When deals are really just "overpriced offerings"

Multi-Family and Apartment Investing
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When deals are really just "overpriced offerings"

David C.
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
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

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  • Ben Leybovich
    Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
    4y
    Originally posted by @Wes Short:

    @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?

     Lol I'd imagine that's what CCIM teaches. I am not sure I concur, though. I find it more useful to think of Cap Rate as a measure of market appetite. The more folks are willing to pay for the income, the lower the cap rate, obviously. The question becomes - is a low cap rate environment representative of higher or lower risk?

    0Reply
  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    4y
    Originally posted by @Russell Brazil:

    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?

    I have a similar mindset.  Amazon before it had any profit was already worth more than every other book store.  Why?  GROWTH.  Today virtually every housing market is a growth market.  Will it end?  Yes.  Will it be soon? No one knows, but I see no indicators that significant rent growth in my market is not a high probability for at least a few years and probably longer.  I am less bullish on the RE price continuing to appreciate much faster than inflation.  

    Let's assume that in my market RE prices increase at about the rate of inflation over the next 5 years, but rent appreciates at the lessor or rate of inflation + 5% or 10%.  I consider this a fairly conservative forecast.  Now assume most investors have fixed rate financing.  This scenario very much is a Growth scenario that could easily justify purchasing a RE with less than good cash flow.

    I do not determine the strength of a purchase by cash flow alone.  I look at many factors when evaluating an RE purchase.  Cash flow is not even at or that near the top of my list.  I would give up cash flow to reduce the short term investment.  Therefore I very much value the underpriced RE and the RE that has a strong value add.  Both of these allow me to obtain the property with very little to no initial investment.  Obtain cash neutral RE with no money invested that in a year has small cash flow and in 5 years has solid cash flow is a good investment for my needs.

    In summary, I do judged over priced based solely (or even primarily) on the cash flow.

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  • David C.
    OP
    Investor · Member since 2021 · 131 posts · 100 votes
    4y

    @Spencer Gray  Exactly right about cap rates.  There is so much misconception as to what a Cap Rate is.  I have seen 6% cap rates that have negative cash flow all dependent upon financing.  Additionally, I have seen people brag about their property having a 10% cap rate, which is in shambles in the middle of a crime ridden demilitarized zone.  Cap rate means very little to me.  In fact, I mostly ignore it and just look at cash flow.

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  • Kyle Alexander
    Member since 2019 · 12 posts · 7 votes
    4y
    Originally posted by @Karl B.:

    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.

    I don’t ever see rates rising. The federal government wouldn’t be able to afford the interest payments on the massive debt and the market would tank.


    Politicians don’t do what is right they do what is popular to get re- elected. They will keep the gravy train rolling as long as possible. 


    I think we will see zero rates for a very long time 

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  • Kyle Alexander
    Member since 2019 · 12 posts · 7 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. 

    Well said. Any advice for a young investor like myself currently house hacking and looking to scale? 

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  • Allen L.
    Rental Property Investor · Chicago and mainly invests in KS remotely · Member since 2018 · 360 posts · 314 votes
    4y

    @Ben Leybovich delta aside, wait until the benchmark rises.. that’s what I think quite a few people including myself are concerned about. Yes your rent can go up 30% in the next 5 years but what if cap rate increases 30% because fed hikes 10+ 0.25 bps times in the next 5 years? Your loan is locked, great, but cap rate did go up. What I'm saying is it affects refi exit strategy and actually your "net worth" as well if you mark to market.

    1Reply
  • Ben Leybovich
    Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
    4y
    Originally posted by @Allen L.:

    @Ben Leybovich delta aside, wait until the benchmark rises.. that’s what I think quite a few people including myself are concerned about. Yes your rent can go up 30% in the next 5 years but what if cap rate increases 30% because fed hikes 10+ 0.25 bps times in the next 5 years? Your loan is locked, great, but cap rate did go up.

     Well, I agree there. If all you are getting is 30% rent bump in the next 5 years, you are not getting much of anything. All of it could get wiped out with cap rate reversion. However, if I can gain 2% on the cap rate upon my basis in the span of 24 months, then I feel pretty well insulated. I could give all of it up to cap rate reversion and still break even, right? 

    Now, to accomplish this, income has to basically double in this time - not a mere 30% in 5 years. 

    To give you an example of what we do, we purchased a community 4 months ago. The 2x2 unit depicted in these pics had been rented for $1,250. After renovations, in August, it had rented for $1,935. Today, this layout rents for $2,225. The NOI at purchase was $1.35M - in 3 years when fully stabilized the NOI will be $2.6M. We paid $45M for this asset, which was exactly 3% capitalization of the in-place NOI. In Y3, at 5% cap it'll be worth $52M - and if the cap rates in Phoenix stay at 3%, as I suspect that they will, this community will be worth $85M.

    Now, my company, WhiteHaven, is a fairly large, vertically integrated company with construction in-house, so arguably we can do things that most cannot. This may be fair. That said, I do not believe cap rates on Class A institutional assets in Phoenix, the fastest growth market in the country, will be heading above 5% any time soon, and we are well-positioned to sustain that and wait it out. 

    3Reply
  • Allen L.
    Rental Property Investor · Chicago and mainly invests in KS remotely · Member since 2018 · 360 posts · 314 votes
    4y

    @Ben Leybovich great post, thank you. 

    1Reply
  • Ben Leybovich
    Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
    4y
    Originally posted by @Allen L.:

    @Ben Leybovich great post, thank you. 

     I am waiting for someone to ask the price per unit. Just for some shock value :)

    0Reply
  • Allen L.
    Rental Property Investor · Chicago and mainly invests in KS remotely · Member since 2018 · 360 posts · 314 votes
    4y

    @Ben Leybovich I’ll bite, what’s the price per unit?

    0Reply
  • Brandon Penn
    Rental Property Investor · Erie, PA · Member since 2018 · 84 posts · 462 votes
    4y

    The cap rates have gone down in my area (Erie, PA) but we are still seeing decent returns. Cap rates 10-15% on 1-4 units. Larger deals are harder to find and have been closer to 7-8%

    0Reply
  • Ben Leybovich
    Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
    4y
    Originally posted by @Allen L.:

    @Ben Leybovich I’ll bite, what’s the price per unit?

     Haha Brave man. This was $330k per unit. Today prices are higher for this level of product, though.

    0Reply
  • Allen L.
    Rental Property Investor · Chicago and mainly invests in KS remotely · Member since 2018 · 360 posts · 314 votes
    4y

    @Ben Leybovich nice! How are the earlier investments that you've made 2 years ago? I followed when you made the live stream walking around the apartment complex and the community pool. For these properties that you've stabilized already, what do you want to do with them going fwd? Like you don't expect rent increases from value add on stabilized asset, so say 30% increase in 5 years may be fair to me, on these assets you're more exposed to cap rate moves.

    0Reply
  • Odester Whitiker
    Investor · Dallas, TX · Member since 2018 · 12 posts · 4 votes
    4y

    @Alexander Felice You took the words right out of my mouth. Everyone is playing a different game, but the social media one isn't that smart. :)

    0Reply
  • Ben Leybovich
    Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
    4y
    Originally posted by @Allen L.:

    @Ben Leybovich nice! How are the earlier investments that you've made 2 years ago? I followed when you made the live stream walking around the apartment complex and the community pool. For these properties that you've stabilized already, what do you want to do with them going fwd? Like you don't expect rent increases from value add on stabilized asset, so say 30% increase in 5 years may be fair to me, on these assets you're more exposed to cap rate moves.

    In the last year and a half we sold 4 communities and bought 2. The average hold period on those we sold was 25 months, with 21 being the shortest and 36 the longest. The average return was 1.8x and IRR of 35%. We sold them because on a risk-adjusted basis it didn't make sense to stay in any longer, even though there was more profit to be had.

    The stuff we buy now is institutional, in much better locations and much newer, so we may stay longer. But, the value-add DNA is still very much there. We have a property in contract right now with in-place NOI of $2.2M. We are paying $72M, which is about a 3% cap. Stabilized NOI in Y3 should be pushing $4M+. You can do the numbers.

    That's the thing - the formula hasn't changed in a long time. Sure, the cap rate has compressed. But, the same economic forces that are pushing the cap rates down are also pushing the incomes up. Comparing these numbers to what they were 5, 4, or even 2 years ago is not terribly effective, but I see people do that all long. What we do, ultimately, is financial engineering, and it doesn't happen in a vacuum - it happens in response to the current and anticipated future environment. 

    2Reply
  • Brian G.
    Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
    4y

    @Ben Leybovich BP is always so much more thought provoking and entertaining when you engage on the forums!

    0Reply
  • Natalie Schanne
    Real Estate Agent · Princeton, NJ · Member since 2016 · 1k+ posts · 1k+ votes
    4y

    @David C. - it's worth jumping in to investing today because interest rates are very low. Someone posted a graphic on Facebook that was essentially like - waiting for the crash? Good for you. You'll pay more. And showing photo one - today, $250k price, $1200/mo PITI payment at 3%, and later, 200k price, $1500/mo payment at 6%. (I made up these numbers because I don't have the properly calculated graphic in front of me, but you can get the jist, even though you saved 20% on the purchase, over 30 years at a higher interest rate, you're actually paying a much higher amount.). As interest rates shift, your low cost loan will "add" value to your investment, even more so if it is assumable (which most single family residential loans are technically not).

    The other reason it’s worth jumping in today is the huge rent bumps that do not appear to be alleviating. Wage increases cause rent increases. Supply and demand. So when locally they started paying $15/hour to target stock people up from $10, the rents in the area went up about 30%. In our area market rents are up 15-20% year over year without renovating. My friend went from 1650 to 1900 easily and still has hundreds of applications within 1 month (many not qualified). I bought a 3 unit place renting for 1800 and now have it rented for 4200/mo with less than $10,000 of new vinyl flooring.

    The last reason to jump in is that real estate investment is a tax advantaged activity. You can get cash flow with low taxes. Some people use real estate to boost their quality of life by having a second home loan on an Airbnb. They use their lake or beach house personally as well as renting it. So in addition to deducting all kinds of expenses (traveling to/from your property, supplies, maintenance), they also get the joy of using it. You love Hawaii? Buy and rent out short term a waterfront condo in Maui and deduct your legitimate trips to maintain and upgrade it. (Talk to your CPA). Win-win.

    0Reply
  • Ben Leybovich
    Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
    4y
    Originally posted by @Brian G.:

    @Ben Leybovich BP is always so much more thought provoking and entertaining when you engage on the forums!

     I am glad you think so :)

    0Reply
  • Peter TverdovBusiness Member
    Developer · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes
    4y

    I have some clients buying FHA and paying whatever they have to, just to "househack". I have some clients who look for value add. I have some clients doing 1031 exchanges and just need to park money. I have some clients liquidating parts of 401k to take money out of the market, etc.

    Everyone is different in their investing strategy. 

    [email protected]732-289-3823
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  • Bobby Gill
    Rental Property Investor · San Clemente, CA · Member since 2020 · 20 posts · 6 votes
    4y

    Apartment Building valuation

    I’m looking at a 9 unit building where 2 of the tenants have not been paying their rent for months. The seller is using rents of all 9 units for property valuation. This does not seem right. Would you analyze the property value based on the 7 tenants paying rent or all 9?

    0Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    4y
    Originally posted by @Kyle Alexander:
    Originally posted by @Karl B.:

    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.

    I don’t ever see rates rising. The federal government wouldn’t be able to afford the interest payments on the massive debt and the market would tank.


    Politicians don’t do what is right they do what is popular to get re- elected. They will keep the gravy train rolling as long as possible. 


    I think we will see zero rates for a very long time 

     The Fed (Federal Reserve) just met and indicated that three prime rate increases are likely next year. They have also begun the process of winding down their bond purchases. The central bank has been buying near every new mortgage backed security for the last couple years. That is not cut in half. These actions are going to cause interest rate increases. 

    The Fed is independent of the federal government, so although politicians may want something, all they can do is ask the Fed. You are right that rising rates will only accelerate accumulation of national debt, which is already at dangerous levels. The problem is without raising interest rates, they will have run away inflation. That is even worse for politicians, because voters feel it in their pocket books. It is kind of like "pick your crisis", either run away inflation or run away debt. They could raise taxes to pay down debt, but the federal government runs in deficit mode already. A balanced budget is unlikely, so any increased taxes will increase government spending. Increased government spending fuels inflation and increases debt. 

    https://www.cnbc.com/2021/12/1...

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  • Account Closed
    Member since 2020 · 41 posts · 56 votes
    4y

    Jay Leno, I agree with you 100%. Also, love your work.

    1Reply
  • David C.
    OP
    Investor · Member since 2021 · 131 posts · 100 votes
    4y

    @Account Closed  I was waiting to see how long it was going to take for that comment to show up.  I get it all the time.  And no, I don't have his cars....I prefer real estate instead. :)

    0Reply
  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    4y

    @David C. a deal to you may not be a deal to me.  I agree that prices seem unsustainably high, but so is demand and rent growth, in many major metros.  I think the difference between today and yesteryear is that in many markets rent growth is so strong year over year that you need to price like a value-add deal and therefore cap rates hold less meaning, while future cash flow projections are driving pricing and returns.

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