Questions to ask when smells too good to be true

19 Replies

So i found this listing in Loopnet for an office building at $1.2mil w/ a 26% cap rate.

It's in a pretty good area and 100% leased up.

Talked to the agent and he said it's closing tomorrow; final price $1.05mil and stated the cap rate is accurate (of course I did not believe it so I flat out asked if accurate).

Besides a pro forma; what other docs could I get to substanitate the agent/sellers claims on the cap rate?  Seller tax returns?

Just want to know what I need to be on the look out for as this deal seemed too good to be true and a no brainer.

I am new and can post the link to the property which just closed; but, need to go back and re-read the T&C of this site.  If I cannot and want me to send you the property in a PM i will.

Thx.

Why would you care about the cap rate for this sold property? There are obviously major problems with a building that only sold for 3.8 times the NOI. I can guarantee you that the calculation was done incorrectly.

Why not ask the agent for the calculations?

@Dan D.

Pro Formas are just projections and they are only as good as the person who made it. Before I dropped a cool million, I'm pretty sure I'd want to see the actual income/expense statements. If the building is 100% occupied and has a cap rate of 26%, they should be proud to show you their financials. I suspect, however, that the real cap rate isn't going to come close to 26% and there will be a ton of reasons why.

-Christopher

Originally posted by @Christopher Brainard :

@Dan D.

Pro Formas are just projections and they are only as good as the person who made it. Before I dropped a cool million, I'm pretty sure I'd want to see the actual income/expense statements. If the building is 100% occupied and has a cap rate of 26%, they should be proud to show you their financials. I suspect, however, that the real cap rate isn't going to come close to 26% and there will be a ton of reasons why.

-Christopher

 Why would you be proud that the market perceives your property as a piece of crap?

Originally posted by @Bob Bowling:
Originally posted by @Christopher Brainard:

@Dan D.

Pro Formas are just projections and they are only as good as the person who made it. Before I dropped a cool million, I'm pretty sure I'd want to see the actual income/expense statements. If the building is 100% occupied and has a cap rate of 26%, they should be proud to show you their financials. I suspect, however, that the real cap rate isn't going to come close to 26% and there will be a ton of reasons why.

-Christopher

 Why would you be proud that the market perceives your property as a piece of crap?

 Because I like making money. 

Originally posted by @Christopher Brainard :
Originally posted by @Bob Bowling:
Originally posted by @Christopher Brainard:

@Dan D.

Pro Formas are just projections and they are only as good as the person who made it. Before I dropped a cool million, I'm pretty sure I'd want to see the actual income/expense statements. If the building is 100% occupied and has a cap rate of 26%, they should be proud to show you their financials. I suspect, however, that the real cap rate isn't going to come close to 26% and there will be a ton of reasons why.

-Christopher

 Why would you be proud that the market perceives your property as a piece of crap?

 Because I like making money. 

A crappy property that can ONLY command 3.8 times the NOI is NOT gonna make you money! At a more realistic 10% cap rate they would have put about $2,730,000 in their pocket instead of the measly $1.05m.

Fortunately, I'm pretty sure I'm smarter than the market (and I would hope most people who can output this type of cash are as well). Just because the cap rate is high, that doesn't ensure that property is a piece of crap. If I look at the property and I find it is in good repair, a reasonable location, and I can keep it full, the worse the market's perception of the property, the better. As I noted in my previous post, I would keep a keen eye on the actual financials. I've found many listing agents to make very 'optimistic' Pro Formas, which lead to unobtainable Cap Rates. I've seen several instances when the realized Cap Rate was 10% to 20% less than the Pro Formas would indicate, often due to high turnover or exceedingly low market rents. 

 -Christopher

@Dan D.

Assuming the 26% cap is accurate, there are lots of off-balance-sheet problems that could be lurking. For example:

- High paying tenant about to leave and no replacement is likely

- Major structural issues

The seller is obviously pricing in a major discount for some reason. Only a sucker would buy the property without figuring out why.

Originally posted by @Christopher Brainard :

Fortunately, I'm pretty sure I'm smarter than the market (and I would hope most people who can output this type of cash are as well). Just because the cap rate is high, that doesn't ensure that property is a piece of crap. 

 -Christopher

@Christopher Brainard  Why would a profitable property trade at a 26% cap rate?  As far as I know there are no 26% markets in the US.  I imagine this is a case of a completely miscalculated cap rate. But still curious why you think a high cap rate means a better deal. 

@Bob Bowling

Nobody said that the Huntington Beach market was trading at 26% - the original poster found one particular property at that price. Either the seller is desperate financial trouble, the building requires repair, there are tenant issues, or some other problem is on the horizon. Until you look at the deal with your own eyes, you have no idea what the real situation is and I think that writing the property off based on the posted Pro Forma Cap Rate is a huge mistake and would lead to passing up several properties that could be good deals.

Purely based on the formula, a higher Cap Rate means more projected NOI, which means there is the potential for more income and a better deal. I make money off fixing problems - I carefully try to select properties where I understand what the problem is and I'm confident I can turn it around. I look at a lot of properties, but I buy very few. I'm sure I could buy properties at the market cap rate all day, but I don't believe that is an effective way to build wealth. When I see a property here in Las Vegas with a Pro Forma Cap Rate of 5%, I know that there isn't going to be a real chance for value add. When I see a property here in Las Vegas with a Pro Forma Cap Rate of 20%, I know that there is something wrong, but evaluating that situation can potentially lead to a much larger profit.



-Christopher

Originally posted by @Christopher Brainard :

Purely based on the formula, a higher Cap Rate means more projected NOI, which means there is the potential for more income and a better deal.

-Christopher

Christopher, a higher cap rate means the exact same NOI is considered riskier by the market.

$100,000 NOI at a 5% cap rate is worth $2,000,000.

$100,000 NOI at a 10% cap rate is worth $1,000,000.

You have learned cap rates backwards,

Originally posted by @Christopher Brainard :

@Bob Bowling

 . When I see a property here in Las Vegas with a Pro Forma Cap Rate of 20%, I know that there is something wrong,

-Christopher

I can pretty much guarantee you that the 20% cap rate is a miscalculation by someone that does not understand cap rates.   Most problem solving is not reflected in the cap rate but are accounted for with below the line adjustments.  Can you post a 20%+ cap rate comp?

Originally posted by @Bob Bowling:
Originally posted by @Christopher Brainard:

Purely based on the formula, a higher Cap Rate means more projected NOI, which means there is the potential for more income and a better deal.

-Christopher

Christopher, a higher cap rate means the exact same NOI is considered riskier by the market.

$100,000 NOI at a 5% cap rate is worth $2,000,000.

$100,000 NOI at a 10% cap rate is worth $1,000,000.

You have learned cap rates backwards,

My understanding of property financials is fine. If you want to spend 2M instead of 1M for 100k cash flow, be my guest. With all things being the same, I want to spend as little as possible and achieve the most cash flow.

-Christopher

Originally posted by @Christopher Brainard :
Originally posted by @Bob Bowling:
Originally posted by @Christopher Brainard:

Purely based on the formula, a higher Cap Rate means more projected NOI, which means there is the potential for more income and a better deal.

-Christopher

Christopher, a higher cap rate means the exact same NOI is considered riskier by the market.

$100,000 NOI at a 5% cap rate is worth $2,000,000.

$100,000 NOI at a 10% cap rate is worth $1,000,000.

You have learned cap rates backwards,

My understanding of property financials is fine. If you want to spend 2M instead of 1M for 100k cash flow, be my guest. With all things being the same, I want to spend as little as possible and achieve the most cash flow.

-Christopher

It is the market that sets the cap rates for times, locations, and property types.  All you are doing by chasing cap rates is investing in riskier areas not making more money!  How do you solve that?   

@Bob Bowling

You clearly seem to be doing your best to derail this thread and be as unhelpful as possible to the original poster, so don't expect a reply from whatever nonsense you post after this. 

The Cap Rate is simply a ratio of the NOI divided by the sale price, therefore, is dependent upon the characteristics of the property in question. While the market can tell you what a 'fair' cap rate is for any given area, it in no way dictates what the exact sale price must be.

You seem to be struggling to understand this concept or understand how I invest. I recommend you stick to buying entries to your real estate lottery, I think the rest of us will stick to using facts and figures. Maybe one day you'll be successful like the rest of us?

-Christopher

@Dan D. Thought you might be interested in this comparable listing. Stated NOI >$1m, stated occupancy 86%, auction starting at $3.5m. 28% cap, what could go wrong????

Obviously, the tenants are about to leave and downtown office vacancies are super high at the moment. I'm guessing you would be lucky to break even - unless of course you happen to own a business that needs a lot of office space.

Yeah Auction.com properties tend to be overpriced. Secret bidders on the site jacking stuff up trying to get to the sellers reserve. The start price means nothing and is built to lure people in.  

I don't even look at auctions anymore. Off market is the way to go to land the best deals. You have the sellers full attention one on one and can negotiate the best price and terms. Some sellers are willing to give great deals in exchange for not having to officially put on the market and go through all the hassle of that process.

I had a similar experience. A saw a NNN strip mall with a 20% cap rate. I thought this was just too good to be true. I looked everywhere for the catch and even wrote my contract contingent on the tenants signing a new five year lease. I tried to flip the paper, advertising the property for a 12% cap and the response that I got from people was it was too good to be true for a NNN property.

A year later and I have the property under contract at a 10 cap and a half million dollar profit.  There was no catch.  The tenants are phenomenal and they are all intending to stay for a long time.  The only "catch" here was that the property was initially listed by a residential realtor doing a favor for a friend.  He did not know how to value commercial property.  The moral of my story, if it is too good to be true, it often is, however, in rare occasions, it pays to be cautiously optimistic.  Best of luck to you all.