Tucson, AZ · Member since 2020 · 64 posts · 53 votes
Newbie question here: I'm looking to buy a Class A triplex or quad within 10 minutes of my house and doing property management and maintenance myself. I live close to a large university. Of the 20 recently-sold small multis I've analyzed, nearly all have little to no cash flow and cap rates averaging 4.6%. (2048/2050 E 6th St, Tucson, AZ 85719 is one example.) Some even have substantial negative cash flow. Everything I'm reading says these cap rates are not favorable. So why are people buying these properties?
I'm thinking the buyers are A) hoping for appreciation and don't mind no cash flow, B) planning to increase NOI or hoping that market rents will rise, C) wealthy parents buying a place for Johnny/Susie to live for four years or D) house hacking. Can folks offer their insights into why buy properties with negative cash flow and low cap rates?
For anyone interested, here are my estimates for my example property: 2048/2050 E 6th St, 85719
Yeah, that wouldn't cashflow like you observed. The short answer is that these people don't know what they're doing, or they're buying with cash just to have a more predictable asset versus holding stocks or something like that.
I've done hundreds of deals and never bought a listed property before. Don't worry too much about what's going on with listed properties, the real savvy investors are often operating off-market, unless they're in a really cheap market where rent/price ratios are inherently better.
Newbie question here: I'm looking to buy a Class A triplex or quad within 10 minutes of my house and doing property management and maintenance myself. I live close to a large university. Of the 20 recently-sold small multis I've analyzed, nearly all have little to no cash flow and cap rates averaging 4.6%. (2048/2050 E 6th St, Tucson, AZ 85719 is one example.) Some even have substantial negative cash flow. Everything I'm reading says these cap rates are not favorable. So why are people buying these properties?
I'm thinking the buyers are A) hoping for appreciation and don't mind no cash flow, B) planning to increase NOI or hoping that market rents will rise, C) wealthy parents buying a place for Johnny/Susie to live for four years or D) house hacking. Can folks offer their insights into why buy properties with negative cash flow and low cap rates?
For anyone interested, here are my estimates for my example property: 2048/2050 E 6th St, 85719
Price: $245,500, two 1BR units, 1219 sq ft total
Rent: $1454
Maintenance: $205
P&I: $938
Taxes: $195
Cash flow: -$39
Cash on cash: -0.7%
Cap rate: 4.4%
1. Cap rates are not a return metric. Cap rates are obtained from cap rate sales comps on large buildings. They are NOT a return metric.
2. You cannot invent or calculate your own cap rate. See above.
3. Did you get your definition of Cap rate from the BP podcast or a Turnkey salesman? Please ask a knowledgeable investor or commercial real estate appraiser what a cap rate actually is.
4. Lower cap rate = more desirable, higher quality asset.
Please don't teach new investors any more misinformation than they are already bombarded with on a daily basis.
1. CAP rate is Net Operating Income divided by property value, so when a property is listed for sale it is net operating income expressed as a percentage of sales price.
2. You can absolutely calculate CAP rate. How do you think they come up with the numbers? It is NOI/value. When selling a property they use offer price as the value.
3. CAP rate has been around since before the internet and there is no question about how it is calculated. Insulting others doesn't prove your point.
4. Lower CAP rate does not mean the asset is higher quality. It means the return relative to current value is low. One reason could be that it is a high quality asset. Higher quality assets have lower risk and therefore lower return. Other explanations could be the that property is overpriced, has excessive expenses or has under market rents. Basically anything that affects NOI or value will change CAP rate.
Nobody is saying CAP rate is a perfect measure. It is one of many different metrics you can use to evaluate and compare investments.
Again, a capitalization rate is not a return metric. It is a measure of desirability, and a lower cap rate is a lower level of perceived risk.
He cannot calculate a cap rate because cap rates are obtained by cap rate comps in that submarket, typically on 50-100+ unit properties.
You cannot calculate your own cap rate, the (sub)market dictates cap rate, and there are no cap rates on SFHs. SFHs have nothing to do with cap rate because their purchase and sale price has NOTHING to do their their income/NOI. There are NO cap rate comps on a SFH lol, this is basic stuff my man.
I understand you are a moderator but you have some responsibility to not spread dangerous information and advice such as higher cap rate is better, and everyone should jump at a 22% cap rate property !!!! Believe it or not, I've seen nonsense like this on one of the BP podcasts.
Becuase if the OP truly believed this property had a "4.3 cap rate" (it doesn't) this means that he can get more than $20 for every $1 in NOI (LOL) which he can't and won't, because that is not that "cap rate" on his SFH.
You could call CAP rate a return metric, although it is not the best metric. It is really used more for quickly comparing investments. Consider this example. Two identical properties are located next door to each other and one is advertised at $100,000 at 5% CAP rate, the other is advertised for $50,000 at 10% CAP rate. Let's assume the "market CAP rate" is 7%. (Keep in mind the market CAP rate is just average of CAP rates for comparable properties that have sold recently in the market). Given this information we can conclude the 5% CAP property is overprice and the 10% CAP is under priced to the market. This is the purpose of CAP rate. To understand at a high level how returns compare between investments. If the properties were not identical, there could be other explanations or things to consider before buying.
Generally speaking higher returns mean higher risk with any investment, but as real estate investors we are chasing higher returns and accepting higher risk. If you want low risk, purchase a 2% FDIC savings account. Most people would agree that an FDIC account is lower risk, but not necessarily a better investment. Demand drives price higher, so more desirable properties often have lower return. Of course there are exceptions. The goal of investor is to look within a market to find the "hidden gem". That could be a property with low CAP rate, but opportunity to increase rents. That could be a property with higher CAP rate that is undervalued. Using any one metric is oversimplifying. Condition of the property, cash flow, cash on cash return, future appreciation, financing terms, tax benefits, etc. are just some of the other things to consider.
I think you are getting hung up on market CAP rate, but forgetting that market CAP rate is just an average of all the individual CAP rates. It moves up and down and income or value of individual properties change.
As far as SFH comments, you are the one who brought that into this conversation. The OP said it is multifamily (not SFH as you state) and she is a woman (not a man as you state).
The OP said they were looking at a Triplex or Quad. Those properties don't have "market caps" as you state because they are NOT valuated by their ability to produce a given NOI !! With the exception of a Turnkey salesman trying to sell (swindle) a property at a higher value to a newbie who doesn't know better.
What you are implying, and what most others are saying in this thread is that the OP should be looking for a "higher Cap rate property" in order for the investment to be good.
No no no!! A higher cap rate is 9 times out of 10 a worse investment! Do you think family offices, insurance companies, and institutional Investors are stupid? The ones would millions of dollars paying attorneys, advisors, and board members? You know better than them, go ahead and tell them higher cap rates are better LOL
These $100MM - $5BB+ NW family offices, insurance companies, and institutional Investors are all going after 3, 4, and 4.5% capitalization rate investments. Why do you think that is Joe? Is it because they are into buying poor, inferior investments? Maybe they should have listened to all the BP podcasts and moderators posts telling them to invest in "higher CAP" properties ;)
@Josephine Wilson I admittedly have not read all of the pages of this post but what I did read had not mentioned an important segment and driver to answer your question of who is buying at these levels: fund investors.
I have been an REI Consultant for some time, primarily to fund/ corporate investors. How fund level investors invest is vastly different than what you will ever see on BP.
Picture your an oil oligarch in the Balkans and your making so much $$$$ every day that banks are calling saying you have too much $$$$ there and you must move some of it. This is real, I have personally listened into these exact conversations before and had the person then turn and say "see, it just never stops, it's become a full time job itself". If you follow the data the last years have been the most profitable for the top 2% in all of human history, ever, and that creates a serious problem of where to put that capital. Where would you put a million dollars a week?
Various savy persons in connection with this world have been and are capitalizing on the opportunity of solving this issue for the ultra wealthy. Real estate is "THE" piggy bank to the ultra wealthy, and in large part they don't care about cash-flow, they care about inflation and liquidity. Real Estate is a perfect hedge against inflation, that's a simple fundamental fact of being #1 in that arena 2nd only to possibly gold but gold has serious liquidity conversion issues. Real estate is maybe the easiest best asset in the world for liquidity conversion.
So what happens is these fund "managers" take in all this investor capital, buy buy buy ESPECIALLY A class property because the focus is not on COC but safe operations and capital nesting, to put it simply. The fund manager is paid on a % of how much capital he manages (various configurations but it is greatly steered/ impacted by fund size so I will leave it at that crude simplification) so COC is not much of a consideration on any 1 property as he is viewing the big numbers and taking a tiny % of a very big pie.
And we get acquisition prices that we individual investors see and scratch our head saying "how are they making money", because no they are not by our system but it dosn't matter as they are on a whole different system and focus.
As a last note, privacy is king, discretion is paramount when working in the HNW world and as such these fund managers are usually very adept at making themselves appear as just another average investor, utilizing dozens and even hundreds of sub-entities at operational levels. So if you are saying "no, I'd know, I'd have seen....", no, no you wouldn't, that's kind of the whole point. Announcing yourself as a multi-million dollar fund here to buy, yeah, not a good thing for business for many reasons.
Cash flow depends on how that person is financing the property. If I bought it for cash, it would cash flow nicely. While it may not meet your or my criteria, everyone has a different situation and different target returns or reasons for investing. Perhaps someone has a 1031 with a huge gain and needs to put that money somewhere to avoid a big tax hit or perhaps its someone with high income that just wants to diversify out of the stock market and is okay with the low cap rate compared to the bond market, etc.
@Andrey Y. I’m not sure what your goal is with contradicting @Joe Splitrock. His explanation is pretty thorough. And yes, you can calculate cap rates. It is basic algebra. You just solve for the unknown variable. We do it all the time when evaluating and comparing commercial properties and mobile home park returns.
I sell and own class A/B most people buy to raise rents or house hack, with BP type buyers typically a combo of both. The rent/value increases you can get in these areas with basic cosmetics is a wide spread.
Lower cap rate deal that makes six figures in equity with a value add always trumps a higher cap rate deal that cashflows on paper a little higher but who's price stagnates. Total return matters.
@Josephine Wilson people are making this thread a lot more complicated than it needs to be. The basic answer is people buy properties at the price they buy them because it makes sense to them for one reason or another. It could be because they have 1031 money they need to put somewhere, or maybe they think the martlet will appreciate, or they need to park money in an asset, or they are new and inexperienced and they just want to get into the game and they don’t know how to buy under market valued properties, or they want to househack and just lower their cost of housing, etc.
What you should be asking is, who out there is buying properties in Tucson that cash flow. Will you show me how you are doing it. That is what you should be asking. A lot of investors say, I want to invest in a certain type of property in a certain type of area and make a certain rate of return. That's great to know what you want. However, what if what you are looking for is what everyone else is looking for and the competition drives you out of the market? What may be more effective is asking how are you all making money in REI in Tucson and then see if you can do similar things.
Currently we just closed on a 12-plex in Tucson for 680k (roughly 58k per door) in a C-class neighborhood. Rents are at $500 currently but they have room to move up to $725. We are buying it at a 6 cap but after we increase rents, it will be a 9 cap. Then we will refinance it at a 6 cap and increase the value to 1.03 million and we will cash flow about 2k a month including paying an assistant to manage the property.
We are also under contract to purchase 2 mobile home parks in Tucson at ridiculously high cap rates that after we fill the pads in the parks with more units the parks will triple or quadruple in value.
So rather than say, how can I make my strategy work, you may want to ask, what strategies work.
If your interested, I’m doing a meetup in Mesa, Arizona, next Wednesday that we will be broadcasting via Zoom. You are welcome to join. Click the link above or go to the Network tab and click events.
@Steve Vaughan I am really digging your strategy, from the off-market relationships to looking for B over A. But I have to admit, I really don't get the off-market seller. I mean, what the heck is in it for them? Sorry, I know this is a newbie question because clearly there are lots of off-market sellers. But, no matter what the condition of the property, they will get top dollar if it gets put on the MLS. All they have to do is make one call to a RE agent to get top dollar. Why would they sell to you? Is it all about saving themselves a commission?
My research is pointing toward targeting an area, getting a list and writing a letter to them. We have a lot of older people owning properties outright or kids who inherited the property. We have a lot of big high-rise student housing going up and I think the rental market for students will be softening. I'm hoping they have started to feel this (along with the students not being around due to Covid) and are thinking of selling. But I feel like I would have more success if I have a better sense of their motivations. It just seems to me like a bad move for them.
Great question! Off market sellers fall in a couple different categories: some are older and don't care about making top dollar. They realize they can't take it with them and just don't want to deal with it. Then you have people who are financailly not very literate; this may be true for many of the low end price points, which is not feasable for RE agents. Lack of understanding, convinience and complacancy are certainly big factors.
Newbie question here: I'm looking to buy a Class A triplex or quad within 10 minutes of my house and doing property management and maintenance myself. I live close to a large university. Of the 20 recently-sold small multis I've analyzed, nearly all have little to no cash flow and cap rates averaging 4.6%. (2048/2050 E 6th St, Tucson, AZ 85719 is one example.) Some even have substantial negative cash flow. Everything I'm reading says these cap rates are not favorable. So why are people buying these properties?
I'm thinking the buyers are A) hoping for appreciation and don't mind no cash flow, B) planning to increase NOI or hoping that market rents will rise, C) wealthy parents buying a place for Johnny/Susie to live for four years or D) house hacking. Can folks offer their insights into why buy properties with negative cash flow and low cap rates?
For anyone interested, here are my estimates for my example property: 2048/2050 E 6th St, 85719
Price: $245,500, two 1BR units, 1219 sq ft total
Rent: $1454
Maintenance: $205
P&I: $938
Taxes: $195
Cash flow: -$39
Cash on cash: -0.7%
Cap rate: 4.4%
1. Cap rates are not a return metric. Cap rates are obtained from cap rate sales comps on large buildings. They are NOT a return metric.
2. You cannot invent or calculate your own cap rate. See above.
3. Did you get your definition of Cap rate from the BP podcast or a Turnkey salesman? Please ask a knowledgeable investor or commercial real estate appraiser what a cap rate actually is.
4. Lower cap rate = more desirable, higher quality asset.
Please don't teach new investors any more misinformation than they are already bombarded with on a daily basis.
1. CAP rate is Net Operating Income divided by property value, so when a property is listed for sale it is net operating income expressed as a percentage of sales price.
2. You can absolutely calculate CAP rate. How do you think they come up with the numbers? It is NOI/value. When selling a property they use offer price as the value.
3. CAP rate has been around since before the internet and there is no question about how it is calculated. Insulting others doesn't prove your point.
4. Lower CAP rate does not mean the asset is higher quality. It means the return relative to current value is low. One reason could be that it is a high quality asset. Higher quality assets have lower risk and therefore lower return. Other explanations could be the that property is overpriced, has excessive expenses or has under market rents. Basically anything that affects NOI or value will change CAP rate.
Nobody is saying CAP rate is a perfect measure. It is one of many different metrics you can use to evaluate and compare investments.
Again, a capitalization rate is not a return metric. It is a measure of desirability, and a lower cap rate is a lower level of perceived risk.
He cannot calculate a cap rate because cap rates are obtained by cap rate comps in that submarket, typically on 50-100+ unit properties.
You cannot calculate your own cap rate, the (sub)market dictates cap rate, and there are no cap rates on SFHs. SFHs have nothing to do with cap rate because their purchase and sale price has NOTHING to do their their income/NOI. There are NO cap rate comps on a SFH lol, this is basic stuff my man.
I understand you are a moderator but you have some responsibility to not spread dangerous information and advice such as higher cap rate is better, and everyone should jump at a 22% cap rate property !!!! Believe it or not, I've seen nonsense like this on one of the BP podcasts.
Becuase if the OP truly believed this property had a "4.3 cap rate" (it doesn't) this means that he can get more than $20 for every $1 in NOI (LOL) which he can't and won't, because that is not that "cap rate" on his SFH.
You could call CAP rate a return metric, although it is not the best metric. It is really used more for quickly comparing investments. Consider this example. Two identical properties are located next door to each other and one is advertised at $100,000 at 5% CAP rate, the other is advertised for $50,000 at 10% CAP rate. Let's assume the "market CAP rate" is 7%. (Keep in mind the market CAP rate is just average of CAP rates for comparable properties that have sold recently in the market). Given this information we can conclude the 5% CAP property is overprice and the 10% CAP is under priced to the market. This is the purpose of CAP rate. To understand at a high level how returns compare between investments. If the properties were not identical, there could be other explanations or things to consider before buying.
Generally speaking higher returns mean higher risk with any investment, but as real estate investors we are chasing higher returns and accepting higher risk. If you want low risk, purchase a 2% FDIC savings account. Most people would agree that an FDIC account is lower risk, but not necessarily a better investment. Demand drives price higher, so more desirable properties often have lower return. Of course there are exceptions. The goal of investor is to look within a market to find the "hidden gem". That could be a property with low CAP rate, but opportunity to increase rents. That could be a property with higher CAP rate that is undervalued. Using any one metric is oversimplifying. Condition of the property, cash flow, cash on cash return, future appreciation, financing terms, tax benefits, etc. are just some of the other things to consider.
I think you are getting hung up on market CAP rate, but forgetting that market CAP rate is just an average of all the individual CAP rates. It moves up and down and income or value of individual properties change.
As far as SFH comments, you are the one who brought that into this conversation. The OP said it is multifamily (not SFH as you state) and she is a woman (not a man as you state).
The OP said they were looking at a Triplex or Quad. Those properties don't have "market caps" as you state because they are NOT valuated by their ability to produce a given NOI !! With the exception of a Turnkey salesman trying to sell (swindle) a property at a higher value to a newbie who doesn't know better.
What you are implying, and what most others are saying in this thread is that the OP should be looking for a "higher Cap rate property" in order for the investment to be good.
No no no!! A higher cap rate is 9 times out of 10 a worse investment! Do you think family offices, insurance companies, and institutional Investors are stupid? The ones would millions of dollars paying attorneys, advisors, and board members? You know better than them, go ahead and tell them higher cap rates are better LOL
These $100MM - $5BB+ NW family offices, insurance companies, and institutional Investors are all going after 3, 4, and 4.5% capitalization rate investments. Why do you think that is Joe? Is it because they are into buying poor, inferior investments? Maybe they should have listened to all the BP podcasts and moderators posts telling them to invest in "higher CAP" properties ;)
I have stated multiple times in this thread that CAP rate is one piece of information, but it is not the only or the best metric to use in evaluating an investment.
Most triplex and quad on the MLS (in my market) have a CAP rate listed. You can argue all day that CAP rate is not useful on small multifamily or single family. I generally agree with that. HOWEVER, there is still a CAP rate. You can calculate NOI for any income producing property and CAP rate is just found by dividing it by purchase price. I would argue if you are comparing within asset class (triplex to triplex) that the relative CAP rates may be interesting to look at. Obviously someone looking at triplex is not also shopping for $100M apartment buildings, so it is not like people are comparing the two.
Let's follow your logic that a "higher cap rate is 9 times out of 10 the worst investment". Following that logic, everyone should chase the highest possible purchase price relative to net operating income. No doubt insurance companies and some institutional investors are seeking low risk, but even they want to maximize return within the asset class. Sometimes lower CAP rate is an indicator of an overpriced investment.
CAP rate compression is often better for people exiting a market, rather than entering a market. It is better to enter a market when CAP rates are higher and exit as they compress. That is kind of investing 101. Buy when nobody else is and sell when everyone is buying. Or buy undervalued assets and improve them. That is how you grow your money faster.
I am getting the feeling you had a bad turn key investment experience. You are the only one on this discussion thread talking about turn key, haha. I am sorry you had a bad experience, but don't project your issues on me. I have never invested in turn key and never really advocated it either.
I ask myself this as well fairly often as I regularly see people buying 3-4 cap small multifamily buildings here in Boulder (when they are available, which isn't very often). These are bought by investors worth tens of millions, so I wouldn't pretend to be smarter than them. They don't care about cash flow so much, as they have plenty of cash. They're looking for a safe place to park that cash, where it will appreciate by hundreds of dollars per day, as opposed to hundreds of dollars per month on paper but less in reality if they bought a lower class property in a higher cash flow (less desirable) market. Class A investors adhere to the golden rule of investing in real estate: location, location, location. Class A properties are also seen as a safer investment as they have higher rent increases (leading to increased cash flow down the road), higher quality tenants (which means less costly maintenance), and less turnover (which is the #1 profit killer and eats up a lot of cash flow on properties that may look better on paper) resulting in higher overall returns.
I ask myself this as well fairly often as I regularly see people buying 3-4 cap small multifamily buildings here in Boulder (when they are available, which isn't very often). These are bought by investors worth tens of millions, so I wouldn't pretend to be smarter than them. They don't care about cash flow so much, as they have plenty of cash. They're looking for a safe place to park that cash, where it will appreciate by hundreds of dollars per day, as opposed to hundreds of dollars per month on paper but less in reality if they bought a lower class property in a higher cash flow (less desirable) market. Class A investors adhere to the golden rule of investing in real estate: location, location, location. Class A properties are also seen as a safer investment as they have higher rent increases (leading to increased cash flow down the road), higher quality tenants (which means less costly maintenance), and less turnover (which is the #1 profit killer and eats up a lot of cash flow on properties that may look better on paper) resulting in higher overall returns.
Exactly right. When you have tens of millions, it is less about making money and it is more about protecting the money you have. Those investors aren't really represented on BiggerPockets. Why would someone with that kind of money be on BiggerPockets talking about lease breaks, LLC, cat pee and complaining about eviction moratoriums. None of these things are even a concern to them. In my market the largest apartment operators don't acquire anything - they build new construction A class properties. The buildings sit half vacant for months and they give away free months with no deposits to get people in. Guaranteed they are cash flow negative for a couple years, but they don't care. Are they smart? They have way more money than me, so from that standpoint yes they appear smarter. However, having less money, I can't afford to invest like them. I would say their strategy is smart for their situation. Another person may be better off buying hundred year old triplex in Ohio or Michigan. The best approach depends on a persons situation. That is why when some people come on BP (not you) claiming their way is the only way to succeed - it is nonsense. Everyone needs to find the best path for their situation and skill set.
It's hard to understand honestly. The big thing is that inventory is super low and the Fed has flooded the market with liquidity. Institutional investors need to put that somewhere, thus they will continue to buy as long as there's any blood to squeeze out of the turnip. A 4.4 cap is still a 4.4% return (with no debt). So it's something. We haven't found much lately because of the high prices mixed with high uncertainty and a recession. We still buy a little, but only when we find a really, really good deal.
Hey @Brian Ellwood, we have the same issue here in Portland, ME. Every property here I’ve analyzed using the BP calcs is significantly cash flow negative. Do you have any suggestions of how to get started in the non-listed property market for a newbie?
@Joe Splitrock "lease breaks, LLC, cat pee" - LOL!! That was literal LOL. So true. I actually know a guy here who just sold a large multi for...$41 million and oddly enough, I have yet to see him on BP! He spent most of his time worrying about bank underwriters, his sugar daddy in Fla and getting his latest project through city council.
@Gerry Logan Kudos to your partner. That is a great stroke of luck. Good luck with your property. A 10-unit sounds really cool. You start to get some economies of scale there that you don't get in the small plex market.
@James Hamling Great insight on private investors. I did not know until this thread that those guys were interested in the triplex around the corner. Kind of a bummer for us small fry looking for both safe investments and cash flow.
Nobody is saying CAP rate is a perfect measure. It is one of many different metrics you can use to evaluate and compare investments.
A cap rate is not evaluating anything except market value and at best you can use cap rates to compare MARKETS as in Class A multifamily might trade at a 7% cap rate in Alabama and a 4% cap rate in CA, Since all comparable properties in either Alabama or CA will trade at 7% and 4% then there is no building comparability. But back to what that cap rate is telling you. It is perfectly telling you that investors have paid $14.29 for a dollar of NOI in Alabama and that same dollar of NOI sold for $25 in CA. It is a perfect valuation metric. It loses its perfection when you are trying to make it do something is does not do. There is no return measurement there.
You cannot call a cap rate a return metric because it does not measure return. Which property has a higher return. A property bought at 10% in Indy or a property bought at 5% in SF? Do you want me to believe that the Indy has DOUBLE the return of the SF property? In your example ALL you are doing is comparing "asking prices". No one does that. Why would you? If two comparable properties have $100,000 NOI and the market cap rate is 7% then they both have a market value of about $1,428,600. That is the purpose of cap rate, to calculate probable market value. Investors don't waste time comparing asking prices. You should know that.
Newbie question here: I'm looking to buy a Class A triplex or quad within 10 minutes of my house and doing property management and maintenance myself. I live close to a large university. Of the 20 recently-sold small multis I've analyzed, nearly all have little to no cash flow and cap rates averaging 4.6%. (2048/2050 E 6th St, Tucson, AZ 85719 is one example.) Some even have substantial negative cash flow. Everything I'm reading says these cap rates are not favorable. So why are people buying these properties?
I'm thinking the buyers are A) hoping for appreciation and don't mind no cash flow, B) planning to increase NOI or hoping that market rents will rise, C) wealthy parents buying a place for Johnny/Susie to live for four years or D) house hacking. Can folks offer their insights into why buy properties with negative cash flow and low cap rates?
For anyone interested, here are my estimates for my example property: 2048/2050 E 6th St, 85719
Price: $245,500, two 1BR units, 1219 sq ft total
Rent: $1454
Maintenance: $205
P&I: $938
Taxes: $195
Cash flow: -$39
Cash on cash: -0.7%
Cap rate: 4.4%
1. Cap rates are not a return metric. Cap rates are obtained from cap rate sales comps on large buildings. They are NOT a return metric.
2. You cannot invent or calculate your own cap rate. See above.
3. Did you get your definition of Cap rate from the BP podcast or a Turnkey salesman? Please ask a knowledgeable investor or commercial real estate appraiser what a cap rate actually is.
4. Lower cap rate = more desirable, higher quality asset.
Please don't teach new investors any more misinformation than they are already bombarded with on a daily basis.
1. CAP rate is Net Operating Income divided by property value, so when a property is listed for sale it is net operating income expressed as a percentage of sales price.
2. You can absolutely calculate CAP rate. How do you think they come up with the numbers? It is NOI/value. When selling a property they use offer price as the value.
3. CAP rate has been around since before the internet and there is no question about how it is calculated. Insulting others doesn't prove your point.
4. Lower CAP rate does not mean the asset is higher quality. It means the return relative to current value is low. One reason could be that it is a high quality asset. Higher quality assets have lower risk and therefore lower return. Other explanations could be the that property is overpriced, has excessive expenses or has under market rents. Basically anything that affects NOI or value will change CAP rate.
Nobody is saying CAP rate is a perfect measure. It is one of many different metrics you can use to evaluate and compare investments.
Again, a capitalization rate is not a return metric. It is a measure of desirability, and a lower cap rate is a lower level of perceived risk.
He cannot calculate a cap rate because cap rates are obtained by cap rate comps in that submarket, typically on 50-100+ unit properties.
You cannot calculate your own cap rate, the (sub)market dictates cap rate, and there are no cap rates on SFHs. SFHs have nothing to do with cap rate because their purchase and sale price has NOTHING to do their their income/NOI. There are NO cap rate comps on a SFH lol, this is basic stuff my man.
I understand you are a moderator but you have some responsibility to not spread dangerous information and advice such as higher cap rate is better, and everyone should jump at a 22% cap rate property !!!! Believe it or not, I've seen nonsense like this on one of the BP podcasts.
Becuase if the OP truly believed this property had a "4.3 cap rate" (it doesn't) this means that he can get more than $20 for every $1 in NOI (LOL) which he can't and won't, because that is not that "cap rate" on his SFH.
You could call CAP rate a return metric, although it is not the best metric. It is really used more for quickly comparing investments. Consider this example. Two identical properties are located next door to each other and one is advertised at $100,000 at 5% CAP rate, the other is advertised for $50,000 at 10% CAP rate. Let's assume the "market CAP rate" is 7%. (Keep in mind the market CAP rate is just average of CAP rates for comparable properties that have sold recently in the market). Given this information we can conclude the 5% CAP property is overprice and the 10% CAP is under priced to the market. This is the purpose of CAP rate. To understand at a high level how returns compare between investments. If the properties were not identical, there could be other explanations or things to consider before buying.
Generally speaking higher returns mean higher risk with any investment, but as real estate investors we are chasing higher returns and accepting higher risk. If you want low risk, purchase a 2% FDIC savings account. Most people would agree that an FDIC account is lower risk, but not necessarily a better investment. Demand drives price higher, so more desirable properties often have lower return. Of course there are exceptions. The goal of investor is to look within a market to find the "hidden gem". That could be a property with low CAP rate, but opportunity to increase rents. That could be a property with higher CAP rate that is undervalued. Using any one metric is oversimplifying. Condition of the property, cash flow, cash on cash return, future appreciation, financing terms, tax benefits, etc. are just some of the other things to consider.
I think you are getting hung up on market CAP rate, but forgetting that market CAP rate is just an average of all the individual CAP rates. It moves up and down and income or value of individual properties change.
As far as SFH comments, you are the one who brought that into this conversation. The OP said it is multifamily (not SFH as you state) and she is a woman (not a man as you state).
The OP said they were looking at a Triplex or Quad. Those properties don't have "market caps" as you state because they are NOT valuated by their ability to produce a given NOI !! With the exception of a Turnkey salesman trying to sell (swindle) a property at a higher value to a newbie who doesn't know better.
What you are implying, and what most others are saying in this thread is that the OP should be looking for a "higher Cap rate property" in order for the investment to be good.
No no no!! A higher cap rate is 9 times out of 10 a worse investment! Do you think family offices, insurance companies, and institutional Investors are stupid? The ones would millions of dollars paying attorneys, advisors, and board members? You know better than them, go ahead and tell them higher cap rates are better LOL
These $100MM - $5BB+ NW family offices, insurance companies, and institutional Investors are all going after 3, 4, and 4.5% capitalization rate investments. Why do you think that is Joe? Is it because they are into buying poor, inferior investments? Maybe they should have listened to all the BP podcasts and moderators posts telling them to invest in "higher CAP" properties ;)
I have stated multiple times in this thread that CAP rate is one piece of information, but it is not the only or the best metric to use in evaluating an investment.
Most triplex and quad on the MLS (in my market) have a CAP rate listed. You can argue all day that CAP rate is not useful on small multifamily or single family. I generally agree with that. HOWEVER, there is still a CAP rate. You can calculate NOI for any income producing property and CAP rate is just found by dividing it by purchase price. I would argue if you are comparing within asset class (triplex to triplex) that the relative CAP rates may be interesting to look at. Obviously someone looking at triplex is not also shopping for $100M apartment buildings, so it is not like people are comparing the two.
Let's follow your logic that a "higher cap rate is 9 times out of 10 the worst investment". Following that logic, everyone should chase the highest possible purchase price relative to net operating income. No doubt insurance companies and some institutional investors are seeking low risk, but even they want to maximize return within the asset class. Sometimes lower CAP rate is an indicator of an overpriced investment.
CAP rate compression is often better for people exiting a market, rather than entering a market. It is better to enter a market when CAP rates are higher and exit as they compress. That is kind of investing 101. Buy when nobody else is and sell when everyone is buying. Or buy undervalued assets and improve them. That is how you grow your money faster.
I am getting the feeling you had a bad turn key investment experience. You are the only one on this discussion thread talking about turn key, haha. I am sorry you had a bad experience, but don't project your issues on me. I have never invested in turn key and never really advocated it either.
You keep incorrectly stating that it is a measure of return when it is a valuation metric. If I buy Class A office in Ohio at a 10% cap rate then the cap rate tells me I paid $10 for a dollar of NOI. In CA I may pay $20 for a dollar of Class A office at 5% cap rate. You cannot tell me which property/market has a higher return.
You wouldn't believe this Joe, but your feeling is incorrect once again. I've only purchased and owned 1 Turnkey property to date, it's in Little Rock, and I am very happy with it.
If you are okay with staying non-truths to newbie investors, thats on you. I for one am adamantly against perpetuation of false information. And if you've been following, there is a lot of that going on right now.
@Shiloh Lundahl "What you should be asking is, who out there is buying properties in Tucson that cash flow. Will you show me how you are doing it." This is just such good advice. I totally get what you are saying, and those three deals you mention sound really good, and make me optimistic that there are good deals to be had in Tucson. I'll check out the meet-up!
@Andrey Y. The confusion arises because people mean different things when they say "return". Most folks on BP only calculate CoC and not IRR, hence cannot differentiate why cap rate and returns mean different things. While not common practice, you can calculate a cap rate on anything - whether it's a SFH, tri, 100+ or a donut shop - it's just a different terminology depending on business. Don't be a semantics bully.
A 4 cap property will return you 4% on a full cash purchase, but that is TODAY’s cash flow. Often reasons why properties sell for low caps is an investor’s valuation of FUTURE cash flow (including appreciation).
If an investor is properly discounting future cash flows, the IRR on a Low cap property may be similar to the IRR on a high cap property (after adjusting for risk and effort). So I agree with you that buying low cap is a great strategy if you have liquidity and want to reduce risk.
But you aren’t helping to educate folks when you don’t make your thinking fully visible and communicate in non-constructive manners.
ahh another great cap rate debate. cap rate is not a perfect measure but unless you are very very good or have a lot of time on your hands you need a cap rate to weed out the stuff you don't want to focus on. yes you should use IRR like @Ben Leybovich will tell you again and again. Problem is that takes time. Garbage in garbage out. So yes if you know your market and can estimate a rehab budget in 20 minutes flat maybe you can use IRR to evaluate properties to look at and once you find something you like already it is absolutely the right metric. For everyone else it is a good screening tool of basic valuation not unlike P/E might be a decent metric in the stock market but is far from the only thing one would look at for judging a stock. Many of the other things people argue about related cap rate are also fairly obvious. Of course, a 10 cap in some terrible part of town or in some tiny town of 500 people is not the same as a low cap rate in LA.
What is true is that properties that used to sell for say a 7 cap now might sell for a 5.5 cap. This is the data in many many markets. It doesn't lie. There are numerous explanations for this and none are the right answer in full. Some is due to growth expectations (right or wrong), some is due to the fact that investors are just willing to go where they did not before so there is more demand, etc. The key, at least in my opinion, is it shows the expectations. Just like the stock market if you buy a stock with a high P/E it just means the expectations are rosy. You might be right you might be wrong. The issue on lower priced cap rates is that if the expectations are wrong or if there is a shift in market expectations it is already priced for that growth. When or if the market changes those expectations or if the growth just is not there it is a major issue. For instance, take NYC. Last year you would have baked in a very rosy picture of rent growth and maybe even some cap rate compression. This year? forget about it. Now in truth will COVID impact things in 5 years or 10 years. Opinions differ but there is certainly a shift in expectations and thus demand.
The confusion is there because growth and expectations are almost impossible to quantify. rent growth of 5% forever, sure why not? Nevermind the fact that rent growth of 5% over 10 or 20 years means that no one can really afford to live there.
High cap rates are desirable because you know that if you have $X dollars in cash flow that is $X dollars in cash flow today and tomorrow. The caveat to that is the cash flow has to be steady, expenses can't grow quicker than rent and generally not take all your time to get. Neither of those three factors will be true in some terrible area or where the population is generally declining or even just staying at some tiny number.
That is why @Andrey Y. I think saying it is a "more desirable, higher-quality asset" is problematic for newer investors. Yes this is mostly the case and there is a correlation but it kind of makes it seems like the lower the cap rate the more signaling of quality there is. It is simply a measure of how much others are willing to pay. In some markets where I certainly would not say they are all that desirable or high quality, the cap rates are down huge. True it is not at 4% but still very low by historical standards. I assure you the assets are not all that desirable and not all that high quality. The issue is as long as expectations are still there it doesn't matter to many people. Prices are there because of expectations and as long as those expectations are still high.....
Newbie question here: I'm looking to buy a Class A triplex or quad within 10 minutes of my house and doing property management and maintenance myself. I live close to a large university. Of the 20 recently-sold small multis I've analyzed, nearly all have little to no cash flow and cap rates averaging 4.6%. (2048/2050 E 6th St, Tucson, AZ 85719 is one example.) Some even have substantial negative cash flow. Everything I'm reading says these cap rates are not favorable. So why are people buying these properties?
I'm thinking the buyers are A) hoping for appreciation and don't mind no cash flow, B) planning to increase NOI or hoping that market rents will rise, C) wealthy parents buying a place for Johnny/Susie to live for four years or D) house hacking. Can folks offer their insights into why buy properties with negative cash flow and low cap rates?
For anyone interested, here are my estimates for my example property: 2048/2050 E 6th St, 85719
Price: $245,500, two 1BR units, 1219 sq ft total
Rent: $1454
Maintenance: $205
P&I: $938
Taxes: $195
Cash flow: -$39
Cash on cash: -0.7%
Cap rate: 4.4%
1. Cap rates are not a return metric. Cap rates are obtained from cap rate sales comps on large buildings. They are NOT a return metric.
2. You cannot invent or calculate your own cap rate. See above.
3. Did you get your definition of Cap rate from the BP podcast or a Turnkey salesman? Please ask a knowledgeable investor or commercial real estate appraiser what a cap rate actually is.
4. Lower cap rate = more desirable, higher quality asset.
Please don't teach new investors any more misinformation than they are already bombarded with on a daily basis.
1. CAP rate is Net Operating Income divided by property value, so when a property is listed for sale it is net operating income expressed as a percentage of sales price.
2. You can absolutely calculate CAP rate. How do you think they come up with the numbers? It is NOI/value. When selling a property they use offer price as the value.
3. CAP rate has been around since before the internet and there is no question about how it is calculated. Insulting others doesn't prove your point.
4. Lower CAP rate does not mean the asset is higher quality. It means the return relative to current value is low. One reason could be that it is a high quality asset. Higher quality assets have lower risk and therefore lower return. Other explanations could be the that property is overpriced, has excessive expenses or has under market rents. Basically anything that affects NOI or value will change CAP rate.
Nobody is saying CAP rate is a perfect measure. It is one of many different metrics you can use to evaluate and compare investments.
Again, a capitalization rate is not a return metric. It is a measure of desirability, and a lower cap rate is a lower level of perceived risk.
He cannot calculate a cap rate because cap rates are obtained by cap rate comps in that submarket, typically on 50-100+ unit properties.
You cannot calculate your own cap rate, the (sub)market dictates cap rate, and there are no cap rates on SFHs. SFHs have nothing to do with cap rate because their purchase and sale price has NOTHING to do their their income/NOI. There are NO cap rate comps on a SFH lol, this is basic stuff my man.
I understand you are a moderator but you have some responsibility to not spread dangerous information and advice such as higher cap rate is better, and everyone should jump at a 22% cap rate property !!!! Believe it or not, I've seen nonsense like this on one of the BP podcasts.
Becuase if the OP truly believed this property had a "4.3 cap rate" (it doesn't) this means that he can get more than $20 for every $1 in NOI (LOL) which he can't and won't, because that is not that "cap rate" on his SFH.
You could call CAP rate a return metric, although it is not the best metric. It is really used more for quickly comparing investments. Consider this example. Two identical properties are located next door to each other and one is advertised at $100,000 at 5% CAP rate, the other is advertised for $50,000 at 10% CAP rate. Let's assume the "market CAP rate" is 7%. (Keep in mind the market CAP rate is just average of CAP rates for comparable properties that have sold recently in the market). Given this information we can conclude the 5% CAP property is overprice and the 10% CAP is under priced to the market. This is the purpose of CAP rate. To understand at a high level how returns compare between investments. If the properties were not identical, there could be other explanations or things to consider before buying.
Generally speaking higher returns mean higher risk with any investment, but as real estate investors we are chasing higher returns and accepting higher risk. If you want low risk, purchase a 2% FDIC savings account. Most people would agree that an FDIC account is lower risk, but not necessarily a better investment. Demand drives price higher, so more desirable properties often have lower return. Of course there are exceptions. The goal of investor is to look within a market to find the "hidden gem". That could be a property with low CAP rate, but opportunity to increase rents. That could be a property with higher CAP rate that is undervalued. Using any one metric is oversimplifying. Condition of the property, cash flow, cash on cash return, future appreciation, financing terms, tax benefits, etc. are just some of the other things to consider.
I think you are getting hung up on market CAP rate, but forgetting that market CAP rate is just an average of all the individual CAP rates. It moves up and down and income or value of individual properties change.
As far as SFH comments, you are the one who brought that into this conversation. The OP said it is multifamily (not SFH as you state) and she is a woman (not a man as you state).
The OP said they were looking at a Triplex or Quad. Those properties don't have "market caps" as you state because they are NOT valuated by their ability to produce a given NOI !! With the exception of a Turnkey salesman trying to sell (swindle) a property at a higher value to a newbie who doesn't know better.
What you are implying, and what most others are saying in this thread is that the OP should be looking for a "higher Cap rate property" in order for the investment to be good.
No no no!! A higher cap rate is 9 times out of 10 a worse investment! Do you think family offices, insurance companies, and institutional Investors are stupid? The ones would millions of dollars paying attorneys, advisors, and board members? You know better than them, go ahead and tell them higher cap rates are better LOL
These $100MM - $5BB+ NW family offices, insurance companies, and institutional Investors are all going after 3, 4, and 4.5% capitalization rate investments. Why do you think that is Joe? Is it because they are into buying poor, inferior investments? Maybe they should have listened to all the BP podcasts and moderators posts telling them to invest in "higher CAP" properties ;)
I have stated multiple times in this thread that CAP rate is one piece of information, but it is not the only or the best metric to use in evaluating an investment.
Most triplex and quad on the MLS (in my market) have a CAP rate listed. You can argue all day that CAP rate is not useful on small multifamily or single family. I generally agree with that. HOWEVER, there is still a CAP rate. You can calculate NOI for any income producing property and CAP rate is just found by dividing it by purchase price. I would argue if you are comparing within asset class (triplex to triplex) that the relative CAP rates may be interesting to look at. Obviously someone looking at triplex is not also shopping for $100M apartment buildings, so it is not like people are comparing the two.
Let's follow your logic that a "higher cap rate is 9 times out of 10 the worst investment". Following that logic, everyone should chase the highest possible purchase price relative to net operating income. No doubt insurance companies and some institutional investors are seeking low risk, but even they want to maximize return within the asset class. Sometimes lower CAP rate is an indicator of an overpriced investment.
CAP rate compression is often better for people exiting a market, rather than entering a market. It is better to enter a market when CAP rates are higher and exit as they compress. That is kind of investing 101. Buy when nobody else is and sell when everyone is buying. Or buy undervalued assets and improve them. That is how you grow your money faster.
I am getting the feeling you had a bad turn key investment experience. You are the only one on this discussion thread talking about turn key, haha. I am sorry you had a bad experience, but don't project your issues on me. I have never invested in turn key and never really advocated it either.
You keep incorrectly stating that it is a measure of return when it is a valuation metric. If I buy Class A office in Ohio at a 10% cap rate then the cap rate tells me I paid $10 for a dollar of NOI. In CA I may pay $20 for a dollar of Class A office at 5% cap rate. You cannot tell me which property/market has a higher return.
You wouldn't believe this Joe, but your feeling is incorrect once again. I've only purchased and owned 1 Turnkey property to date, it's in Little Rock, and I am very happy with it.
If you are okay with staying non-truths to newbie investors, thats on you. I for one am adamantly against perpetuation of false information. And if you've been following, there is a lot of that going on right now.
CAP rate is the expected annual rate of return based on cash invested at a given purchase price. It is a high level metric used mainly to compare different investments. A metric is simply a unit of measurement. NOI is a measure of net operating income. When divided by vale, it is a percent return based on all cash purchase. You can call it valuation, but it is actually NOI divided by value.
People do use the average market CAP rate to value a property for sale, so yes it is used for valuation. It is just using income (NOI) to determine value based on average CAP rates of other properties in the market.
In your example, the percentage return is higher for the class A office in Ohio at 10% versus 5% in California. That is based on annual projected net operating income. Of course if you pay less for the property, the CAP rate goes higher. If the value changes or net income changes, the CAP rate changes. It doesn't mean the property in Ohio is a better investment, because there are more factors to evaluating an investment than just CAP rate (appreciation, taxes implications, financing terms, etc). It sounds like your point is that although a property in California has lower annual return, the appreciation over time makes it a better investment. That could be true, but assuming a lower CAP rate means higher future appreciation can be a mistake. There are properties listed in my market with CAP rates similar to California, but is it unlikely my market will appreciate as much as California over the long term.
In your last response you said which "property/market" has a higher return. These are two separate things. Market is an average of every property in the market. Property is a specific property within the market. You can use market CAP rates to compare markets or you can use market CAP rate to analyze a specific property within that market.
Strange, I heard that same refrain in 2013, by many now sad people.
You need to analyze what you want to buy and make reasonable assumptions about the future. If it meets your guidelines, you should go for it, if you're serious at all about investment real estate.
There's always going to be bad news and within 3 months, you'll see another property that is an absolute steal in your eyes - That's just life.
Hey @Brian Ellwood, we have the same issue here in Portland, ME. Every property here I’ve analyzed using the BP calcs is significantly cash flow negative. Do you have any suggestions of how to get started in the non-listed property market for a newbie?
Rob
Very first step is to pick a new market with cheaper properties