Cap rate suppression - has it changed your investment strategy❓

4 Replies

I thought the graph below from NorthMarq's 1Q21 Capital Report was interesting with the spread between major market and non-major market cap rates falling to the tightest spread in over a decade. Definitely have seen this movement across the various markets we are underwriting and making offers in. I know some folks seek secondary or tertiary markets for lower entry points, but with the cap rate movement nationwide has this changed your strategy?

@Brian Pownall

Excellent data, clearly shows cap rate decline and cap rate compression.

This cap rate compression does not impact my investing strategy.

My strategy is based more on investing where I have a competitive advantage than relative cap rates.

“Competitive advantage” is closely tied to local market knowledge.

Research, investigate, and visit several markets.

Pick one or two and then become experts in the chosen markets.

That’s how one can gain an edge.

@Brian Pownall

The access to capital is at some of the highest levels we’ve seen.

I personally still buy good cash flowing value add deals in A/B markets in Columbus and plan to hold them for the long term. It’s very tempting to jump on stuff now because it’s so hot but it’s definitely not the right move.

Marc Rice nailed it. CAP rate compression is almost meaningless when you have virtually unlimited access to investment capital.

My real estate agent put it this way: even if this place only cash flows $100 and it costs $1,000,000... if it doesn't cost you anything (i.e. 100% financed or investment capital), in 15 years you have a paid off asset worth $3,000,000.  Why would you not do that?

This is clearly demonstrated in the formula: CAP = NOI/Total Capital Invested. So let's say you buy a 5 CAP...after ALL expenses, there's only enough cash left over to cover the mortgage. From a CAP rate standpoint, it stinks. From a Cash Flow standpoint, it stinks. And after 15 years, you own a $3,000,000 property for which you paid nothing out of pocket and did nothing in terms of management or maintenance.

$200,000 per year reward for doing not much other than putting a deal together.  Not bad wages.

Of course, this assumes everything works out just fine and a 5 CAP is enough to support the debt-service/equity partner payouts. But it illustrates the point that even at very compressed rates, as long as the property "pays for itself," it can still be very attractive to many investors.

Here's the fun thing though: this graph is an industry generalization based on limited data and survey responses. For example, I bought a property that penciled out as a 9 CAP this past year (it was vacant, $0 rents at the time) and since then I've turned into a 13 CAP. Other local agents said that the best deal one could hope for in today's market was a 6 CAP. But my agent and I did it. So....there's no reason to "settle" for compressed CAP rate properties. Find the property types that are exceeding official market data. They are out there, but they aren't being touted by gurus or on the front page. Think about abandoned retail strip malls, boarded up restaurants, and vacant automotive shops. Stuff that institutional investors won't touch because they are smaller ($500,000 - $1,000,000) and aren't multi-family residential.

Originally posted by @Arn Cenedella :

@Brian Pownall

Excellent data, clearly shows cap rate decline and cap rate compression.

This cap rate compression does not impact my investing strategy.

My strategy is based more on investing where I have a competitive advantage than relative cap rates.

“Competitive advantage” is closely tied to local market knowledge.

Research, investigate, and visit several markets.

Pick one or two and then become experts in the chosen markets.

That’s how one can gain an edge.

A lot of people have made very good points- just being consistent and persistent has payed off for us. Reaching out to brokers more than everyone else, underwriting more deals, etc- all of it gives us that advantage. No new strategy- just turning up the hustle!