When deals are really just "overpriced offerings"

Investor · Member since 2021 · 131 posts · 100 votes

To the group: As more and more "deals" cross my desk and I perform underwriting, I find that the vast majority of these deals are simply overpriced offerings - even in lousy locations, Cap Rates are around 3-4%. Most offerings have minimal meat on any of the bones, and by the time financing is factored in, it cripples the cash flow, sometimes into the negative. It's amazing to see what are being called "deals" these days.

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Alexander FelicePro Member

Guy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votes

Cap rates are compressed right now, and mania is in the air.

I just sold a property that didn't make money to someone who paid far more than me. Maybe rent increases will save him, but there is nothing in my market that would suggest such a thing to happen.

Everyone is a playing a different game. Some people need to make big returns, some people just need to spend capital, some people have access to different debt, some people need to show losses. Some people are willing to overpay for a deal just to say that they closed something on social media.

Everyone has different reasons for buying

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Jaron WallingPro Member
Rental Property Investor · Indianapolis, IN · Member since 2018 · 4k+ posts · 4k+ votes
4y
Just preaching to the choir.

We continue to offer what makes sense on distressed deals and see what happens.
2 Reply
Robert ONeill
Member since 2020 · 5 posts · 2 votes
4y
Who is buying these deals? Most of the stuff I've seen in the Los Angeles area at sub 4 cap rates and rent control are selling in weeks.
2 Reply
Chase Parrish
Investor · Thomasville, GA · Member since 2020 · 8 posts · 13 votes
4y
I understand that and experience similar challenges in my Georgia markets. In times like this, it is imperative that we abide by Joe Fairless's three laws of investing: invest for cashflow, secure long-term debt and have adequate cash reserves.
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David C.
OP
Investor · Member since 2021 · 131 posts · 100 votes
4y
@Robert ONeill Precisely! I had omitted that part of my post at the risk of sounding like "captain obvious", but my thought is that unless there is something that I am missing, when the market cools/corrects from this frenzy, and/or vacancy rates increase, people who overbought will be hemorrhaging cash, with such little (or no) cashflow to begin with. It's just crazy stupid.
1 Reply
Joseph Bagley
Investor · Chula Vista, CA · Member since 2019 · 51 posts · 21 votes
4y
I’m considering building from the ground up. Maybe a duplex neighborhood or even tiny home communities.
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Shiva Bhaskar
Investor · Los Angeles, CA · Member since 2017 · 523 posts · 476 votes
4y
Originally posted by @Robert ONeill:
Who is buying these deals? Most of the stuff I've seen in the Los Angeles area at sub 4 cap rates and rent control are selling in weeks.

Hey Robert, I invest in LA so I see this often. There are plenty of deep pocket investors, mostly rich families, that like owning real estate here for the long term. They're able to work with the various laws, but they also have a long horizon and often will keep these properties in the family for the long run if possible. Many of them use minimal debt, buying cash and refinancing or getting a bridge loan in a few years.
Also, we have a lot of foreign buyers here who are parking cash as you know. I think even in lower quality areas, plenty of them are buying these deals. I know of an under 3 cap property near Hollywood that traded for over $6 million, all cash to an Asian investor group that works with local management. Granted, Hollywood is a good area as far as rentals go, but you can find these sorts of folks buying in rougher areas too.
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Russell BrazilBusiness Member
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Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
4y
In an environment where prices and rents are exploding quickly....why wouldn't cap rates be low to account for rapid asset and rent growth?
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Alexander FelicePro Member
Guy with Great Hair · Austin, TX · Member since 2013 · 2k+ posts · 4k+ votes
4y
Cap rates are compressed right now, and mania is in the air.
I just sold a property that didn't make money to someone who paid far more than me. Maybe rent increases will save him, but there is nothing in my market that would suggest such a thing to happen.
Everyone is a playing a different game. Some people need to make big returns, some people just need to spend capital, some people have access to different debt, some people need to show losses. Some people are willing to overpay for a deal just to say that they closed something on social media.
Everyone has different reasons for buying
[email protected]Podcast Guest on Show #301
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Karl B.
Rental Property Investor · Erie, PA · Member since 2015 · 1k+ posts · 2k+ votes
4y
I look at commercial cap rates and laugh. There are well-established, safe stocks that have been around for 100 years that offer more in dividend payouts than a paltry 3.5%-4% cap rate. It's a joke.
I bought some value-add properties in November that are 20%-35% below market rents. There are deals out there - but they go quickly. I was contacting the seller two hours after he posted the rental portfolio on the MLS.
I don't factor nor consider appreciation when I buy. I'm all about cash flow.
There will be a point when interest rates rise (to combat inflation) and banks tighten. At that time those of us who have cash will be growing our portfolios with deals that will vary in degree according to market.
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Spencer Gray
Syndication Expert and Investor · Indianapolis, IN · Member since 2016 · 591 posts · 808 votes
4y
@Karl B. cap rates do not equal return or yield. We bought a deal at the end of 2020 for a 4.75% cap rate, it cash flowed 13% in 2021 (this year). This was a class A 2018 built asset, one of those that when one would look at it you would assume no cash flow, but one would be incorrect.
Cap rates reflect market sentiment, nothing else.
What many are missing is that there is a $150-250 (10%-35%) spread between effective and market rents depending on your market. With inflation still rising that delta is likely to increase.
If you are still operating out of the same playbook that you were in 2019, you will be left behind.
That being said, in this environment it's easy to over speculate, and may groups are. In my mind when I see we are going to fall short a few hundred thousands units of supply this year when we are already millions of units short, there are good reasons for modest speculation on future growth.
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Satyam Mistry
Investor · Omaha, NE · Member since 2019 · 130 posts · 139 votes
4y
@Spencer Gray Hello Spencer, I had a follow up to your message. In your opinion what is driving the higher CoC returns on compressed cap rate acquisition? In the example class A asset you had purchased at a 4.75% cap rate and are yielding a 13% CoC is this factoring in P&I payments or interest only? Of course cash flow is real either way, but was curious on the debt structure.
For say sub 5 cap multi family acquisitions what have you generally being seeing as the lead driver to achieving 10%+ CoC returns on compressed cap rates? Would you say these are generally more common for A class assets that are able to achieve these returns based on the higher rents and lower OPEX ratios due to age of the building?
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Karl B.
Rental Property Investor · Erie, PA · Member since 2015 · 1k+ posts · 2k+ votes
4y
Originally posted by @Spencer Gray:
@Karl B. cap rates do not equal return or yield. We bought a deal at the end of 2020 for a 4.75% cap rate, it cash flowed 13% in 2021 (this year). This was a class A 2018 built asset, one of those that when one would look at it you would assume no cash flow, but one would be incorrect.
Cap rates reflect market sentiment, nothing else.
What many are missing is that there is a $150-250 (10%-35%) spread between effective and market rents depending on your market. With inflation still rising that delta is likely to increase.
If you are still operating out of the same playbook that you were in 2019, you will be left behind.
That being said, in this environment it's easy to over speculate, and may groups are. In my mind when I see we are going to fall short a few hundred thousands units of supply this year when we are already millions of units short, there are good reasons for modest speculation on future growth.

You state that cap rate reflects market sentiment and nothing else. Cap rate is NOI/current market value/price. It's a concrete number based on a formula and not a matter of opinion. It literally states the current return for an income property.
We won't consider anything less than a 7 cap. And my 2019 playbook is the same as my 2015 playbook: nothing less than a 7 cap. And it's worked well for us and stating we'll be left behind is your opinion and one I can only chuckle at. Good day.

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Curtis S Lake
Member since 2021 · 2 posts · 0 votes
4y
Cap rate is based on a formula, but the current market value is in part based on how much people think it is worth, the appraiser's, seller's, buyer's, real estate agent's opinion. Market value is not always easy to nail down and it can change more because of sentiment than actual value. The only time you have a solid market value is the day it sells.
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Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
4y
@ everyone
Watching Monday night Storage wars on TV. Reading BP posts.
We do SelfStorage. If there was ever a REI type to use Cap Rates that would be it. We don't follow or use it as a metric.
Trick question.
On the properties your looking at, where do you get your cap rate from?
Who gives it to you?
2 Reply
Nathan McIntire
Investor · Detroit, MI · Member since 2014 · 97 posts · 40 votes
4y
@David C.
I agree that most deals i underwrite today just don't make sense for myself or my investors. The pandemic has certainly affected the real estate sectors more than others. With low interest rates, cap rates for commercial real estate properties are at all-time lows for just about every asset class. With that being said, there are still plently of good deals out there, just harder to come by now days.
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Don Gouge
Specialist · Johnson City, TN · Member since 2021 · 139 posts · 146 votes
4y
Just look around this site and see all of the new investors willing to take thin deals just to " get into the game".
3 Reply
Andrew Carlson
Rental Property Investor · Rochester, MN · Member since 2017 · 224 posts · 323 votes
4y
@Don Gouge
The hosts of bigger pockets podcast constantly say “just start, just get in”
This could be dangerous advise to a new investor in this market. I “got in” last year. We will see what happens.
When listening to podcasts (specifically BP), remember, virtually everyone on the show started after the Great Recession and has been riding this insane wave of appreciation.
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Don Gouge
Specialist · Johnson City, TN · Member since 2021 · 139 posts · 146 votes
4y
Originally posted by @Andrew Carlson:
@Don Gouge
The hosts of bigger pockets podcast constantly say “just start, just get in”
This could be dangerous advise to a new investor in this market. I “got in” last year. We will see what happens.
When listening to podcasts (specifically BP), remember, virtually everyone on the show started after the Great Recession and has been riding this insane wave of appreciation.

People only make money when property changes hands. Realtors will always say that now is the time to buy. Appraisers, inspectors, attorneys, bankers, government and many others make money when someone makes the decision to buy. The economy depends upon churn. Just about everyone in any kind of business will slant their advice in order to make their product or service look better and more needed. I am not saying that all of these people are being dishonest but many have been just conditioned to believe whatever they do is the best or needed. I do work as a in person mentor. Is my service superior to a book or a seminar or podcast? Yes. Is it always best to hire me in order to learn more? I would like to say yes and it would benefit my wallet to always say yes but it depends upon the situation. If it is a toss up question I will always say my service is needed. BP is a business and a stagnant market is a losing market for them. Wannabe investors are their gold mine to sell enhanced memberships, seminars and books to. You don't want to fun of prospects with the dirty, ugly truth
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Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
4y
Originally posted by @David C.:
To the group: As more and more "deals" cross my desk and I perform underwriting, I find that the vast majority of these deals are simply overpriced offerings - even in lousy locations, Cap Rates are around 3-4%. Most offerings have minimal meat on any of the bones, and by the time financing is factored in, it cripples the cash flow, sometimes into the negative. It's amazing to see what are being called "deals" these days.

I don't post very much anymore. I don't even log on much anymore. But, when I do, I seem to immediately be exposed to your posts, and I have yet to figure out whether you are a rather dumb person with a big mouth, or a smart person who'd like to learn how the big boys play, what makes us tick, and what we see differently :)
If you do, in fact, want to know what it takes to be an investor in this environment, then comment on this post with 1 very specific question and I'll be happy to be direct with my answer.
I'll kick us off by saying that cap rates have exactly nothing to do with the value of an investment to me. So, any post leaning on the low cap rate as an indication that the investment is over-priced is automatically misguided and misses the point 100%, as fr as I am concerned.
Your turn...

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Joe SplitrockPro Member
Moderator
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
4y
Keep in mind that a deal is just a sale. There are good deals, bad deals and average deals. What appears to be a bad deal today, could look amazing in a few years. I actually love it when people "overpay" for several reasons:
1. It helps push up market prices. Every higher price sale creates a sales history to help support higher prices in the future. Valuation is is based on comparable sales.
2. It forces rents higher. If someone has payments higher than rent, they will feel pressure to increase rents. When properties sell, the new owners almost always raise rents because they are supporting a higher cost basis. This helps me justify higher rents on my properties.
3. If things turn and investors have trouble making payments, it can open buying opportunities. There were many landlords who had to short sell or lose properties after the housing crash. So if scenarios 1 or 2 don't end up coming true, I can benefit from scenario 3.
As far as "get into the game" I actually think this is more important than people think. Time will make an average deal profitable. Time gives you the benefit of cash flow and appreciation. When people "wait" for a good deal, they often end up paying more than they would have in previous years. This is why I say that waiting is a fools game. People are waiting for something that will never happen. Even if a crash does happen, most people will not take advantage of it. If you think it is scary to buy in a hot market, trying having the guts to buy in a tumbling market.
I am not a realtor, but I do agree that "now is the best time to buy". You can't travel back in time and waiting is just missed opportunity.
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Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
4y
We've been selling more than buying. The effort/reward hunting ratio, like 200:1, is way too high for me.
To get a deal, we need to create one by changing or repurposing the asset or solve a seller's problem. Off-market doesn't hurt.
To sell, I just need to estimate the 5 yr ARV, ask for that and present it as a value-add opportunity. LOL. We used to call it a fixer that needed work. They still sell. Be a seller.
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Satyam Mistry
Investor · Omaha, NE · Member since 2019 · 130 posts · 139 votes
4y
@Ben Leybovich Hello Ben, when you say that the cap rate is irrelevant to you is this because if you see great upside on the NOI not currently being captured than you focus more on what your opportunity is and how fast you could get to those desired returns rather than the going in cap rate? Thank you for your input.

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Ben Leybovich
Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
4y
Originally posted by @Satyam Mistry:
@Ben Leybovich Hello Ben, when you say that the cap rate is irrelevant to you is this because if you see great upside on the NOI not currently being captured than you focus more on what your opportunity is and how fast you could get to those desired returns rather than the going in cap rate? Thank you for your input.

Short answer- yes. If you think about it, all of the money is made in the Delta. This is nothing new and this is same in all markets. When you buy stocks, for example, it's because you either think they are underpriced relative to the intrinsic value of the company (you are buying the Delta to the upside) or because you think they are overpriced (you are shorting the Delta to the downside). In both cases, the money is in the Delta.
Real estate has always been the same. The cap rate describes the market. We buy the Delta. The more Delta there is, the more we pay for the asset, which in turn drives the cap rate down. And, the truth of this is that in the current cycle cash flow is the enemy of value in that if you are able to purchase healthy CF on day 1, which means you are purchasing at a fairly high cap rate, this necessarily means that there isn't much Delta because if there were the cap rates in the market would be lower and you'd never be able to buy at such high cap rate so as to see healthy CF. It's a ying and yang.
Makes sense?
4 Reply
Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
4y
If an REI investment arena was to ever use Cap Rate it would be self storage. But we don't use it. We analyze deals based on an 8 to 12 year payback; with a loan amort period of 20 or more. This does not include value add potential since, I would be paying the current owner for improvements that I would be doing.

Can Cap Rates be used to analyze properties, I guess so. But to me only to the following degree:

When I want to go catch Red Snapper I look for Salt water, not fresh water. That to me is the level of use of Cap Rates looking for a deal. You might use at a macro standpoint, but I wouldn't even do that. You have to look at the details as shown below.

I am using the Self Storage arena for the following discussion. There might not be as many variables or potential in the SFH and MFH world, but still the same concepts.

Same property, same market, same everything except the following:

  Option 1:    Option 2: How???????????????
Selected P/L items:

Rental deductions $20,000 $5,000   ??????

Property Tax $30,000    0    ??????

Insurance $10,000   0 ????????

Electric $12,000   0   ????????

Auto $ 6,000 0   ????????

Management    $20,000 0    ????????

Snow/Landscaping $  4,000    0 ????????

Advertising    $20,000   0   ????????

Net Operating Income    $100,000 $207,000

Property Market Value $1,500,000 $1,500,000
Yes, Market value would go up as NOI increases, left the same for discussion, you can adjust to $3,089,000 new NOI value at 6.7% cap.

CAP rate    6.7% 13.8%

All of the above tactics, positions, decisions, situations are legal and easily executed. But see the big swings in CAP rate, and in turn potential Market Value. Some of these are "timing" and others are permanent.

If you respond, please address the following:

A. Where and from whom do you get your CAP rate figures?

B. To what degree do you analyze the CAP rate figure?

C. How would you move the above figures or how could they move without your efforts? They could go up or down in your scenario.

Don't trust me or the Cap Rate figure. Do your due diligence. Because if I'm selling to you, I want your money.

There is a tool or metric for everything, make sure you're using the right tool.

nbsp; 4,000 0 ????????

Advertising $20,000 0 ????????

Net Operating Income $100,000 $207,000

Property Market Value $1,500,000 $1,500,000 Yes, Market value would go up as NOI increases, left the same for discussion, you can adjust to $3,089,000 new NOI value at 6.7% cap.

CAP rate 6.7% 13.8%

All of the above tactics, positions, decisions, situations are legal and easily executed. But see the big swings in CAP rate, and in turn potential Market Value. Some of these are "timing" and others are permanent.

If you respond, please address the following:

A. Where and from whom do you get your CAP rate figures?

B. To what degree do you analyze the CAP rate figure?

C. How would you move the above figures or how could they move without your efforts? They could go up or down in your scenario.

Don't trust me or the Cap Rate figure. Do your due diligence. Because if I'm selling to you, I want your money.

There is a tool or metric for everything, make sure you're using the right tool.

1 Reply
Wes Short
Real Estate Broker · Indianapolis, IN · Member since 2015 · 112 posts · 64 votes
4y
@David C.@Ben Leybovich @Satyam Mistry

I would add that many sellers at this time understand the market and are going out aggressive because they know a delta is present in current rents vs what rents could be. Thus pushing down cap rates and trying to account into the price the potential that is already present. This becomes a hard sell to buyers because it isn't actualized yet but its in the price. Some buyers will pay this but some won't.

Have to reminder also that cap rate is suppose to, in a perfect market, represent a correlation of risk vs reward. so finding delta, or having a competitive advantage, can increase your reward compared to risk in certain situations.
Would you agree with that last part Ben?
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