage payment each month. With the 15, it's 29,587.52. $10,000 per month is big enough money for me to consider letting the tenants take a little longer to pay off the mortgage.
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Account Closed
OP
Steubenville, OH · Member since 2015 · 10 posts · 1 vote
11y
is it common place for investors to use 30 year loans vs 20, or 15?
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Robert Whitelaw
Residential Real Estate Broker · Morgan Hill, CA · Member since 2015 · 79 posts · 65 votes
11y
Originally posted by @Account Closed:

We are doing 11-13% cap rates with cash purchases in my city, down a bit from a year ago but still good. I only buy cash, owner finance all houses. It works for me.
Hi Joe,
Wondering what kind of paper you put together with owner financing. What kind of terms do you typically get?
Thanks,
R
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Yinan Q.
Engineering Consultant, Investor · Seattle, WA · Member since 2013 · 213 posts · 61 votes
11y
Originally posted by @Account Closed:

is it common place for investors to use 30 year loans vs 20, or 15?
Yes if cash flow is what you are after.
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Roy N.Pro Member
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
11y
Originally posted by @Yinan Q.:

Originally posted by @Account Closed:
is it common place for investors to use 30 year loans vs 20, or 15?
Yes if cash flow is what you are after.
Not always correct, nor always possible. It depends on what you are buying and where.
Outside the U.S.A., many of us are accustomed to mortgage terms as short as 6-months, but more commonly 3-5 years. Even in the U.S.A. a 30yr term mortgage appears to only be a residential vehicle. Once in the commercial space, mortgage terms are shorter.
When it comes to cash flow, the term is less important than the amortization - though, in U.S.A. residential lending the term often coincides with the amortization.
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Daniel Mohnkern
Investor · Titusville, PA · Member since 2015 · 298 posts · 150 votes
11y
Yeah, I would say @Roy N. is right. I didn't think about the differences from residential to commercial. I am most interested in cash flow. If it is at all possible, I would take as long of an amortization term as possible so my cash flow is better. It all depends on what's important to you. For me, if the cash flow didn't make sense to me, I would pass on the deal (barring any other impelling reason to do it). If they would let me amortize over 60 years, I would. In my opinion, the amortization schedule is just another form of leverage. The longer it is, the more cash I keep each month. On my personal property, I feel differently. The quicker I pay it off, the quicker I become personally debt free. I got a 30, but I can throw more at it when I want to (rather than HAVING to, as with a 15).
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