Cap rates for same building differ for in/out of state investors?

Question

I was on the phone last night with a broker who informed me that the 8% cap rates in his market are for in-state investors. He said most out-of-state investors only get 6% cap rates on buildings. I had never heard of this before. I have yet to do a deal, but in all of my reading I thought the cap rate for a building was set based on market demand not the location of the investor. Am I missing something?

Unless he means the expenses for an out-of-state investor are usually higher, which lowers the rate of return? I've only been looking for deals for a couple of months, but I have never seen anything that lists 1 cap rate for in-state investors in 1 for out-of-state, so I'm just guessing at what he meant but it didn't quite make sense to me.

Greg Dickerson · Answer

@Christa S Rickard  This is not a broker you want to deal with. Price is price regardless of who or where the buyer is. What they are telling you is nonsense. No other way to put it.

Chase Louderback · Answer

All deals should be marketed with the same cap rate.  Like Greg said, the price is the price regardless of who the buyer is.  That is actually interesting to hear about a broker saying that.  Maybe they are new?  Either way, you would be better off to find another broker.

Teague Anderson · Answer

Whether you self manage or not does not affect the NOI.  For commercial property, the management expense is baked into the overall expenses regardless of who does it.  Maybe you could self manage a 5-unit and reap the extra profit, but what about a 100-unit?  Just because you're local doesn't mean you can somehow manage the property for free.  Like other people said, a lot of times the numbers in the pro formas are baloney, particularly if the property is listed on the MLS or Loopnet.  Some brokers actually have somewhat legit pro formas, with just a little biased tweaking, but you still want to verify those.

Something that I've noticed lately, is that some properties that are over 4-units, which should be trading as commercial properties and valued based off of cap rates, are trading more like single-family homes and are valued based on comps and emotion.  It can be frustrating, because you can make your case for a price based on cap rate, but then some other investor comes along and buys it for a price that makes no sense at all with a ludicrously low cap rate for the area.  It seems like some people are just looking for a parking lot for their money.

John Corey · Answer

The building is the building and the expenses that are based on the building will be the same. Management should always be included in your numbers. You could be local and yet become ill, etc.

If some investors want to overpay, it will become noise in the data. If most investors are overpaying, the cap rate changes. It is an average rather than a law.

My read of the comment, without directly talking to the agent, is this.

1. There is a subtle meaning which the statement does not fully capture. 1 point for the agent to recognize some differences. There could be an arbitrage by segmenting the two sets of buyers.

2. The agent is naive and does not understand that the cap rate is a market average and mostly driven by the buildings and not the buyer's way of dealing with the buildings.

3. Of the way, the listener heard the message is different from what the agent actual meant. Language is like that.

Out of town buyers can overpay as they sometimes look at their local market and see a bargain at a distance.

David Smith · Answer

Instate maybe means self management

Brandon Sturgill · Answer

@Christa S Rickard I'm sure you could operate at 21% but it suggests that you are on auto-pilot...letting the roof rot of the place with insufficient reserves...I'd like to take a look at the actual property performance if you're inclined to send it over...

Brandon Sturgill · Answer

@Christa S Rickard 21% no...I've never seen it...the last 500 properties I have looked at are 40% and above...

Christa S Rickard · Answer

The numbers that I was looking at where the actuals for the property - not proforma. Property management was not included in the expenses because he was self-managing. And while I agree that self managing is still an expense that needs to be accounted for, he was not doing so in his actual expenses. That was only one of the things missing from his expense categories. Because his expenses excluded management and other necessary fees, his NOI I ended up looking larger then it really is.

I also completely agree about what people are buying. I posted somewhere else about not understanding how others are making money with some of these purchases. I've been running my numbers and most them I just don't see being cash flow positive. Most of what I'm seeing just seems overpriced based on my numbers. But I'll keep plugging away and hopefully find something.

Christa S Rickard · Answer

Ok, I think I understand what you're saying, but isn't that the same as saying in-state investors are using lower expenses - which is why they are seeing higher returns? If they accounted for the same/similar expenses, the cap rates should be the same.

Do you see expenses as low as 21% for a B property in your area? Again, I haven't bought my first property yet, but I thought expenses ranged from 45-55% of gross income. And I thought the 45% range was for new buildings. This building was built in the early 80's.

Brandon Sturgill · Answer

@Christa S Rickard Not saying that everyone that responded to your post is incorrect, but...

So, capitalization is relative...as are all financial calculations associated with analyzing property. In reality, he is likely saying out-of-state guys are settling for 6 CAP, while in-state guys still want 8....Cap rates are merely the minimum return an investor is willing to settle for. We're seeing it here all day...most out-of-state guys are settling for lower cap rates than in-state guys.

Cap rates for same building differ for in/out of state investors?

Most Popular Reply