Where do you see cap rates going over the next 24 months?
Gino BarbaroPro Member
Rental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votesWhere do you see cap rates headed in your market over the next 24 months?
We just purchased a B asset at an actual 8 cap in our market. Unfortunately, it feels as if this is the last hoorah and cap rates are only going to go down from here.
What's going on in your market?
Gino
The purpose of a cap rate is to measure what NOI's are trading for a specific market at a particular time for a particular property type. It is basically to value NOI when you are buying commercial properties
But wait Jon H., there's more! Since it is easier and more accurate to value pretty much any residential property by direct sales comparison why EVER consider a cap rate? Jon H., I'm glad you asked. Commercial properties are usually encumbered by long term leases and often have hundreds of leases with some being at market, some below and some above. You can have three identical buildings and even tho their v/c are the same and their expenses are the same they can have drastically different NOI's depending on when their leases were signed. Imagine near identical buildings that have NOI's of $50,000, $100,000 and $150,000. You are buying the NOI's not the buildings so if similar buildings NOI's are selling at a ten cap then each building would be worth $500,000, $1,000,000 and $1,500,000. This is simplified a bit since the buyer would look at the lengths of the leases and the strength of the tenants etc. but cap rate is only meant to look at one year NOI. And a cap rate is never meant to predict profitability so there are other calculations that will determine if the buyer wants a property at market cap rate.
Residential properties are generally NOT encumbered by long term leases except say in the case of rent control where identical buildings can have drastically different NOI's because one has 30 year tenants at low rents and another just replaced their 30 year old tenants that died with new market rate tenants. Those buildings will not sell for the same. Usually a GRM will be used for valuation. Large residential complexes will calculate a cap rate basically because they all will have similar expenses and share information so it is an easy calculation. But they will look at other metrics that are more reliable like price per unit/bedroom/NOI per sf, etc.
If all commercial properties were leased at market every year the buyers and sellers would be more than happy to use the more accurate method of valuation of direct sales comparison. Since that is NOT so then they have to RESORT to a more cumbersome and inaccurate way to measure NOI. That is what is so funny with the little investors here that clamor to use it just because they think it makes them look "professional" and well, smarter than they are. Look Ma, I'm talking cap rates.
@Gino Barbaro everyone is looking for safer bets, but the higher the cap rate the higher to risk or more work that will need to be done to turn it around.
One reason people are able to buy at a lower CAP rate and keep profitable in our areas is due to banks finance the safer deals (lower CAP) at higher levels. I don't think this is a tell of where the CAP's are going but a shift to encourage safer investments.
Big box stores (Walgreens, Sears, etc.) have been deploying on a 4% CAP for 25+ years. Triple NET leases and super safe investments.
Generally IMO all ties to risk vs reward.
CD's and Bank accounts are also safe, if safety is all you are looking for?
It all depends on your goals.
@Gino Barbarobut the higher the cap rate the higher to risk or more work that will need to be done to turn it around.
A higher cap rate does not require more work to "turn it around". $10,000 bought at $100,000 is a 10% cap rate. What would you be "turning around"?
I think regional location is an extremely important factor to the answer. For example, in the Pacific Northwest region (from Portland OR North to Vancouver BC) we see cap rates continuing to decline as the desire to live here is only increasing. I use to get deals with 7-8% caps and now we see deals with asking price caps in the 5% range. I can put $ into a high yield muni bond fund and do better than 5% without the work. Deals in Seattle make no sense to me (caps near 4%) and very unfriendly landlord environment but Thurston and Kitsap counties offer good value .
I think regional location is an extremely important factor to the answer. For example, in the Pacific Northwest region (from Portland OR North to Vancouver BC) we see cap rates continuing to decline as the desire to live here is only increasing. I use to get deals with 7-8% caps and now we see deals with asking price caps in the 5% range. I can put $ into a high yield muni bond fund and do better than 5% without the work. Deals in Seattle make no sense to me (caps near 4%) and very unfriendly landlord environment but Thurston and Kitsap counties offer good value .
Mike R. You are looking at a cap rate as a measure of profitability when it is not. A sophisticated investor does NOT buy cap rates. They invest for profits. You can buy at a low cap rate and be VERY profitable. You can buy at a high cap rate and lose everything.
Obviously low cap rates are the result of HIGH demand. A smart investor determines if that demand is rational.
thanks guys. I think cap rates are used a lot by commercial brokers to underwrite properties they want to market for sale. Met a broker Friday and drove around. My problem is that he was pricing assets at his pro forma cap, which made the deal impossible. Purchasing at an actual cap is pretty difficult, let alone some pro forma figure
I think regional location is an extremely important factor to the answer. For example, in the Pacific Northwest region (from Portland OR North to Vancouver BC) we see cap rates continuing to decline as the desire to live here is only increasing. I use to get deals with 7-8% caps and now we see deals with asking price caps in the 5% range. I can put $ into a high yield muni bond fund and do better than 5% without the work. Deals in Seattle make no sense to me (caps near 4%) and very unfriendly landlord environment but Thurston and Kitsap counties offer good value .
Mike R. You are looking at a cap rate as a measure of profitability when it is not. A sophisticated investor does NOT buy cap rates. They invest for profits. You can buy at a low cap rate and be VERY profitable. You can buy at a high cap rate and lose everything.
Obviously low cap rates are the result of HIGH demand. A smart investor determines if that demand is rational.
@Bob Bowling, interesting response. while you are correct that cap rates don't directly measure profitability, cap rates (not profitability) were the subject of the original question and they do provide insight into how much a buyer is paying for every dollar of net income. Cap rates are also one, of many, useful measures of relative value. Yes, someone my make a good profit paying $25 dollars for every $1 of NOI (4% cap), but i believe money is better spent looking for deals where the profitability is the same or even better and you pay less for every dollar of NOI (i.e. a higher cap rate)...assuming all else equal (location, condition, etc).
@Account Closed Cap rates are another measure of profitability and investors purchase based on cap rates all the time.
Low cap rates are a result of high prices, which is typically a result of high demand, but not always. It's a function of risk vs. reward.
By the way...you can lose everything no matter what you invest in.
@Gino Barbaro there is a reason why commercial brokers use cap rates. they matter. but just be careful not to look at pro forma cap rates with any amount of certainty. they are usually pie in the sky numbers exaggerated by the listing broker or seller.
I think regional location is an extremely important factor to the answer. For example, in the Pacific Northwest region (from Portland OR North to Vancouver BC) we see cap rates continuing to decline as the desire to live here is only increasing. I use to get deals with 7-8% caps and now we see deals with asking price caps in the 5% range. I can put $ into a high yield muni bond fund and do better than 5% without the work. Deals in Seattle make no sense to me (caps near 4%) and very unfriendly landlord environment but Thurston and Kitsap counties offer good value .
Mike R. You are looking at a cap rate as a measure of profitability when it is not. A sophisticated investor does NOT buy cap rates. They invest for profits. You can buy at a low cap rate and be VERY profitable. You can buy at a high cap rate and lose everything.
Obviously low cap rates are the result of HIGH demand. A smart investor determines if that demand is rational.
@Bob Bowling, interesting response. while you are correct that cap rates don't directly measure profitability, cap rates (not profitability) were the subject of the original question and they do provide insight into how much a buyer is paying for every dollar of net income. Cap rates are also one, of many, useful measures of relative value. Yes, someone my make a good profit paying $25 dollars for every $1 of NOI (4% cap), but i believe money is better spent looking for deals where the profitability is the same or even better and you pay less for every dollar of NOI (i.e. a higher cap rate)...assuming all else equal (location, condition, etc).
Mike R. I was referring to your comparison of a muni bond fund to a cap rate. You were saying it was preferable to a 5% cap rate when there really isn't a comparison. A NOI purchased at 5% can very well "blow the doors off" your bond fund.
But then you said, "i believe money is better spent looking for deals where the profitability is the same or even better and you pay less for every dollar of NOI (i.e. a higher cap rate)...assuming all else equal (location, condition, etc)." See, assuming all else equal (location, condition, etc.) WHY would a seller sell to you a NOI for less than what he can sell on the open market? If it's in a different location say INDY sure he'll sell it for lower than what he'd want for the same NOI in San Fran. Also, condition has nothing to do with cap rates. I'm not sure what your etc. is
Where do you see cap rates headed in your market over the next 24 months?
We just purchased a B asset at an actual 8 cap in our market. Unfortunately, it feels as if this is the last hoorah and cap rates are only going to go down from here.
What's going on in your market?
Gino
If cap rates go down and your NOI stays the same your value will go UP! What are you complaining about?
Where do you see cap rates headed in your market over the next 24 months?
We just purchased a B asset at an actual 8 cap in our market. Unfortunately, it feels as if this is the last hoorah and cap rates are only going to go down from here.
What's going on in your market?
Gino
If cap rates go down and your NOI stays the same your value will go UP! What are you complaining about?
I read that as "I won't be able to find any more 8 cap deals to take advantage of artificially low values" (or, alternatively, "I can't afford to invest any more money at the 4 caps it's headed to so I'll need to find a new market")
@Account Closed Cap rates are another measure of profitability and investors purchase based on cap rates all the time.
Low cap rates are a result of high prices, which is typically a result of high demand, but not always. It's a function of risk vs. reward.
By the way...you can lose everything no matter what you invest in.
Patrick, please explain exactly HOW a cap rate measures profitability?
Also real investors do NOT shop cap rates. WHY would they? They shop markets that they think will be profitable. If they decide that the prices are TOO high for them (thus low cap rates) they are forced into other markets that may or may NOT be less or more profitable. Obviously whoever is creating those low cap rates by paying the high prices think they are getting a deal and are willing to pay for it.
Where do you see cap rates headed in your market over the next 24 months?
We just purchased a B asset at an actual 8 cap in our market. Unfortunately, it feels as if this is the last hoorah and cap rates are only going to go down from here.
What's going on in your market?
Gino
If cap rates go down and your NOI stays the same your value will go UP! What are you complaining about?
I read that as "I won't be able to find any more 8 cap deals to take advantage of artificially low values"
But if cap rates are going down it is because demand has increased or supply decreased, If demand has increased from 8 cap to lower caps it is because the market has changed. 8 cap was market THEN. 5 cap is market NOW. Possibly in hindsight you could say the values were artificially low but at the time most of the market didn't think so or they would have bid down cap rates/
Where do you see cap rates headed in your market over the next 24 months?
We just purchased a B asset at an actual 8 cap in our market. Unfortunately, it feels as if this is the last hoorah and cap rates are only going to go down from here.
What's going on in your market?
Gino
If cap rates go down and your NOI stays the same your value will go UP! What are you complaining about?
I read that as "I won't be able to find any more 8 cap deals to take advantage of artificially low values"
But if cap rates are going down it is because demand has increased or supply decreased, If demand has increased from 8 cap to lower caps it is because the market has changed. 8 cap was market THEN. 5 cap is market NOW. Possibly in hindsight you could say the values were artificially low but at the time most of the market didn't think so or they would have bid down cap rates/
Of course, but it could be that Gino knows something the market at large doesn't know. (a new development, unannounced insider-info plans for a company move, etc)
Where do you see cap rates headed in your market over the next 24 months?
We just purchased a B asset at an actual 8 cap in our market. Unfortunately, it feels as if this is the last hoorah and cap rates are only going to go down from here.
What's going on in your market?
Gino
If cap rates go down and your NOI stays the same your value will go UP! What are you complaining about?
I read that as "I won't be able to find any more 8 cap deals to take advantage of artificially low values"
But if cap rates are going down it is because demand has increased or supply decreased, If demand has increased from 8 cap to lower caps it is because the market has changed. 8 cap was market THEN. 5 cap is market NOW. Possibly in hindsight you could say the values were artificially low but at the time most of the market didn't think so or they would have bid down cap rates/
Of course, but it could be that Gino knows something the market at large doesn't know. (a new development, unannounced insider-info plans for a company move, etc)
Or in his case the sewage treatment plant in going in the NBHD and he is not willing to pay market rate because he sees this having a negative impact on values. THAT makes sense, but to just not buy because of a number is foolish.
just remember back in 08 when cap rates were very low. Risk premium is difference between 10 yr treasury and cap rate. In 08, risk premium was really low and smart investors were not willing to have a 2 risk premium. I wish I was one of those smart investors. As cap rates decrease real estate becomes less attractive
As cap rates decrease real estate becomes less attractive
But remember the REASON cap rates decrease is because the real estate is more attractive.
If you remember the TV show "Name That Tune" the contestants were given a clue about the song (market knowledge) and then to get the prize (property) they had to bid (cap rate) on how few notes they would have to hear to identify the song. If they bid three notes but couldn't name it they lost. In real estate it is pretty much the same. Multiple people want the property. One say I can make a profit on that property at 7% cap. Another says I can make a profit paying a 6% cap. Then the first guy can go lower or tell number two "OK, take it at 6% and see if you can profit because I won't take the risk at that cap rate" .
http://www.bing.com/videos/search?q=name+that+tune...
Maybe I should
bring my "Name That Cap Rate Show" to the huge fantastic second time SF/Oakland Extravaganza. First clue, Beatles song about grasping an appendage. Millennial contestant seems unsure. Boomer constant says I can name that tune in ONE note. I Wanna Hold Your Hand.
In Name That Cap Rate the clues would be location or property type. The more market knowledge you have the more likely you'll not over pay for a property or lose a profitable property.
As cap rates decrease real estate becomes less attractive
But remember the REASON cap rates decrease is because the real estate is more attractive.
If you remember the TV show "Name That Tune" the contestants were given a clue about the song (market knowledge) and then to get the prize (property) they had to bid (cap rate) on how few notes they would have to hear to identify the song. If they bid three notes but couldn't name it they lost. In real estate it is pretty much the same. Multiple people want the property. One say I can make a profit on that property at 7% cap. Another says I can make a profit paying a 6% cap. Then the first guy can go lower or tell number two "OK, take it at 6% and see if you can profit because I won't take the risk at that cap rate" .
http://www.bing.com/videos/search?q=name+that+tune...
Maybe I should
bring my "Name That Cap Rate Show" to the huge fantastic second time SF/Oakland Extravaganza. First clue, Beatles song about grasping an appendage. Millennial contestant seems unsure. Boomer constant says I can name that tune in ONE note. I Wanna Hold Your Hand.
In Name That Cap Rate the clues would be location or property type. The more market knowledge you have the more likely you'll not over pay for a property or lose a profitable property.
Is there a BP Award for most helpful analogy ever?
Seriously - two days ago, I kind of rolled my eyes every time Bob started in on someone about Cap Rates and their (lack of) understanding about them - but this analogy makes perfect sense to me. Finally. Is it just that I've had some 'great awakening' in Cap Rate understanding?
I personally dislike PROForma cap rate scenarios, but in generally in my market I think cap rates will go up rent is going up as less people can afford to buy a house, but rent is growing a little faster then home prices in San Diego, I don't know what area of new York you buy but I know new York city is getting similar, as is a renter metropolis thinking on the big picture cap rates will remain the same or go up, rent always goes up. almost there could be some terrible scenarios but in all terrible scenarios rental properties is still a great option. the only type of property I see going down on cap rate is office and retail but anything residential will go up
@Account Closed Just reading the thread here. As an investor what is the purpose of calculating a cap rate. Is it to compare properties when purchasing? Would it be reasonable to use cap rates as market trend, perhaps for demand, or stability?
As cap rates decrease real estate becomes less attractive
But remember the REASON cap rates decrease is because the real estate is more attractive.
If you remember the TV show "Name That Tune" the contestants were given a clue about the song (market knowledge) and then to get the prize (property) they had to bid (cap rate) on how few notes they would have to hear to identify the song. If they bid three notes but couldn't name it they lost. In real estate it is pretty much the same. Multiple people want the property. One say I can make a profit on that property at 7% cap. Another says I can make a profit paying a 6% cap. Then the first guy can go lower or tell number two "OK, take it at 6% and see if you can profit because I won't take the risk at that cap rate" .
http://www.bing.com/videos/search?q=name+that+tune...
Maybe I should
bring my "Name That Cap Rate Show" to the huge fantastic second time SF/Oakland Extravaganza. First clue, Beatles song about grasping an appendage. Millennial contestant seems unsure. Boomer constant says I can name that tune in ONE note. I Wanna Hold Your Hand.
In Name That Cap Rate the clues would be location or property type. The more market knowledge you have the more likely you'll not over pay for a property or lose a profitable property.
Is there a BP Award for most helpful analogy ever?
Seriously - two days ago, I kind of rolled my eyes every time Bob started in on someone about Cap Rates and their (lack of) understanding about them - but this analogy makes perfect sense to me. Finally. Is it just that I've had some 'great awakening' in Cap Rate understanding?
For me, it wasn't that particular analogy but the way the info is being laid out in this thread as a whole. I've been put off by Bob's presentation of this kind of info before, but I had a feeling I should look into it further. I'm glad I continued to read his posts because I think there's some valuable info to be learned.
The purpose of a cap rate is to measure what NOI's are trading for a specific market at a particular time for a particular property type. It is basically to value NOI when you are buying commercial properties
But wait Jon H., there's more! Since it is easier and more accurate to value pretty much any residential property by direct sales comparison why EVER consider a cap rate? Jon H., I'm glad you asked. Commercial properties are usually encumbered by long term leases and often have hundreds of leases with some being at market, some below and some above. You can have three identical buildings and even tho their v/c are the same and their expenses are the same they can have drastically different NOI's depending on when their leases were signed. Imagine near identical buildings that have NOI's of $50,000, $100,000 and $150,000. You are buying the NOI's not the buildings so if similar buildings NOI's are selling at a ten cap then each building would be worth $500,000, $1,000,000 and $1,500,000. This is simplified a bit since the buyer would look at the lengths of the leases and the strength of the tenants etc. but cap rate is only meant to look at one year NOI. And a cap rate is never meant to predict profitability so there are other calculations that will determine if the buyer wants a property at market cap rate.
Residential properties are generally NOT encumbered by long term leases except say in the case of rent control where identical buildings can have drastically different NOI's because one has 30 year tenants at low rents and another just replaced their 30 year old tenants that died with new market rate tenants. Those buildings will not sell for the same. Usually a GRM will be used for valuation. Large residential complexes will calculate a cap rate basically because they all will have similar expenses and share information so it is an easy calculation. But they will look at other metrics that are more reliable like price per unit/bedroom/NOI per sf, etc.
If all commercial properties were leased at market every year the buyers and sellers would be more than happy to use the more accurate method of valuation of direct sales comparison. Since that is NOT so then they have to RESORT to a more cumbersome and inaccurate way to measure NOI. That is what is so funny with the little investors here that clamor to use it just because they think it makes them look "professional" and well, smarter than they are. Look Ma, I'm talking cap rates.
Bob is spot on with this explanation. Anyone questioning how to understand cap rates should take the time to re-read this a few time.
Well the post above it anyway... Quoted the wrong post from my phone