Who's Buying 4-5 Cap Properties?

Investor · Bakersfield, CA · Member since 2015 · 483 posts · 234 votes

My question is simple: Who is buying these 4 cap and 5 cap properties? I know its someone because they are being sold... quickly. But who?

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Russell BrazilBusiness Member

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Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes

Me.

Some people see cap rates as reflective of the return of the property, and that is simply not the case. Does a 4% cap rate return less than a 10% cap rate? Not typically actually. Cap rate is a reflection of risk, as well as often the market pricing in rent growth and appreciation of the asset. Lower cap rates are indicative of a lower risk asset and higher cap rates are indicative of higher risk assets.

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Adam Drummond
Investor · Greenville, SC · Member since 2013 · 252 posts · 92 votes
8y
@Sanjeev Advani
i guess they are banking on appreciation??
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Sanjeev Advani
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Investor · Bakersfield, CA · Member since 2015 · 483 posts · 234 votes
8y
@Adam Drummond yeah I just don't understand it. People are getting crazy amounts of money for their multi-family properties right now (which as a Realtor is great), but I just don't see the value.
People are coming in and buying properties for prices that I would not touch with a 10' pole, like its nothing, and earning basically net zero on the property which I guess is better than negative cash flow, but as an investor it drives me insane that people are willing to pay these prices.
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Adam Drummond
Investor · Greenville, SC · Member since 2013 · 252 posts · 92 votes
8y
@Sanjeev Advani
you're absolutely right, man. it does seem like since the market is good people in the western part of the country experience crazy appreciation. i have noticed many posts on bp where people bought a house 3-4 years ago for 200k, and now they say it's worth almost double. i guess your cash flow doesn't have to be great if you're expecting that kind of gain in property value. of course that will slow down at some point too. i have a sf home near downtown greenville that i bought for 32k, and i have about 17k in reno costs (do most of the work myself). I will rent it for 900-950 per month. can't buy anything out west for 32k though.. lol.
adam
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Russell BrazilBusiness Member
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Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
8y
Me.
Some people see cap rates as reflective of the return of the property, and that is simply not the case. Does a 4% cap rate return less than a 10% cap rate? Not typically actually. Cap rate is a reflection of risk, as well as often the market pricing in rent growth and appreciation of the asset. Lower cap rates are indicative of a lower risk asset and higher cap rates are indicative of higher risk assets.
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Mike Dymski
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
8y
Me too...purchase caps in the 5s and 6s with large value adds (and some poorly run 4s). Not banking on market appreciation....forcing appreciation.
4 Reply
Adam Drummond
Investor · Greenville, SC · Member since 2013 · 252 posts · 92 votes
8y
@Russell Brazil
i agree that higher cap rates usually come with higher risk. not always the case though. it seems like a high risk is investing in a property that barely breaks even every month.
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Russell BrazilBusiness Member
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Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
8y
That is adding in the risk of leverage. That is independent of the risk of the asset.
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Adam Drummond
Investor · Greenville, SC · Member since 2013 · 252 posts · 92 votes
8y
@Russell Brazil
my perspective is from someone who is limited in funds. i only own three properties that are investment (looking for another one). i have to have a higher cap rate for it to even be considered. if i had an insane amount of money.. maybe my criteria would change. that's not a knock on anyone w/ more financial means. it's just how it is for me.
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Omar Khan
Rental Property Investor · Dallas, TX · Member since 2017 · 1k+ posts · 1k+ votes
8y
@Sanjeev Advani There can be a ton of reasons to buy low-cap properties:
- HNW investor with a capital preservation mandate buying core/core+ assets
- Value-add opportunity: The asset is not managed properly. Contrary to most people's opinion, commercial property DOES get valued on comps.
Why else do people compare rent comps/PSF and other comparable metrics? Hence, an inefficiently managed asset in an attractive market could be sold for a low cap rate. A sponsor could come in and turnaround the asset in no time (increase NOI i.e. increase cap rate or unlevered yield to the investor).
- Amateur hour, newbies with money burning a hole in the pocket
- Experience sponsors with money burning a hole in their pocket
- 1031 folks with money burning a hole in their pockets
- Speculators
A ton of people have done stupid things in the past few years and have been handsomely rewarded. It's hard to stop a good party when one confuses luck with skill :)
P.S. @Russell Brazil raised an excellent point which folks often do not fully comprehend (thanks Russell!)
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John Coleman
Investor · Greer, SC · Member since 2015 · 25 posts · 3 votes
8y
Bottom line: no one buys a 4-5 cap with their own money.
It’s either a banks money (leverage) -or- investor’s money where sponsor/buyer/‘managers’ are gettting a carry/performance fee/Earn in and can’t afford not to invest. Hard to make a career ‘waiting out’ a cycle. Shooters got to shoot.
HNW individuals don’t buy 4 caps - if anything managers buy them on their behalf telling a story and clip fees along the way. If they actually want 4% ‘low risk’ they’d buy munis. Chances are they got HNW by buying 12 caps and riding them to a 4 cap over 20 years
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Adam Drummond
Investor · Greenville, SC · Member since 2013 · 252 posts · 92 votes
8y
@John Coleman
i'd be lying, if i said i understood half of what you just wrote.
6 Reply
Joseph M.
Flipper/Rehabber · Los Angeles, CA · Member since 2009 · 1k+ posts · 732 votes
8y
@Sanjeev Advani
People are buying at caps lower than that in L.A There are a lot of stories these days in the news about new owners buying apartment buildings and kicking out the tenants but the reality is if someone buys at market and continues to operate the property as is at current rents they would lose money after all expenses and debt service .
I’ve been looking at the Bakersfield market again recently and I do see prices have gone way up for Multis . Prices have definitely gone up a lot more percentage wise versus L.A. It's not common to see stuff today for 3 -4x more than prices during the crash.
I don’t see quite the same opportunity in Bakersfield though in terms of value add like one might be able to do in a market like L.A . I haven’t heard much about neighborhoods in Bakersfield gentrifying much. But I could be wrong.
4-5 cap doesn't mean much if someone is going to improve units and drastically increase rents or if they are going to redevelop the property to best and highest use into new luxury apartments, condos/townhomes or small lot homes etc.
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Nick B.
Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
8y
Nobody mentioned that, but there are also Chinese and Japanese buyers that buy with cash. For them 5% stable cap rate is better than negative rates in Japan or communist government in China.
In addition, Japanese fully depreciate their properties in 4 or 5 years. It's a great tax shelter for them even at 0% cap rate.
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Tyler Weaver
Investor · Cincinnati, OH · Member since 2008 · 319 posts · 243 votes
8y
Buyers that are getting debt from Freddie and Fannie at great rates. If the cap rate is higher than the apr, there is positive leverage.
If you are confident the property will trade at 4-5 cap in the future, there is way more opportunity if you can decrease costs or increase revenue. When in a market with job growth and inventory that is expensive to add to, it creates a good opportunity for rent growth. These are typically the markets that are seeing 4-5 cap.
If you increase noi by 100k a year at 4 cap, you have created 2.5Mil of value. If it is a 10 cap, you have only increased the value by 1Mil. Created more value while sitting on a more attractive, likely more liquid, less risky asset.
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Hai Loc
Specialist · Toronto, Ontario · Member since 2012 · 2k+ posts · 891 votes
8y
@Sanjeev Advani High net worth people/groups Absolute NNN with long term corporate backed leases on new commercial buildings.. virtually hands off and collecting checks every month.. ROI is not most important factor on these plays. Corporate guarantees minimize risk and no fuss no headache Class A quality built buildings..
1 Reply
Jay Sloan
Real Estate Broker · Virginia and Florida · Member since 2015 · 12 posts · 5 votes
8y
I've sold net lease deals subject to assumption with self amortizing debt that produced zero cash flow. Institutional investors buy these as loss leaders. There are a plethora of reasons deals trade at very low cap rates. More often than not, there is an underlying value add play to the asset
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Michael Stange
Rental Property Investor · Woodinville, WA · Member since 2017 · 23 posts · 33 votes
8y
@Sanjeev Advani Lol. No idea but they need a math class!
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
8y
Originally posted by @Sanjeev Advani:

My question is simple: Who is buying these 4 cap and 5 cap properties? I know its someone because they are being sold... quickly. But who?
Everyone who is buying blue sky performas on 7 to 9 caps and has no real history.. by the time reality sets in they are buying 4 to 5 caps they just don't know it yet.
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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
8y
Originally posted by @Russell Brazil:

Me.
Some people see cap rates as reflective of the return of the property, and that is simply not the case. Does a 4% cap rate return less than a 10% cap rate? Not typically actually. Cap rate is a reflection of risk, as well as often the market pricing in rent growth and appreciation of the asset. Lower cap rates are indicative of a lower risk asset and higher cap rates are indicative of higher risk assets.
Market generally always prices for risk.. that's one of the tenants of investing.. spot on Mr. Russell.
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Dawn Curry
South Jersey · Member since 2016 · 78 posts · 35 votes
8y
@Russell Brazil Could you elaborate more on that please?
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Adam Trinciante
New Kensington, PA · Member since 2017 · 2 posts · 1 vote
8y
@Sanjeev Advani, High cap rates usually reflect depressed neighborhoods where prices are low. Id rather take a value add 4 cap in a hot market over a section 8 12 cap any day!
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Russell BrazilBusiness Member
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Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
8y
Originally posted by @Dawn Curry:
@Russell Brazil
Could you elaborate more on that please?
Elaborate on what part?
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Joel OwensBusiness Member
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Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
8y
Lot's of reasons.
Main one is location. Over time investors can see higher value with land and rent growth than a high cap rate mediocre type area.
Sure the mediocre area over 10,20,30 years might could turn and the investor makes it big but that is speculating and not investing.If an investor is trying that they better not make it their whole strategy but just a small part.
I had lunch the other day with one of my friends. His company builds the new high end big open air malls across the country about 500,000 sq ft in size. He is about 60 years old. We had a deep discussion about time versus money and how much is enough. Basically he echoed what I have heard from many older investors is that when you are younger 20's,30's you can tend to take bigger risks for higher payoffs. If it doesn't work out you can start over again. As you age and net worth grows the pendulum tends to swing from more of the portfolio to wealth preservation and outpacing inflation than wealth creation. As he said if you lose it all at an old age or most of it you do not have much time or energy to start over again.
Someone making 50k a year at a job might need to (swing for the fences) each time to generate even a small cash flow versus income. Someone getting 5% on 5 million or that is a doc making 1 million a year doing surgery does not need high income potential with high risk assets.
I can tell you I know some very wealthy people. My database over the years i haven't tallied it exactly but the investors I know would add up to in the billions in wealth and not even counting companies but individuals. There is a ton of cash out there.
I recently picked up 2 clients the other day from CA. One has 1031 proceeds of 4 million and the other 2.5 million and they are wanting to 1031 exchange into passive retail assets. They are selling apartment buildings for low cap rates which have had huge equity gains but they are tired of the tenants,toilets, and termites. Also from what I hear CA is pushing hard the socialism angle and there is rent control existing but also a proposed vacancy control coming down the pike. Many of these property owners want to get out and some are considering moving out of the CA state also.
Someone is buying the properties though because they have standing offers before they even put on the market they are telling me.
Money is just not what you think it is folks. It is nice but people remember the life experiences. I know some older people in the 70's who would go back to half the wealth to get the 20 to 30 years of time back where they overworked and family, friends, travel suffered.
I do have some clients that buy the bigger stuff tens of millions or higher in price. A year ago when debt was 3's for rate they could pay high 4's. Now they want high 5's to low 6's because Fannie and Freddie is around 5 today. So if everything is maxed out and they only have regular annual rent growth there has to be a spread there to make it work. My buyers might consider in the 4's for cap rate but there would have to be big drivers for upside like full but rent is 900 and market is 1250 etc. along with cost reduction savings. They are a preferred vendor buyer with Fannie and Freddie so can close in about 2 months. If an investor is new the financing could take 6 to 7 months in some cases.
I have had some companies tell me they would sell off market but wanted 4.5 caps and full value was extracted. My clients put 20% down and 80% LTV with Fannie/Freddie. They are not going to dump down all cash of 40 million for a 4.5 cap with limited upside. Some owners are not realistic.
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Dawn Curry
South Jersey · Member since 2016 · 78 posts · 35 votes
8y
@Russell Brazil Low cap rates are correlated to low risk and vice versa. You’re saying because of low cap rates generally are homes in a hot market and are A properties whereas your more depressed properties typically have higher cap rates - tenants, property itself, neighborhood, etc?
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Mike SzaboPro Member
Real Estate Agent · Asheville, NC · Member since 2016 · 48 posts · 29 votes
8y
@Mike Dymski
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