Rental Property Investor · St Augustine, FL · Member since 2014 · 2k+ posts · 1k+ votes
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.
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.
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.
But by the time you sell it, won't you want its cap rate to go back to the market 7 cap?
@Nick B. - Once the funds are 'parked' the change in market CAP rates becomes immaterial. Take the following example;
An out of country investor purchases a class A property for $5,000,000 which as a CAP rate of 3%; NOI = $150,000. Note - I am making no assumptions about financing at the moment.
If the market changes and CAP rates expand to 6%, it does not change his NOI (as long as the property continues to perform); it will still be $150,000. On paper, if he sells, he has lost $2,500,000 but if he does not sell and simply holds, he continues to receive the 3%. You, perhaps rightly, can beat up on him for bad timing but we all make decisions based on the information in front of us and no one (that I know) has perfect crystal ball.
Now lets bring in the financing issue; Assuming the buyer has arranged some financing (without doing the math, I don't think a 3 CAP can carry even at current interest rates). Maybe he puts down 66% and is only carrying 34% but that is still irrelevant. In arranging the financing, the lender has contracted for a certain period of time at a certain rate and under certain conditions (e.g. DSCR). As long as the payments are made and the conditions are met, they should have no issue. The buyer will / may have a problem at the end of the term but not before.
@Oren K., I guess I have a problem with the "parking" concept as well. My understanding of it is what has been "parked" should be easily "unparked" without incurring any losses and/or transaction costs. In other words, for me, liquidity is a must if I want to "park" my money. So, I park it on a savings account. Now, if I buy into a RE project, the money is no longer "parked". It's pretty much gone and cannot be taken out on a moment notice. In exchange I get a stream of income and a slice of equity. However, I have to sign a PPM that tells me that this is a high risk venture and I may lose all my principal. I have not seen a PPM that would say that RE is some sort of "save haven". I am fine with this but I do not consider my money "safe", "parked", or "protected" at this point.
@Gino Barbaro back to your question, I am seeing compressed Cap rates and fewer value add properties. It is a difficult part of the cycle, but we have to work harder to find the deals.
I look at it two ways. It is more difficult to find a deal but guys who work harder and longer will find the deal. Guys who don't want to work will not find a deal in the current market
So I guess it's time to start working harder and networking
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.
This is the wrong way to look at it. It will not be an 11 cap or higher. You will have increased the value by increasing the NOI, not changed the cap rate. If the market cap is 7, your property is still 7, it's just worth more money now.
For example, if you have a property that you bought 100k and has a NOI of 10k, and you increase that NOI to 20k you have NOT increased the cap rate on the property -- that makes no sense, since cap rates are a property of the open market. You *have* increased the value of your property to 200k by doubling the NOI. The cap rate is still 10% even though you double the NOI.
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.
This is the wrong way to look at it. It will not be an 11 cap or higher. You will have increased the value by increasing the NOI, not changed the cap rate. If the market cap is 7, your property is still 7, it's just worth more money now.
For example, if you have a property that you bought 100k and has a NOI of 10k, and you increase that NOI to 20k you have NOT increased the cap rate on the property -- that makes no sense, since cap rates are a property of the open market. You *have* increased the value of your property to 200k by doubling the NOI. The cap rate is still 10% even though you double the NOI.
Jeff already pre-empted your point (agreeing) when he responded to my post. Nevertheless, while he HOLDS the property and it's receiving an 11% cap (vs. what he PAID) - then THAT'S what it is!
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.
This is the wrong way to look at it. It will not be an 11 cap or higher. You will have increased the value by increasing the NOI, not changed the cap rate. If the market cap is 7, your property is still 7, it's just worth more money now.
For example, if you have a property that you bought 100k and has a NOI of 10k, and you increase that NOI to 20k you have NOT increased the cap rate on the property -- that makes no sense, since cap rates are a property of the open market. You *have* increased the value of your property to 200k by doubling the NOI. The cap rate is still 10% even though you double the NOI.
Jeff already pre-empted your point (agreeing) when he responded to my post. Nevertheless, while he HOLDS the property and it's receiving an 11% cap (for what he PAID) - then THAT'S what it is!
This is wrong.
He is not receiving an 11% cap rate. He's receiving cashflow equal to 11% of his purchase price; his ROI could be considerably higher or lower than that depending on rehab / cost of value adds / depreciation of the property / etc. His cap rate remains at market, 7%.
@Wes Brand I won't argue with you. The Cap is a ratio of the NOI and purchase price. Once the property closes, Cap no longer means anything until you sell. We did have the reverse situation where we were closing on a deal that was at an 11Cap until we finalized the insurance costs. They dropped us down to a 9 cap before closing.
Cap rate is one tool used to level the playing field when discussing value. It should be used in conjunction with other tools to determine if you should do the deal or not.
@Wes Brand, ..."He is not receiving an 11% cap rate. He's receiving cashflow equal to 11% of his purchase price"... Sheesh.
Really?...
Yes. That's not a cap rate. The divisor for a cap rate is the property's value to the market, not how much you paid for it. It may or may not (hopefully not) be his actual ROI.
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.
This is the wrong way to look at it. It will not be an 11 cap or higher. You will have increased the value by increasing the NOI, not changed the cap rate. If the market cap is 7, your property is still 7, it's just worth more money now.
For example, if you have a property that you bought 100k and has a NOI of 10k, and you increase that NOI to 20k you have NOT increased the cap rate on the property -- that makes no sense, since cap rates are a property of the open market. You *have* increased the value of your property to 200k by doubling the NOI. The cap rate is still 10% even though you double the NOI.
Jeff already pre-empted your point (agreeing) when he responded to my post. Nevertheless, while he HOLDS the property and it's receiving an 11% cap (vs. what he PAID) - then THAT'S what it is!
NO, as @Wes Brand correctly stated increases in NOI do not change cap rates. And @ Brent Combs incorrectly states that the property is receiving an 11% cap rate. NOI's are bought and sold at cap rates. They do not "receive" "earn" cap rates. They earn NOI's. AND those NOI's are valued at what the market will pay for them,
@Wes Brand I won't argue with you. The Cap is a ratio of the NOI and purchase price. Once the property closes, Cap no longer means anything until you sell. We did have the reverse situation where we were closing on a deal that was at an 11Cap until we finalized the insurance costs. They dropped us down to a 9 cap before closing.
Cap rate is one tool used to level the playing field when discussing value. It should be used in conjunction with other tools to determine if you should do the deal or not.
But if 9% cap rate was the market cap then you are a fool to offer to buy the NOI at 11% even if the NOI was wrong. Obviously the seller was trying to make you think you were buying below market. Think about that and use your MBA training.
I think it is important to know how to use cap rates and they are only one barometer to analyze your deal. If you hear cap rates being quoted for SFH or small multis, you are wasting your time.
They are only really used in larger properties. They are market and property class specific, meaning you need to know what a B property that is 30 years old on the south side of the city is trading for. They can be subjective. I am learning the Jacksonville Fl market and these brokers are underwriting properties at unrealistic caps. It is on me to know what the asset is trading for, and buy at an "actual" figure. I don't think people should only focus on cap rates, there are son many other calc that affect the buying process. Cap rates calculate a return on a property with the exclusion of debt service, so it is easier to compare two similar properties.
Basically the OP's question is where are prices going over the next 24 months vs possibility to increase income and/or reduce expenses.
That's a tough call considering the changes in purchase laws for international investors and valuation of currencies.
@Wes Brand I won't argue with you. The Cap is a ratio of the NOI and purchase price. Once the property closes, Cap no longer means anything until you sell. We did have the reverse situation where we were closing on a deal that was at an 11Cap until we finalized the insurance costs. They dropped us down to a 9 cap before closing.
Cap rate is one tool used to level the playing field when discussing value. It should be used in conjunction with other tools to determine if you should do the deal or not.
But if 9% cap rate was the market cap then you are a fool to offer to buy the NOI at 11% even if the NOI was wrong. Obviously the seller was trying to make you think you were buying below market. Think about that and use your MBA training.
20,000 / .11= $181,818 market value
$16,634 / .09 = $181,818
Pretty sloppy to over state NOI by 17%!
NOI (basically, income less expenses) is what it is, regardless of market value!
If the NOI is $20,000 and the normal cap rate is 9% , market value is $222,222!
Who wouldn't rather pay an 11% cap of $181,818 instead? I don't call that foolish!
Alternatively, if the NOI is $16,634 and the seller is selling at 11% cap, I would certainly rather be buying it for that $151,218 price instead of the 9% cap market value of $181, 818!
But if 9% cap rate was the market cap then you are a fool to offer to buy the NOI at 11% even if the NOI was wrong. Obviously the seller was trying to make you think you were buying below market. Think about that and use your MBA training.
Seriously, do you ever make an offer based on asking price? Is your projected NOI ever the same as theirs. I don't make offers based on my projected Cap, their actuals, or the Broker's proforma. Cap rate gets me interested in the deal, so I can take a closer look. Cap does not take into consideration, deferred Maint expenses, capex improvements needed, closing costs, financing and a host of other items that need to be considered.
Why would someone be a fool for making an under market offer? I guess I will continue to be a fool. All of my deals are under market sales.
But if 9% cap rate was the market cap then you are a fool to offer to buy the NOI at 11% even if the NOI was wrong. Obviously the seller was trying to make you think you were buying below market. Think about that and use your MBA training.
Seriously, do you ever make an offer based on asking price? Is your projected NOI ever the same as theirs. I don't make offers based on my projected Cap, their actuals, or the Broker's proforma. Cap rate gets me interested in the deal, so I can take a closer look. Cap does not take into consideration, deferred Maint expenses, capex improvements needed, closing costs, financing and a host of other items that need to be considered.
Why would someone be a fool for making an under market offer? I guess I will continue to be a fool. All of my deals are under market sales.
You are welcome to pay retail.
You're missing the point -- You're a fool to make an offer on it because of the cap rate. The cap rate gets you interested, you make the offer based on other factors. Let's say the cap rate on a property was 25%, with market being 10%. Sounds great, right? But cap rate doesn't take deferred maintenance or capex into account...let's say our 25% cap rate property needs a new foundation...and our current tenants are moving out in a year and are paying significantly over market rent. And in the 10 years since they moved in, central air became standard in office buildings so you won't be able to re-rent it unless you add in central air. Oh, and it's getting to the end of it's useful 30 year commercial building lifetime, so you might need to teardown and rebuild soon.
All the sudden you have a ton of extra expenses and some real risk about what ROI you'll end up getting on your property, despite the cap rate. If you made an offer based on the cap rate you're paying significantly under market, but if you take everything else into account it could be a terrible investment.