Qs about Cap Rates, Appreciation, and at sale calculations

Multi-Family and Apartment Investing
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Qs about Cap Rates, Appreciation, and at sale calculations

Fran Arti
Member since 2020 · 28 posts · 3 votes

Hi, guys:

I have several questions that I dont get right at the moment. Im doing a bunch of projections and calculations with a variety of scenarios to get confident enough to buy my first deal. With this my questions are:

- When it comes to calculate the exit cap rate of a property, how is it calculated? Heard that brokers can give you and estimate and heard (Justin Kivel, Breaking into CRE - Youtube Channel) that the industry standart is to add +0,1% cap rate during your holding period) and Im confused. How I can know the cap average in my area for my type of asset/class?

- Then, in terms of appreciation vs cap rates, in my deal analysis simulator, I must fill an average % of appreciation per year. If I bought at 1M, the asset will appreciate 5% a year during 4 years, then the final value, appreciated is 1.215M but I think I have to take into consideration factors like NOI, cash flow after taxes, the "calculated" cap rate at resale, economic occupancy, % vacancy, etc, to have the big picture and look at it with a next buyers eye.

Thanks for your time, have a great sunday a week ahead.


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Immanuel Sibero
Carrollton, TX · Member since 2015 · 415 posts · 371 votes
6y

@Fran Arti

Forget the video, it is misleading when people (even very experienced investors) say a value add project is when you purchase a property, increase the cap rate, and then sell it for a profit. I wish they would stop saying that because it confuses a lot of people trying to understand cap rate. A classic value add project is when you purchase a property, increase the NOI, and then sell it for a profit. So your effort to add value is by doing something to NOI not doing something to cap rate. So what do you do with NOI? You increase it! How do you increase it? You increase revenue, OR decrease expenses, OR both, that's it!! So what do you with cap rate??? Well... Nothing! Who cares!

When I hear people say "cap rate", I pay attention to which cap rate they are referring to. Many investors (even syndicators) may not even realize which cap rate they're talking about. There is the "property" cap rate, then there is the "market" cap rate! The property cap rate is the one that many investors calculate every year by taking the NOI of their property and divide that by the original purchase price of the property (pretty useless, IMO). On the other hand the market cap rate is a measure of how much investors in a particular market are willing to pay for a particular type of property at a given time. Sometimes, you hear this market cap rate referred to as "market sentiment". It's a measure of how desirable/appealing the properties are to the investors in that particular market (think California).

If you refer to the chart above, I listed two kinds of cap rate (propCap Rate and mktCap Rate). propCap Rate is simply NOI/Purchase Price. mktCap Rate is, again, a measure of market sentiment and can only be obtained by talking to the local market experts (i.e. commercial bankers/brokers, property managers, etc). The point here is you don't calculate this cap rate! It is market driven and you have NO control over it. In the chart above, I'm assuming the "market" cap rate to stay the same at 5%.

So let's say you buy the property with $100,000 NOI in year one. You would have to pay $2M because NOI is $100,000 and market cap rate is 5%, in other words properties are trading at 5CAP (we will assume market cap rate stays at 5CAP). Let's say you're a syndicator with a bag full of tricks and are able to increase NOI to $150,000 in year 2 (wouldn't that be nice!). Well in year two you calculate your property cap rate to be $150,000/2,000,000 which equals to 7.5%. But remember the "market" cap rate has its own movements! It could stay the same at 5% (which I'm assuming here) or it could go higher or lower... again this depends on the market (i.e. market sentiment). In this example, if you were to sell the property, then you would likely sell it by taking your NOI divide it by the "market" cap rate - $150,000/5% = $3,000,000.

The above example is a classic example of value add! Now you could say I have increased my cap rate (i.e. propCap Rate) from 5.0% to 7.5% but it's highly misleading because people may be thinking "market" cap rate which in this example stays the same at 5% (5CAP). What I have really done is increasing my NOI, in fact I really don't care that much about my property cap rate (propCap Rate). I could take off that propCap Rate line in the chart above and everything would still make sense. Hope this helps.

Cheers... Immanuel

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  • Arn CenedellaPro Member
    Rental Property Investor · Greenville, SC · Member since 2008 · 786 posts · 1k+ votes
    6y

    @Fran Arti

    Your question is of course the $64 Million question.

    You can calculate your purchase cap rate : current NOI/purchase price.

    You are correct adding 1/10% to cap rate for every year of hold is the industry standard.

    In terms of all your other questions, the answer is primarily based on market knowledge. 

    You can find reports from major commercial real estate brokerage companies they provide market data for each market area.  Talk with local brokers, property managers and other investors.

    In addition, you watch and learn the market in your area: 

    1. watch what other MF properties trade for 

    2. watch what rents for other MF properties do

    3. watch what vacancy and collection rates are

    And slowly over time, one can get a sense of the market and start to make some reasonable rational projections over time.

    My final thought is to understand - all of this analysis is simply making assumptions about what will happen in the future. None of us know the future. Think about it, trying to predict what the local economy will be doing, what interest rates will be doing, what tax laws will be doing, what will be in vogue five to seven years from now is impossible. I mean who would have predicted Covid and our reaction to it, who would have predicted Donald Trump would be President (no political statement just fact) - the point being the future is unpredictable. Yes one can look at recent past performance to have some basis for making assumptions about the future.(Texas will continue to gain population while Illinois will continue to lose population is a reasonable future projection but that doesn’t mean it will happen.)

    After four decades of investing experience, here is how I do it:

    Does the deal make sense TODAY? Do the numbers work TODAY?

    And if you have optimism about the future of a certain location, then buy the property - knowing it makes sense today - hopeful that your analysis of the local market’s future is accurate - having the humility to understand there are hundreds of factors outside your control that will impact future performance.

    One final point, I have found that if one is prudent at purchase, properly leveraged, with cash reserves, over the long term say 10 years, real estate will prove a good investment. Time is on your side.

    Good luck moving forward. It’s an exciting step.

    [email protected]650-575-6114
    2Reply
  • Steve Morris
    Real Estate Broker · Portland, OR · Member since 2019 · 4k+ posts · 2k+ votes
    6y

    "When it comes to calculate the exit cap rate of a property, how is it calculated?"

    I'd think it'd be NOI/Sales Price, like usual.

    If you mean how do you project a CapRate on sale? That's the whole issue with IRR and forward looking projections - The assumptions you make. Add in that I don't trust CapRates based on reporting bias and you have one more variable.

    Biggest thing is that while you can take an average return over time (like with the stock market), some years are good (like 13-17) and some years not so much (09-11).

    THink the question needs to be what you need to do to increase NOI/CFBT over time. CapRates may change, but sell/hold, you need to increase your NOI.

    1Reply
  • Rick MartinPro Member
    Rental Property Investor · Redondo Beach, CA · Member since 2017 · 411 posts · 477 votes
    6y

    @Fran 

    @Fran Arti one place I see underwriters make a mistake is adding that .1% per year (or .15% if you are conservative) to the purchase cap rate. Your purchase cap does not matter. You want to find the stabilized area cap rate at this point in time. You can look to something like CBRE's cap rate survey to find that, and cross-reference it by pooling commercial brokers and PM's. If you have some time you could also create a spreadsheet and take everything that has been sold in your submarket on Loopnet (for like properties), and take the average, and then throw that into the mix. 

    I wouldn't rely on market appreciate either. If your analyzer requires it, fill something in for inflation. Maybe 2%. Your value add will determine your true, forced appreciation, and this will depend entirely on the NOI that you create each year. Be accurate with your projected rents and expenses, and see where you net out. Be very conservative in your rent growth projections. Many are projecting 0 to negative growth over the next year to two years.

    1Reply
  • Fran Arti
    OP
    Member since 2020 · 28 posts · 3 votes
    6y

    Thanks for the great answers. Duly noted.

    Yesterday I was watching a Grant Cardone Video were he said that if he purchases a 6 cap property, then with value play can move this cap rate up to 8, for example and I dont understand this. Im confused because (as I understand) when you add value to a property, its price should go up, so the cap rate moves down because its formula ( Price= NOI/ Cap Rate). Maybe is he talking about returns? I dont know. Now, Im more confused... I have been trying to see the video again to post the reference here.

    0Reply
  • Immanuel Sibero
    Carrollton, TX · Member since 2015 · 415 posts · 371 votes
    6y

    @Fran Arti

    Forget the video, it is misleading when people (even very experienced investors) say a value add project is when you purchase a property, increase the cap rate, and then sell it for a profit. I wish they would stop saying that because it confuses a lot of people trying to understand cap rate. A classic value add project is when you purchase a property, increase the NOI, and then sell it for a profit. So your effort to add value is by doing something to NOI not doing something to cap rate. So what do you do with NOI? You increase it! How do you increase it? You increase revenue, OR decrease expenses, OR both, that's it!! So what do you with cap rate??? Well... Nothing! Who cares!

    When I hear people say "cap rate", I pay attention to which cap rate they are referring to. Many investors (even syndicators) may not even realize which cap rate they're talking about. There is the "property" cap rate, then there is the "market" cap rate! The property cap rate is the one that many investors calculate every year by taking the NOI of their property and divide that by the original purchase price of the property (pretty useless, IMO). On the other hand the market cap rate is a measure of how much investors in a particular market are willing to pay for a particular type of property at a given time. Sometimes, you hear this market cap rate referred to as "market sentiment". It's a measure of how desirable/appealing the properties are to the investors in that particular market (think California).

    If you refer to the chart above, I listed two kinds of cap rate (propCap Rate and mktCap Rate). propCap Rate is simply NOI/Purchase Price. mktCap Rate is, again, a measure of market sentiment and can only be obtained by talking to the local market experts (i.e. commercial bankers/brokers, property managers, etc). The point here is you don't calculate this cap rate! It is market driven and you have NO control over it. In the chart above, I'm assuming the "market" cap rate to stay the same at 5%.

    So let's say you buy the property with $100,000 NOI in year one. You would have to pay $2M because NOI is $100,000 and market cap rate is 5%, in other words properties are trading at 5CAP (we will assume market cap rate stays at 5CAP). Let's say you're a syndicator with a bag full of tricks and are able to increase NOI to $150,000 in year 2 (wouldn't that be nice!). Well in year two you calculate your property cap rate to be $150,000/2,000,000 which equals to 7.5%. But remember the "market" cap rate has its own movements! It could stay the same at 5% (which I'm assuming here) or it could go higher or lower... again this depends on the market (i.e. market sentiment). In this example, if you were to sell the property, then you would likely sell it by taking your NOI divide it by the "market" cap rate - $150,000/5% = $3,000,000.

    The above example is a classic example of value add! Now you could say I have increased my cap rate (i.e. propCap Rate) from 5.0% to 7.5% but it's highly misleading because people may be thinking "market" cap rate which in this example stays the same at 5% (5CAP). What I have really done is increasing my NOI, in fact I really don't care that much about my property cap rate (propCap Rate). I could take off that propCap Rate line in the chart above and everything would still make sense. Hope this helps.

    Cheers... Immanuel

    4Reply
  • Fran Arti
    OP
    Member since 2020 · 28 posts · 3 votes
    6y
    Thanks! The confusion is gone ;)

    Originally posted by @Immanuel Sibero:

    @Fran Arti

    Forget the video, it is misleading when people (even very experienced investors) say a value add project is when you purchase a property, increase the cap rate, and then sell it for a profit. I wish they would stop saying that because it confuses a lot of people trying to understand cap rate. A classic value add project is when you purchase a property, increase the NOI, and then sell it for a profit. So your effort to add value is by doing something to NOI not doing something to cap rate. So what do you do with NOI? You increase it! How do you increase it? You increase revenue, OR decrease expenses, OR both, that's it!! So what do you with cap rate??? Well... Nothing! Who cares!

    When I hear people say "cap rate", I pay attention to which cap rate they are referring to. Many investors (even syndicators) may not even realize which cap rate they're talking about. There is the "property" cap rate, then there is the "market" cap rate! The property cap rate is the one that many investors calculate every year by taking the NOI of their property and divide that by the original purchase price of the property (pretty useless, IMO). On the other hand the market cap rate is a measure of how much investors in a particular market are willing to pay for a particular type of property at a given time. Sometimes, you hear this market cap rate referred to as "market sentiment". It's a measure of how desirable/appealing the properties are to the investors in that particular market (think California).

    If you refer to the chart above, I listed two kinds of cap rate (propCap Rate and mktCap Rate). propCap Rate is simply NOI/Purchase Price. mktCap Rate is, again, a measure of market sentiment and can only be obtained by talking to the local market experts (i.e. commercial bankers/brokers, property managers, etc). The point here is you don't calculate this cap rate! It is market driven and you have NO control over it. In the chart above, I'm assuming the "market" cap rate to stay the same at 5%.

    So let's say you buy the property with $100,000 NOI in year one. You would have to pay $2M because NOI is $100,000 and market cap rate is 5%, in other words properties are trading at 5CAP (we will assume market cap rate stays at 5CAP). Let's say you're a syndicator with a bag full of tricks and are able to increase NOI to $150,000 in year 2 (wouldn't that be nice!). Well in year two you calculate your property cap rate to be $150,000/2,000,000 which equals to 7.5%. But remember the "market" cap rate has its own movements! It could stay the same at 5% (which I'm assuming here) or it could go higher or lower... again this depends on the market (i.e. market sentiment). In this example, if you were to sell the property, then you would likely sell it by taking your NOI divide it by the "market" cap rate - $150,000/5% = $3,000,000.

    The above example is a classic example of value add! Now you could say I have increased my cap rate (i.e. propCap Rate) from 5.0% to 7.5% but it's highly misleading because people may be thinking "market" cap rate which in this example stays the same at 5% (5CAP). What I have really done is increasing my NOI, in fact I really don't care that much about my property cap rate (propCap Rate). I could take off that propCap Rate line in the chart above and everything would still make sense. Hope this helps.

    Cheers... Immanuel

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