New Low Cap Rates = Lower Return on Money; Should We Cash Out into Long-term Stocks?

[Tony T.]

Hi there, I have recently discovered that the cap rates in my area have gone from 8.5% down to about 5.5% in the past few years! That makes my (debt-free) property worth a lot more.

BUT if cap rates are at 5.5%, that means I'm getting only a 5.5% return on my money/investment! That's low in my opinion! But I realize it's not including yearly appreciation (inflation). So, if inflation got around 5%, then investing in a 10% return stocks would be the same return as rentals except without the time required to manage those rentals.

Since the stock market does around 10% in the long term, I'm considering selling.

Does anyone have any input on such a major shift in investing? It would be an incredibly big step since I have been in multifamily for 25 years. Thanks for any input.

[James Storey]

Hey Tony,

You definetly have a lot of opportunity cost in this asset especially with it having no debt on it. Couple things to consider. Cap rates are great to quickly analyze the value of an asset based on todays NOI but for most circumstances it fails to take into account general rent growth and overal future setiment for a particular asset. This is why sofisticated funds value assets on discount rates and not cap rates (except for proforma cap rates) and can purchase an asset and position it to be worth a heck of a lot more in 5 years. That said if you think you are pushing the max rental rate capacity and feel you have been a great manager and feel we are at the top of the capital market, then it might make sense to sell. You just want to make sure there isnt a lot of money being left on the table from future growth.

Investing is risky and selling and repositioning is risky also. However, sounds like you made a decent amount on your investment. Congratulations!

James Storey, CCIM

[Henry Clark]

I don't like Dancing, so here goes.

From what I can see you are an investor and not an REI person, even though you own a MF.

Recommend you sell and put your money into Stocks/Bonds or a RE syndication.

You own a fully paid off MF. Thats not REI investing. You're losing lots of money (opportunity cost).

Your comparing Stocks versus REI. There is no comparison in returns or Risk if you're an REI person. Use the magnifying glass and read all of the posts on REI versus Stocks.

Harrisburg looks like a beautiful town.

Did a quick look.  I saw 6 properties (at list price) for sale, that in 1 1/2 years I could make over $1mm profit; plus get my downpayment back.  With anywhere from $200k to $350k cash downpayment.

Actually, looked at Harrisburg on a post about 3 months ago.  You have a lot more opportunities just outside the city, than the above I mentioned.

All of this, in the current interest rate and economic environment. You truly are in a great REI location. I've only seen one other community that I didn't know existed, that was more appealing. Looks like your last BP post was about 2 years ago. Recommend you challenge yourself and look at all of the REI avenues and apply them to your area. If not, Stocks/Bonds and REI syndications are the best bet.

As mentioned above. Forget CAP rates. What percentage is $1,000,000 gain on $250,000 downpayment in 1 1/2 years? Forget cap rates.

[Ronald Rohde]

I feel like the timing is still one cycle off. Cap rate compression for MF occurred from 2016-2022, cap rates have increased for the past 10 months...I doubt your building would sell for negative leverage unless the upside is extreme. Where are you on market rents, NOI?

[Steve Vaughan]

Quote from @Tony T.:

Hi there, I have recently discovered that the cap rates in my area have gone from 8.5% down to about 5.5% in the past few years! That makes my (debt-free) property worth a lot more.

BUT if cap rates are at 5.5%, that means I'm getting only a 5.5% return on my money/investment! That's low in my opinion! But I realize it's not including yearly appreciation (inflation). So, if inflation got around 5%, then investing in a 10% return stocks would be the same return as rentals except without the time required to manage those rentals.

Since the stock market does around 10% in the long term, I'm considering selling.

Does anyone have any input on such a major shift in investing? It would be an incredibly big step since I have been in multifamily for 25 years. Thanks for any input.

I sold my last 2 commercial MF on contracts last year, but it was a combination of tired of it and really, you'll pay that much?  Interest rate received is higher than cap rate and ROE.  
How's your indigestion level? 
Selling after 20 years definitely had tax implications,  but I mitigated well with lower down payment requirements.  Also reduced closing costs essentially selling by owner.   Each still took about 7 weeks and, like a lot of things RE, sucked. 
Redeploying into paper equities at 10% isn't as easy as it was last summer and fall.  Need to do more than buy and hope index funds at these levels. 

[John McKee]

5.5 % is a good rate of return if your properties are turnkey and you are a cash flow investor.  However if you have to work to manage that 5.5% then maybe you sell and 1031 that into something more passive. I'm not a fan of chasing returns just to stay ahead of inflation.  If you think that your spending power is eroding to the point of being on the streets then I would raise your rents.  It's all perspective on how you value your money today and how does your real estate fit into the overall portfolio of your wealth and risk tolerance. I would be more nervous today about putting money into the market vs buying a MF property.  Perhaps you can hold onto your MF as the conservative part of your portfolio and then dollar cost buy into the market for the next 30 years. Much to think about but great question!

[Tony T.]

OK, thanks for the replies so far everyone! Evidently I left out some key info about me and where I am in my life/thinking.

* I am 55 and have downsized from holding and improving and flipping many properties in the past. I am finished with all the work and with all the leveraging to purchase more; I am making things as simple as possible after 25 years of RE investing.

* I own a 12-unit building which gives me about 120k NOI and rents are about $150/200 below market.

* A 5.5 cap rate would give me 2 million for the building and I have no debt.

* I live in a very affordable city which came in 2nd place in the best places to retire this year - Harrisburg, PA. As I said, I'm kind of in retirement mode now.

* ALL of my net worth is in RE, I have nothing in stocks/bonds/etc.

* I manage my 12-unit building myself and after improving every unit (kitchens, baths, etc) myself, I have very little to do to make that 5.5% ROI, but it'll be more later, I'm sure.

* I am considering selling because: (1) I am a little tired of managing, (2) The cap rates would give me an incredible price in this moment, (3) MOST OF ALL, I see government control creeping in which will cause the RE sector to downturn badly.

Example of unjust government control: (1) Calls/Bills introduced to "cancel rent," (2) Federal rent controls just introduced, (3) Eviction moratoriums, (4) Forbidding the use of credit scores to not accept a prospective tenant, (5) Banning criminal background checks, (6) Requirement to accept dogs for simply emotional reasons, (6) Banning use of eviction records to accept a prospective tenant, etc.

[John McKee]

You need to hang on if you are saying that rents are under market. Raising rents 200 a unit x 12 =2,400 a month or $28,800 a year. Your total NOI would increase to $148,800 a year at that point or a $2,705,454 valuation (assuming 5.5 cap). That's a lot of money to leave on the table.

[Tony T.]

Yes, thank you. I do know that and I'm raising the rents $100 right now, so I'd have to convince a buyer that they're low and maybe get a higher valuation. I've been raising the rents $90/year and can never catch up with inflation! I just can't go higher than $90 for the tenant's sake, so hopefully I'll catch up by next year. The (4) 1 bedrooms are probably $100 lower, not $200. 

[Claude Goodman]

Quote from @Tony T.:

Yes, thank you. I do know that and I'm raising the rents $100 right now, so I'd have to convince a buyer that they're low and maybe get a higher valuation. I've been raising the rents $90/year and can never catch up with inflation! I just can't go higher than $90 for the tenant's sake, so hopefully I'll catch up by next year. The (4) 1 bedrooms are probably $100 lower, not $200. 

Would imagine the capital gains tax on the sale would be significant. Perhaps do a large cash out refi (e.g.tax free) and invest that. Then hire a property manager with the job of raising rents to market (without destabilizing the place too much). then forget it for a few years until the rents are much closer to market, then refinance again and take even more tax free cash out....do that over and over till you die and pass the property off to your kids tax free....then they can sell with no cap gains.

[Henry Clark]

Now we are talking.

Random thoughts.

1. Hire a Real estate company to manage your properties. This will not hurt your Valuation/Cap Rates/NOI numbers if you go to sale. They will factor management fees in any ways. Backs you away from some of your discussion points. More importantly frees you up. Who wants to be in Belize or Sicily and get an HVAC call.

2. Although we love REI. We also hate/love cash. Pick a cash or liquid asset number for 1/2/3/4/5 years of your lifestyle and set it on the side. Put it in near-term CD's or MMF. Keep replenishing it, once a year. Near term assets for Near term needs; Long term for Long term.

3.  Do a wholistic review of your financial position.  Use the magnifying lookup with my name and "what if you die"?

4.  Government control issues.  

Increase your rates and require Autopay (dr/cr card or bank account).

I love dogs (in my yard).  Require a $5,000 insurance policy and a $1,000 deposit.  Miss you Lilly.

Cancel Rent, Eviction Moratoriums, Rent Controls- Got to love them.  - make money off these issues.  Rent the best places you can find in Seattle, San Franciso or LA.  Don't pay rent, and then do Short term or vacation rentals.  You get paid, the owner doesn't.

Criminal issues- got to love them.  Make a Sexual offender rental complex.  Will be some of your best tenants.  They won't want to move.

Take the crap and make it into hamburger; or is it lemons into lemonade.

5. 1031 part out to xx investment or REI syndication and the rest to Cash as needed.

6. Switch to an easier investment type. You are truly in a great REI location. Lookup my name and Silver Lake or Journeys End subdivisions. You might be tired of REI or just the type of REI. Hard to get rid of the Itch. Don't sell your MFH, use it as collateral. Don't sell all of the lots, keep one next to the pond for yourself.

7.  Or just go and find this spot or "Your" spot.  It's a low of 5 tonight and high of 20 tomorrow.  One week a month in Belize for us.

The above are not "Right", just avenues and concepts.

[Ronald Rohde]

Either way keep us updated! You're living the dream for most