What reversion cap rate to use in 5yr projection?

Question

I have an offer out on a 60 unit MF property and would like to hear what others are using for their analysis and projections.  I'm in DFW, looking at c class properties.  If I'm buying at an 8 or 8.5 cap, wouldn't it be smart to increase it for projecting a cap rate when selling in 4-5 years?  My thinking is that interest rates almost certainly will be higher at that point, so cap rates will not be able to stay as low as they are now.   I'm seeing a lot of projections that use a 7.5 cap in 5 years and I can't imagine that is likely.

Tom Lafferty · Answer

, that post was over four years ago.  I definitely try to under promise.  @Josh Stack, I didn't buy that property, but I did buy another shortly after that post. I was WAY off on the reversion cap I used, as the market just kept going crazy.  I projected doubling investors money in five years, but we hit that goal in two years.  I have another one we bought in 2014 that is under contract to sell and will be around the same return in just under two years as well.

I'm still using conservative exit caps, but it makes it VERY difficult to land anything.  The longer we go in this cycle though, I want to be even more careful.  I've missed out on a LOT of deals and millions of dollars, but I'm ok with that to stay out of even ONE bad deal.

Josh Stack · Answer

@Tom Lafferty

Hey Tom, just found this post when googling "reversion cap rate"  Intesrstingly it's 4/5 years after you posted.  Did you buy the complex?  How did your reversion cap rate projection work out?

Bryan Hancock · Answer

Why not do a sensitivity analysis and vary the reversion cash flow to see how sensitive your analysis is to it?  I wouldn't personally use anything lower than your purchase cap rate any analysis I do; especially if you're presenting the numbers to investors.

In a 5-year hold the reversion cash flow can highly impact the numbers.  I would resist the temptation to tweak the numbers to make it look like a better investment than it is!

Tom Lafferty · Answer

6.8 would be a steal in DFW for C class right now.  Most are going well below that.

Todd Dexheimer · Answer

I would go with the historical average, which in DFW, I would guess to be around an 8 or 8.5 cap for C class. The figures I have seen in DFW for C class right now is 6.8 cap for a C class.

Will G. · Answer

Historic fluctuations around 2%, we are at record lows so hard to imagine lower. Potential factor will be  where we are in the physical cycle. We always overbuild this segment and vacancies go up, but 5 years, you might be ok. Check out Ian ippolitos website for some good info on the cycle

Lennon Lee · Answer

Hey Tom,

Regardless of where the market is right now and the type of strategy you'll be pursuing to increase NOI, you should always play it "safe" by at least projecting your "going out" cap rate to be the same as the "going in" cap rate.

That being said, if you are going to have investors involved in the deal you are going to want to be as conservative as possible. At the end of the day your aim should be to under promise and over deliver.

Following a conservative approach, we like to calculate reversion cap rates by adding 10-15 basis points per year of hold to the going in cap rate.

Anyone out there forcing the numbers on a deal by projecting lower cap rates in the future, either has a crystal ball or is in desperate need of attracting "dumb" money. Don't be that guy.

Best of luck and happy investing!

Tom Lafferty · Answer

oh I definitely have done that and it's made me pass on several deals.  Good advice that I have to think some are not following.

Tom Lafferty · Answer

Half a point is what I've been using, just concerned that's not conservative enough given what people are paying around here.  On the other hand, I know of some very experienced people paying top dollar, so who am I to say its too much?  I know were one of the top areas in the country for population growth and jobs, but I sure don't see how some of these deals will be successful given what they paid.

Jim Farrell · Answer

I'm with @Larry Flanagan .  I'm in the DC area, and work for a company acquiring shopping centers.  All of our reversion cap rates 5 years out are 50 basis points higher than our going-in.

What reversion cap rate to use in 5yr projection?

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