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.
@Wes Brand Sorry that you missed my first statement that got embedded in the quote.
When working with brokers, I need to give them my criteria. That being an 8+ deal with value adds. Once I get interested I can look at all the other items that both you and I agree on.
My point that I was making in response to @Account Closed "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." Comment. I will be a fool on ever deal if it means trying to get a deal under the market cap rate. My offer is based on the value that I project as it's value. I always do a reality check on the sellers NOI. He may be calling the deal an 8 cap while I am calling it a 7 cap for the price he is asking. So even if this is an 8 cap market, my offer is going to be under his asking. I also have no problem offering a 9 cap price in an 8 cap market. Call me a fool.
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.
$100,000 NOI 7% market cap= market value of $1,428,600
$100,000 NOI 8.75% cap rate = sales price of $1,143,900
Property discounted $284,700 or 20%!
Ok, you are not going to see that very often if at all. But maybe you really didn't get a discount but just valued incorrectly because then you stated,
"Once we add some value adds it will be an 11 cap or higher."
Exactly HOW do you increase a cap rate by "value adds"??
@Account Closed Exactly HOW do you increase a cap rate by "value adds"??
Yes I did correct myself on that statement
"The Cap is a ratio of the NOI and purchase price. Once the property closes, Cap no longer means anything until you sell."
I still don't understand this statement. "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."
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 were buying a $20,000 NOI because you thought it was under market based on incorrect calculations that overstated NOI by 17%. It is foolish to focus on an 11% cap rate when your attention should be on the NOI and the market cap.
@Wes Brand, Are you Bob's apologist now? Giving his "fool" comment a back-tracked spin?
Because what you just said can apply to buying ANY property, and Jeff dutifully allows for it!
You think no-one sells at a genuine discount without there being some sinister reason?...
Nobody apologizes for Bob and I stopped apologizing when management took my last apology incorrectly. "I'm sorry that your ignorance on the subject prevents you from participating in an intelligent discussion".
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.
Ian
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I live in New York and do not consider condo investing investing. You have no shot of cash flowing. It is an appreciation play. The market is hot right now. Just wait until the market turns