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 going over the next 24 months?
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Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
10yThe 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.
86 Replies
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes10y
There is location of a property, asset type, issues with the property that determine pricing. REGARDLESS of what an average cap rate for a particular asset class is in the market that doesn't always determine what that asset will sell for.
One item that changes is SELLER MOTIVATION. You could have properties selling for a 6 cap all day long in a market. A question is posed as to why would they sell for anything different than what that local market is averaging? The simple answer is the needs of the seller. I have seen sellers in an estate sale let a property go at a much higher than market cap rate because they want to be done with it. I have seen a divorce decree where the wife had real estate assets left to her and she cared less about RE and just wanted the money. Bad partnerships are another one or a partner needs to sell off their shares so on the sale will let more of their equity go to do a quick sale to get cash.
Some commercial developers will sell at higher than market cap rate to move product quickly as it is a volume business to them versus a one parcel owner trying to extract every cent out of a property.
So based on experience I know there are sellers who will sell at better than average market rates due to their unique and individual situation. How fast they need to sell also is a factor. The average days might be 60 in a market. The seller is however affecting a tax strategy or wanting to 1031 into a property in another location that gives them even more upside than what they are giving away to get a 2 to 3 week versus a 2 to 3 month close.
- Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes10y
As @Gino Barbaro rightly says, its about the risk premium. I still remember getting 5% in a money market account 10 years ago. Getting me to invest in real estate for less than a 10% projected return would be not worth the time. Without arguing cap rates or other nomenclature, the real ROI (or IRR) can be calculated on the bond vs. the REI investment. The bond is fully predictable (if held to maturity) while the REI return depends on a lot of factors. Some are in your control (you can force equity, you can increase NOI) some not (market forces, interest rates etc). Due to artificially depressed bond rates (thank you Fed with unlimited money printing and buying of bonds) people are forced into riskier assets to get even 5% return. Hence bubble form in all kinds of assets from stocks to RE. Also it forces people who should not be taking risks (like already retired folks) into these investments. Which also forces down yields (or cap rates).
So the short answer is: Cap rates in the future will depend on what the interest rates on bonds are. If I can once again get a 5% CD, I will expect more from REI and cap rates increase. If rates stay the same, then so do cap rates (within reason). Of course this is a macro view. Supply demand in any local region can also affect. In the Bay Area multifamily cap rates are like 3-4% already I think.
- Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes10y
Market Value Defined In appraisal practice, the term Market Value is defined by agencies that regulate federal financial institutions in the U.S. That definition is given as: “The most probable price which a property should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus.”
Joel what you describe above is not an open market sale. When a independent third party would analyze the sale they would note a condition of the sale. Yes, sometimes even buyers of $100,000,000 offices find themselves in a bind on a 1031 downleg. But, the market will know that the cap rate created by the sale is an outlier.
Unfortunately when an unethical TurnKey provider touts Crap rates they most likely are using unrealistic NOI's and their own actual not open market sales. Since there isn't a third party analyzer of SFR's then off course all the locals know that property is not a comp..It was sold to some fool from CA.
- Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes10y
Originally posted by @Account Closed:
Originally posted by @Gino Barbaro:
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.
Bob,
You hit it out of the park with this analogy. I've watched so many investors, who believe they know it all or clueless (eyes rolling), scrutinize you about cap rate. I've tried and tested this theory in my market over and over and over again 6-7 different times in the last couple of years, and it was spot on every single time. I've shared the details of these deals with some local BP members such as @J. Martin, @Johnson H., @David C. and @Xiaojun M.. I've shared some personal emails, appraisals and LOIs from our lenders on the value of these apartments. It was like WOW...Minh actually knows what the heck he's doing. He's buying a $1.225M building and making it worth $1.8M in 6 months. It's going to worth over $2M once fully stabilized in the next year or two. He's in the process of taking his $1.1M purchase in December and making it worth $1.75M. LOL!
I gave away my secret sauce to 7 individuals this past week at Johnson's meet-up. If I'm lucky, two of them will take the info and do something about it. I know for sure one of them will for sure. You sir, have earned an award for "Name That Cap Rate." Unfortunately, I don't have 100 votes to give to you now. :0)
Thanks @Account Closed for giving me those pointers. It definitely give me a framework to evaluate MFRs. Know your market, know the cap rate, know the financing guidelines, know the local regulations, network with the right people. But it is really up to you to find your own niches.
Originally posted by @Account Closed:
LOL... That was funny
Thanks for taking the time to explain that in depth!
- Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes10y
Right now regular multifamily is way overheated in many markets. Yes you can buy a low cap rate and with rent growth and other measures such as cost cutting and challenging property taxes the yield can be increased.
California is a rise and fall market. I have plenty of clients doing a 1031 out. While they held the asset made very little in cash flow but had great equity upside. California at some point will cycle again.
The latest thing developers have been focusing on is the 55 plus community apartment buildings. You can lease out at higher rents but there is not assisted living,memory care etc. as that is highly regulated by the government. It is an under served niche in many markets.
The rent growth for multifamily will let off at some point and go back to historical averages. The rents are simply becoming too much of a percentage of an earners monthly income.
- Real Estate Agent · Sisters, OR · Member since 2014 · 1k+ posts · 1k+ votes10y
Cap rates are low and going lower.
It sucks!
Originally posted by @Eric Bilderback:
Cap rates are low and going lower.
It sucks!
Not for Sellers :)
Originally posted by @Account Closed:
As @Gino Barbaro rightly says, its about the risk premium. I still remember getting 5% in a money market account 10 years ago. Getting me to invest in real estate for less than a 10% projected return would be not worth the time. Without arguing cap rates or other nomenclature, the real ROI (or IRR) can be calculated on the bond vs. the REI investment. The bond is fully predictable (if held to maturity) while the REI return depends on a lot of factors. Some are in your control (you can force equity, you can increase NOI) some not (market forces, interest rates etc). Due to artificially depressed bond rates (thank you Fed with unlimited money printing and buying of bonds) people are forced into riskier assets to get even 5% return. Hence bubble form in all kinds of assets from stocks to RE. Also it forces people who should not be taking risks (like already retired folks) into these investments. Which also forces down yields (or cap rates).
So the short answer is: Cap rates in the future will depend on what the interest rates on bonds are. If I can once again get a 5% CD, I will expect more from REI and cap rates increase. If rates stay the same, then so do cap rates (within reason). Of course this is a macro view. Supply demand in any local region can also affect. In the Bay Area multifamily cap rates are like 3-4% already I think.
Anish, is that an absolute statement that older folks should not be taking risks while younger folks can afford to take more risks? I think this is dependent on the person's mentality, net worth, other assets, health etc.
Let me explain. If a 60 year old man, pretty healthy, say has $1MM net worth, wants to invest in a very risky investment about $200k? Ok, now a 25 year old, with $0 net worth, who says she should tolerate higher risk? She should probably put aside $1k per month on less risky investments, THEN she can jump into more riskier stuff.
It makes me cringe when so called "financial advisors" tell the exact same advise to everyone, without delving into it further.
That said, I am definitely not risk averse and tend to like "riskier" investments, do to a healthy dose of reading and practicing stoicism. Thoughts on the above?
- Rental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes10y
It all depends how you define risk.. The 60 year old may have a ton of experience in his investing space and the investment may appear to be risky, but to him it isn't. Lack of experience and market fundamentals are two of the biggest risks. Younger investors may be at a disadvantage due to experience in the market. If an investor learns from his mistakes, risk will go down
Gino
- Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes10y
@Andrey Y. Sure, each individual can choose their risk tolerance. But its indisputable that a retired 65 year old with no earned income should have a different risk profile than a 25 year old doctor with years of high earnings ahead right? My point is that the retired people are screwed by low interest rates and are forced into risky investments to generate enough income to survive. If you had a $1M nest egg and follow the 4% recommendation that gives you a pre tax $40K income. Less than the median US household income. So what can one do? Try to earn a greater return by taking more risks. Which you dont really have the time or future earnings to weather.
- Rental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes10y
@Account Closed
The problem is the vast majority of Americans have been conditioned to work, and investing is not even on their radar, unless they invest in a mutual fund. Thus, all types of investing become risky due to low financial intelligence. Sorry if i sound like Kiyosaki, but his message is true and should be consumed by more Americans.
Gino
Hard to imagine them going much lower in the next 2 years. I work for a Southeast Class A Office REIT. I'm not a psychic but in the office market, we have seen a lot of cap rate compression over the past few years. There have been a lot of unconventional players jump into the market causing prices to drive higher.
In Miami submarkets, we have seen investors purchasing buildings at 3 and 4 caps, which is insane. Some of them are parking their money as a safe haven from their crippling economies (think Venezuela, Brazil, etc.) It isn't about return; it is about capital preservation.
It will be interesting to see how the NYC luxury condo market fares now that we are starting to see the international buyer pool cool down a little bit. I suspect a similar phenomenon is already happening in the Miami condo market as well.
Fun times.
Originally posted by @Ian Tudor:
... Some of them are parking their money as a safe haven from their crippling economies (think Venezuela, Brazil, etc.) It isn't about return; it is about capital preservation...Can someone please explain to me this "preservation of capital" concept as it relates to buying RE at low cap rates? If they buy an office building or an apartment complex at 3% cap rate, how would their capital look like if the cap rates go from 3% to 6%? Cut in half! Not so good, right? And if they are leveraged at 75% LTV? Full loss! How is this a preservation of capital?
If they want their principal to be preserved, why don't they buy 30 years US Treasures? Same 3% interest but no need to do anything to get those 3% and principal is guaranteed if held until maturity.
@Nick B. For one, they're not leveraged.
Two, cap rates only matter if they're buying an apartment complex or office building. If cap rates go from 3% to 6% they lost 50%, but what would they have lost in their home country? For example, Venezuela's official inflation rate for 2015 was 141% -- estimates from sources not controlled by their government are higher. Further, market cap rates going from 3% to 6% is a pretty huge drop if you're buying into the markets they're buying into.
But now treasury bonds...valid, but the returns are much lower. "Real Yield" 30 year treasury bonds return ~0.8% nowadays (non-inflation adjusted is ~2.5%). In general property values track inflation in almost every US market; some markets beat inflation. There are a few losers, but no one is buying into Detroit for wealth preservation purposes. The cashflow is secondary to the asset.
Originally posted by @Nick B.:
Originally posted by @Ian Tudor:
... Some of them are parking their money as a safe haven from their crippling economies (think Venezuela, Brazil, etc.) It isn't about return; it is about capital preservation...Can someone please explain to me this "preservation of capital" concept as it relates to buying RE at low cap rates? If they buy an office building or an apartment complex at 3% cap rate, how would their capital look like if the cap rates go from 3% to 6%? Cut in half! Not so good, right? And if they are leveraged at 75% LTV? Full loss! How is this a preservation of capital?
If they want their principal to be preserved, why don't they buy 30 years US Treasures? Same 3% interest but no need to do anything to get those 3% and principal is guaranteed if held until maturity.
@Nick B.
Well if you are talking about investors from other countries, you have to think in terms of rampant inflation. This is their alternative.
Check out this article from CNN about Venezula - http://money.cnn.com/2016/04/12/news/economy/venez...
Inflation rate of 500% by the end of the year. Just think of what that would do to your money if this trend persisted over a long period of time. You can no longer buy as much and your wealth would disappear in a very short time. This is why certain foreign investors flee to United States. Even if you make no money in the US, you are better off than keeping it in Venezuela. This is the concept of parking money or capital preservation in a safe country.
To your Treasury point, there is some merit, and I wouldn't be surprised if these types of investors bought those as well. One of the benefits of holding real estate is the potential for asset appreciation. If you hold an asset that yields 3% per year and in 10 years you sell for 20% higher. That is considerable money made. I suspect these investors see the stability of the US economy and the ability for some asset appreciation as their investment thesis.
- Rental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes10y
Hi Nick,
REITS are normally buying A assets at 2-3 caps. They need to find a safe return with some upside. I am no where near that mindset in my investing. I am still in the wealth creation and cash flow mode, so A assets don't do it for me, not yet at least. When we look at strictly cap rates, so many other returns are neglected, such as the huge benefits of cost seg, amortization and "hopefully" appreciation
Gino
@Wes Brand We must have been writing at the same time. haha good stuff
A good point you make is these are not leveraged deals. A lot of these players are coming in all cash well above asking price.
Thank ya'll for the answers but I am not conviced yet :-) If one's concern is hyperinflation then convering that inflating currency to USD is the simplest and cheapest option. Then figure out what to do with those dollars.
Personally, I think lower cap rates represent higher risk because bigger value swings may happen based on a smaller movement of a cap rate. Going from 3 to 6 lowers the value by half while going from 10 to 13 only causes 23% drop.
Just saved his rundown to a word document. Bob's consistently awesome and contrarian (for BP anyway) comments have really changed the way I approach purchasing property and prevented me from buying junkers in the rust belt. Thanks @Account Closed
- Rental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes10y
How are Bob's comments contrarian? They make a ton of sense to anyone who understands real estate and has been through a couple of market cycles.
Gino
@Gino Barbaro I suspect the above was for me. I put parentheses around "for BP anyway" because my impression of BP is mostly a collection of newbies and wholesalers who often don't know what they are talking about or are trying to sell me a turnkey for a referral fee. There are plenty of exceptions though and he is one of them. Learning to filter the chaff is a required skill around here. Sorry that wasn't evident in my comment.
Edit- I'm trying to move into the commercial multifamily arena and have been visiting your site. Pretty legit thus far. Thanks!
- Rental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes10y
I am one of those guys who bought wrong and fortunately learned from my mistakes. Don't think of multifamily as that much more difficult than SFH. They are different and have their pluses and minuses, but once you become comfortable with multis, you will see the huge benefits
Gino
- Real Estate Consultant · Camarillo, CA · Member since 2010 · 2k+ posts · 1k+ votes10y
i just purchased a property at an 8.75 Cap in a 7 Cap market. Why, because the sellers were moving their focus to other markets and this was one of their last holdings. There are many reason people sell below market. Divorce, death, partnership battles, etc. Once we add some value adds it will be an 11 cap or higher.
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