Who buys Multi Families w/ 6% Cap Rates

Commercial Real Estate Investing
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Who buys Multi Families w/ 6% Cap Rates

Emilio Ramirez
Contractor · Denver, CO · Member since 2009 · 399 posts · 166 votes

I've been looking at multifamily properties on MLS, backpages, loopnet, etc and applying the 50%/2% rule to them. I've also been looking at the cap rate, cash on cash return, IRR and NPV. On the surface, none of these seem like good deals and don't come close to meeting the 50/2 rule. Many of them seem to be overpriced by 3-400% in order to achieve a 20% cash on cash ROI. What is the game being played here? Do people actually buy these properties at these rates? Is the seller just starting high, knowing that the offers he is going to receive will be lower?

Here's an example of what I'm finding typically.

# Price:$598,000
# No. Units:12
# Building Size:11,520 SF
# Price/Unit:$49,833.33
# Property Type:Multifamily
# Property Sub-type:Garden/Low-Rise
# Property Use Type:Investment
# Construction Status:Existing
# Commission Split:2.5%
# Cap Rate:8%
# Occupancy:100%
# No. Stories:2
# Year Built:1977
# Lot Size:0.57 AC
# Tax ID / APN #4023
# Parking Ratio:17 / 1,000 SF

I understand that is not necessarily the best way to find a bargain purchase, but I am seriously wondering who buys this type of property? And why?

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Kyle K.
Real Estate Investor · Chicago, IL · Member since 2008 · 122 posts · 46 votes
17y

Emelio R,

Many people buy Multi-Families with Cap Rates of 6% and less. In fact, in San Diego you won't find a multi-family with a Cap rate less than 7.5%. Does that mean that no one buys multis in San Diego or that, even worse, anyone that does loses money? Of course not. To say otherwise would be ignorant.

In fact, in another thread, https://www.biggerpockets.com/forums/48-general-real-estate-investing/topics/34916-appreciation-vs-cash-flow-the-clash-of-the-titans-?page=8, I address an example where my company not only increased the value of the multi-family in question, but it also provided positive cash flow.

Now, am I saying that it's easy? Absolutely not. Sometimes the negotiations alone take an extraordinary amount of time. Closing a multi-family usually takes significantly longer than, say, a single family home. However, to those experienced teams that know how to spot a good value and, more importantly, capitalize on that value, the rewards are lucrative. I hope that answers your question!

Kyle

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    "Who buys Multi Families with 6% cap rates?" Thousands of newbies with a financial death wish - that's who!

    You bet they do! They're dazzled with a lot of important sounding gibberish about cap rate, IRR, NPV, pro-forma, and other meaningless nonsense. They have no clue that they're about to lose their butt on the negative cash flow, because they don't even understand how to calculate real world cash flow! Sad, but true!

    Mike

    4Reply
  • Karen Parker
    Real Estate Investor · Tampa, FL · Member since 2008 · 456 posts · 42 votes
    17y

    While we're on that topic, where would you suggest someone that is interested in moving into multifamily properties go to get information on determining the cashflow of a property.

    0Reply
  • Emilio Ramirez
    OP
    Contractor · Denver, CO · Member since 2009 · 399 posts · 166 votes
    17y
    Originally posted by MikeOH:
    "Who buys Multi Families with 6% cap rates?" Thousands of newbies with a financial death wish - that's who!



    You bet they do! They're dazzled with a lot of important sounding gibberish about cap rate, IRR, NPV, pro-forma, and other meaningless nonsense. They have no clue that they're about to lose their butt on the negative cash flow, because they don't even understand how to calculate real world cash flow! Sad, but true!

    Mike


    Financial death wish! That's hillarious. I think I had a financial death wish on my first project. Luckily for me it was a duplex and turned out to be financial road rash, painful, but I survived and learned from it.
    1Reply
  • Emilio Ramirez
    OP
    Contractor · Denver, CO · Member since 2009 · 399 posts · 166 votes
    17y
    Originally posted by Karen Parker:
    While we're on that topic, where would you suggest someone that is interested in moving into multifamily properties go to get information on determining the cashflow of a property.


    I would start by reading all the MF threads on this site.
    0Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    Karen,

    The cash flow calculation for a multi is EXACTLY the same as for a SFH.In other words, to find cash flow you still subtract the debt payment from the half of the gross rents to get cash flow.

    Good Luck,

    Mike

    0Reply
  • Karen Parker
    Real Estate Investor · Tampa, FL · Member since 2008 · 456 posts · 42 votes
    17y

    Thanks MikeOH. Being accustomed to dealing only with SFH it seems the sheer size of a 200+ unit complex would make it more complicated. You might have noticed at this point I do mostly short sales. I'm running into a lot of apartment complexes lately that seem would be screaming good deals by the time I got them negotiated but have been reluctant to dive on any of them because of my lack of experience with something of that size.

    1Reply
  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    17y

    A multi-unit isn't really more complicated, but it is MORE. More leases to look at; more units to inspect; more tenants to evaluate; more evictions; more lawsuits; more problems; more money (in and out); more maintenance; etc.

    I certainly wouldn't suggest jumping from a few SFHs to a 200+ unit complex. That would almost certainly be too much.

    Mike

    1Reply
  • Karen Parker
    Real Estate Investor · Tampa, FL · Member since 2008 · 456 posts · 42 votes
    17y

    My feelings exactly ;)

    0Reply
  • Louis Bergman
    Real Estate Investor · Weston, FL · Member since 2008 · 47 posts · 28 votes
    17y

    I say it's actually easier to get good financing when you're buying a large 100 unit plus Multifamuly complex, but that's another story.

    But as to the specific remark on more work, the following.
    I strongly suggest you carefully select a Professional Management Company to help you with a lot of the due diligence. They have systems in place to do such a review, and as they will be responsible to run your property at the lowest cost possible, they will be very detailed in their evaluation.

    Yes, it may cost you a couple of thousand dollars, but in this playing field beware for penny wise pound foolish. The Lender who is evaluating your financing request will recognize you as a Pro and that will have a very positive influence on their willingness to do business with you.

    Hope that helps a bit.

    3Reply
  • Dory Peters
    Real Estate Investor · dc, Washington D.C. · Member since 2008 · 392 posts · 89 votes
    17y
    Originally posted by MikeOH:
    A multi-unit isn't really more complicated, but it is MORE. More leases to look at; more units to inspect; more tenants to evaluate; more evictions; more lawsuits; more problems; more money (in and out); more maintenance; etc.

    I certainly wouldn't suggest jumping from a few SFHs to a 200+ unit complex. That would almost certainly be too much.

    Mike

    Mike, you have a way with words. :cool:
    0Reply
  • Karen Parker
    Real Estate Investor · Tampa, FL · Member since 2008 · 456 posts · 42 votes
    17y

    Louis, thanks for the input. I have already discovered during my escapades with SFHs that I do not want to be a hands on landlord. A good property management firm is a necessity for me no matter what type of property it is.

    0Reply
  • Kyle K.
    Real Estate Investor · Chicago, IL · Member since 2008 · 122 posts · 46 votes
    17y

    Emelio R,

    Many people buy Multi-Families with Cap Rates of 6% and less. In fact, in San Diego you won't find a multi-family with a Cap rate less than 7.5%. Does that mean that no one buys multis in San Diego or that, even worse, anyone that does loses money? Of course not. To say otherwise would be ignorant.

    In fact, in another thread, https://www.biggerpockets.com/forums/48-general-real-estate-investing/topics/34916-appreciation-vs-cash-flow-the-clash-of-the-titans-?page=8, I address an example where my company not only increased the value of the multi-family in question, but it also provided positive cash flow.

    Now, am I saying that it's easy? Absolutely not. Sometimes the negotiations alone take an extraordinary amount of time. Closing a multi-family usually takes significantly longer than, say, a single family home. However, to those experienced teams that know how to spot a good value and, more importantly, capitalize on that value, the rewards are lucrative. I hope that answers your question!

    Kyle

    7Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y

    Many people that live in areas where project-level returns are driven almost exclusively by the reversion cash flow...or on appreciation. People buy "growth stocks" all of the time based on optimistic cash flow assumptions and nobody claims they have a "financial death wish."

    REITs or large institutions with a very low cost of capital may even be able come close to cash flowing with 6% cap rates...especially with a large equity stake at the project's outset.

    2Reply
  • Jon Klaus
    Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
    16y

    I looked at a 6% cap 12 unit just yesterday that could make sense. Why? 2 reasons; assumable 6% fixed, interest only mortgage (possible low down), and a great area that should be able to support rent increases now and in the near future.

    6Reply
  • Mona Shaboon
    Real Estate Broker · San Antonio, TX · Member since 2009 · 49 posts · 3 votes
    16y

    Unfortunately a lot of investors would look for the higher cap rate and would skip a distressed property mistakingly by looking at the low cap rate thinking it is too overpriced.

    Sometimes you have to look beyond the low cap rate one more step further to look for reasons that NOI was low and see if you can fix that reason then you got yourself a gem and would make fortune.

    Cap rate could be artificially depressed in underperforming properties. That is why you should sometimes buy properties with six percent cap rate.

    2Reply
  • Account Closed
    Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    16y

    While I agree that I want to look at a properties potential, I do not want to pay for something that currently doesn't exist. If I was reasonably assured of some upside potential I might place less way weight on current negatives, but those current negative will effect the price I am willing to pay.

    Would I buy an apartment with a 6 cap, maybe. In this current market though in my area it is possible to find properties that are in good locations that have better cap rates. It takes time and patience to find gems at reasonable prices.

    1Reply
  • Rich Weese
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    16y

    I don't know if I would buy a 6% cap property or not. I don't even LOOK at a cap rate. There are so many other tangilbles AND intangibles that I want to check out. I really don't have a clue as to what the cap was on the last 2 projects I purchased, in the amount of $7,000,000. Different strokes for different folks, I guess. Its' worked out ok for me for decades. Rich

    0Reply
  • Ingrid Nagy
    Property Manager · Passaic, NJ · Member since 2008 · 369 posts · 83 votes
    16y

    Like Rich I ignore cap rate too. If you see a potential for the property that's what counts. Do your due diligence properly-verify expenses, improvements, income, maintenance. If it means going into every apartment-I will go in every apartment. Verify your NOI, apply your debt service and get your true cash flow. See who generally pays late, what is your turnover rate, which tenants are not at market rate. Interview tenants as if you were a tenant looking to move into the building - talk to people on the street as if you were moving into the area. They will tell you EVERYTHING - especially the bad. Then decide if and where you can make changes that would be beneficial. Determine what changes you can make to improve that cash flow that the current owner is not doing. Cap rate is irrelevant - key is to finding the diamond in the rough.

    2Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    16y

    If your goal is to reposition product skillfully an inflated (lower) cap rate is actually BETTER for you. As you add value to the product you get paid more for each unit of work you put into it relative to something with a high cap rate. A blanket statement that claims a 6% cap rate is "bad" is inaccurate to me. There is plenty of good product with those cap rates. Nobody says that you have to leverage to the max to properly capitalize your project. Stuff with a 6% cap rate DOES cash flow if you drop a 40% equity stake into it...even as interest rates inch a bit higher.

    If that 40% equity stake keeps your operating leverage positive and you reposition the unit quickly to add value it may very well return a better IRR than dropping 20% into a 10-cap apartment in class-C-ville where it takes several years to stabilize...with your 18%+ IRR hurdle rate equity stake in the deal.

    Speed and timing are sometimes worth more than frothy leverage. You have the run the models and see what the sensitivity is to known possible source of trouble...like vacancy, capex, repairs, rent escalators, etc...those are the main ones that come to mind.

    4Reply
  • Mona Shaboon
    Real Estate Broker · San Antonio, TX · Member since 2009 · 49 posts · 3 votes
    16y
    Originally posted by Charles Perkins:
    Unfortunately a lot of investors would look for the higher cap rate and would skip a distressed property mistakingly by looking at the low cap rate thinking it is too overpriced.

    Sometimes you have to look beyond the low cap rate one more step further to look for reasons that NOI was low and see if you can fix that reason then you got yourself a gem and would make fortune.

    Cap rate could be artificially depressed in underperforming properties. That is why you should sometimes buy properties with six percent cap rate.


    While I agree that I want to look at a properties potential, I do not want to pay for something that currently doesn't exist. If I was reasonably assured of some upside potential I might place less way weight on current negatives, but those current negative will effect the price I am willing to pay.

    Would I buy an apartment with a 6 cap, maybe. In this current market though in my area it is possible to find properties that are in good locations that have better cap rates. It takes time and patience to find gems at reasonable prices.


    The deal has to make sense before you consider it a deal. And yes it takes practice to find those gems. Although it is not tied to one market or another. It is on a case by case scenario. Gems can be found in bad and in good areas. Deals are everywhere as motivated sellers are everywhere.

    If you study the properties' financials real good and do your homework, then you can make your decision logically after that, then you will come across a deal and something would jump right at you.

    0Reply
  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    16y

    I think where many make a mistake is trying to fit one situation into a way everyone should invest.

    In the multi-family arena most small investors will not pursue class A properties.The reason is they will lose out to Reit's,pensions,hedge funds every day of the week.

    These companies will seek SAFETY for MARGINAL returns to place their money.They are into wealth preservation with small growth instead of wealth creation.

    This is why I get calls from investor groups looking for B,C buildings with an A,B,C location.

    They don't go after A's because the returns don't justify their investor pools guidelines for acquisition.

    I have investors from California,New York etc. contact me every week looking for property here in Ga. In the other states they are only hitting say a 5 or 6 CAP for trophy class A properties.

    A self-manage will usually hit a wall at anything more than 20 units or start to run very poorly.Many want at least 50 units or more as you can land a quality IREM property manager for 5%.

    If you buy less units the fees go up and you have a different type of manager.

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    1Reply
  • Dory Peters
    Real Estate Investor · dc, Washington D.C. · Member since 2008 · 392 posts · 89 votes
    16y

    The cap rate alone doesn't mean much. Yet, a discussion that addresses the cap rate along with the other terms (ie the loan interest rate, the amount of cash invested, the yield, one's investing goals [for that property], etc) is much more meaningful.

    I've seen some class A commercial properties in NYC being sold at a 3% and 4% caps that might make sense for some buyers. The only way I'd even consider getting something with a cap that low is if I got it with great terms.

    0Reply
  • Tony Albanese
    Commercial Real Estate Broker · Dallas, TX · Member since 2010 · 11 posts · 6 votes
    16y

    I'm looking at a MF deal right now that goes like this:

    200+ units
    Currently 95% leased
    ~$1.25 effective rents (after concessions)
    NOI ~ $1.7M
    6.5% Cap

    This is a GREAT deal for the following reasons:

    1. It is Class A project in a desirable sub-market with low historic vacancy

    2. The city it is in has stable job growth

    3. It is new, with no deferred maintenance

    4. I can get 4.7%, 30 yr amort, non-recourse debt at 80% of cost

    Cash flows about $350k

    In five years, if I can grow the rents to $1.50 (reasonable), I can refinance and pull all of our equity out

    The key is the debt. MF is the only product type I can get 80% non-recourse at those rates.

    3Reply
  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    16y

    As to the point about C buildings taking years to lease up that doesn't happen if you buy correctly.

    Due diligence should be performed in the local area as to what other apartment buildings there are with the age,unit mix,rents,amenities,location,and current occupancy levels.

    Sellers and brokers like to paint a picture of our rents for example are 550 a month.

    You have to ask the question WHY.Is it because the property doesn't offer amenities? Is it because the property needs a lot of capital improvements? Is it because the market rent they are asking is too high for the area leading to low occupancy rates?

    So I usually will look and if other buildings are at 550 a month I want to buy and base my numbers off of 475 to 500 a month.This way I lease up fast and the rest if I get more is cake.Tenants want the nicest place at the cheapest rate most times with a decent location.

    I don't want to increase rents where the lease up process is real slow.I want to increase cash flow fast for a little under market rent and then increase later on.

    So it's all about buying it right.

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  • Alfredo S.
    Real Estate Agent · Orlando, FL · Member since 2016 · 8 posts · 0 votes
    10y

    Hi Rich. Where do you find good deals then. Im having a very similar problem. I have all the financing i need, but i need to find deals that are worth it. Deals that have enough cashflow to support 100% financing. can you help please?

    0Reply
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