Newbies - Stop Using Cap Rare to Qualify Investments!

8 Replies

@Ben Leybovich I'm not a newbie but are you talking about commercial properties or SFH. If it's the latter I completely agree. If it's the former then I disagree. It would be helpful if you clarified.

Originally posted by Bruce M.:

@Ben Leybovich I'm not a newbie but are you talking about commercial properties or SFH. If it's the latter I completely agree. If it's the former then I disagree. It would be helpful if you clarified.

Bruce, relative to SFR, Cap Rate is not an applicable metric all together. In the income-producing space - while it is one of the most popular metrics, and it certainly has an application, this application is not what most folks do.

Cap Rate is a metric which underscores the behavior of the market-place. It is highly misleading relative to accessing valuation. Yet, that is how most people use it...

True, historic cap rates can be misleading in any property to an extent, much more so in residential less with a low maintenance commercial property, take a self storage facility or a ground lease on a drive-in theater....oops, not many of those left, LOL. When maintenance and management are minimal, operations are efficient, the cap rate can be telling you the truth as what can be expected.

We've discussed this in other threads as well, opportunity costs and similar investments, risks, management expertise, efficiency, vacancy can all play in actual rates of return and be much different from one owner to another, not to mention market influences. :) 

You're right @Ben Leybovich . In single family home investing the only measure anyone should use to determine value are comparable sales. I think we're on the same page here.

Hey, Bruce, Ben and Bill all agree! Or did we? The Income Approach is not the best to use for SFDs or when similar properties have an efficient market. I always want to know what I can sell it for before I know what I can rent it for. :)

@Ben Leybovich

the biggest issue I see using cap rate for SFR is most rental SFR's are sold with no history of performance so its all blue sky any way.. just like pro forma's on multi that are all based on best case scenarios to derive at a cap rate.

a combination of actual sales comps and GRM is probably more appropriate in the SFR space.. GRM gives a value in Heavy SFR rental areas.. as to what an investor will pay for a 700 rent ext... since comps will be all over the board..

Originally posted by @Jay Hinrichs :

@Ben Leybovich

the biggest issue I see using cap rate for SFR is most rental SFR's are sold with no history of performance so its all blue sky any way.. just like pro forma's on multi that are all based on best case scenarios to derive at a cap rate.

a combination of actual sales comps and GRM is probably more appropriate in the SFR space.. GRM gives a value in Heavy SFR rental areas.. as to what an investor will pay for a 700 rent ext... since comps will be all over the board..

 Ha - could it be cause most rental SFRs are sold as turn-key, which is as much blue sky as anything...?! haha

OK.  I'll bite.  How do you suggest comparing different sfr performance amonst each other for analysis. I have an excel sheet that shows cash on cash, cap rate, equity, total return.  I like knowing the cap rate to get an idea of the potential compared to other properties in my area. Higher the cap rate the better.  it's good to use to keep it simple from financing and down payment variations,  which can be used to make something look better than it is.  

I don't use it as a market number to value any property. Only as an analysis based on my numbers to compare the property against my current ones and new properties im looking at.  Maybe you "professionals" don't want to call what I use a "cap rate" but that's what it is, just used differently....

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