Your Min Cap Rate requirement on a 20-30 unit residential?

Question

What is your min Cap Rate requirement on a 20-30 unit residential?

Also consider these units are NOT new and are in good maintained condition. Vacancy rate is 5%. Rents are just about maxed out.

I use Cap Rates as a quick way to judge a property to see if I should go the route of running the stack of numbers.

For me my Cap Rate number in this market is 9% as a minimum.

What is your's and why?

Russell Brazil · Answer

My minimum is 3, my maximum is 6. And yes, cap rate is reflective of the risk of the market or asset.  Yield in any asset class (real estate, stocks, bonds, reits, mlps, any asset class) measures risk. Its a fundamental truth to investing.

Russell Brazil · Answer

Or maybe you have a higher risk tolerance, or lack an understanding of lower risk assets. Typically these lower risk assets and markets out perform the higher risk markets. And yes, almost immediately these lower risk markets have rent growth. Thats why we invest in them. My average rent growth over the last decade in lower risk assets is 5%. My average rent growth in higher risk assets is near zero. And thats just one of the several ways the lower risk assets out perform. Asset values rising is the other, lower vacancies, lower credit losses, lower repair percentage, etc.

John Franklin · Answer

Cap rates are the most misunderstood aspect in RE investing.  It’s also where shrewd sellers kill novice buyers.

There are differences between going in cap rates, stabilized cap rates and reversionary cap rates.  Know which one you are analyzing.  Banks are going to focus on the NOI and DCR more than the cap rates.

Brokers tend to use the going in rate but not stabilized. Cap rates for comparison should be the same type.  Unstabilized multi tenant properties should utilize discounted cash flows to analyze the true cost of stabilization.

Every aspect of risk influences cap rates.  Two properties with identical cash flow can have different cap rates if one has a much higher underlying land value.

I totally agree with Seth.  Quit focusing so much on cap rates and focus on stabilized occupancy, market rent and cash flow potential.

Then I’d focus on interest rates and what happens to your cap rate if you refi at 1-2%  higher interest rates in the next few years.

Just my $0.02!

Russell Brazil · Answer

Cap rate is a reflection of the risk of the asset and or market. 9% is indicative of a high risk asset or market. Id never buy something with a cap rate that high.

Ned Carey · Answer

@David K. assuming you are buying at close to market rate, cap rate is an indicator of the risk of the property. In most markets a 9 cap would be a fairly risky property.

I can't tell you mine because I am not buying Multi family right now. The risk reward does not seem worth it to me right now.

@Seth Ferguson I would be interested in hearing a story about how to make a killing with a 2.5 cap property.

David K. · Answer

Bill can you give me any examples of people who did 6% sub deals? For example, how many units, where and how long have they had the property?

I am looking at a large Medical office buildings. These are suppose to be solid stuff (cap rate 7.4) but what happens when a few Doctors offices leave? It's going to be a while before the unit is filled.

David K. · Answer

Russell, can you kindly show me how that low cap rate property worked with how much you put down, how much you leveraged, and your cash flow?

David K. · Answer

Sorry guys, my appologies, I am not saying I am smarter than you guys! But I have been around. I am just questioning this and seeing what side of the arguement holds more true. Kindly stick it out with me.

Russel, can you kindly show me how that low cap rate property worked with how much you put down, how much you leveraged, and your cash flow?

How did you deal with high ticket repairs like when a boiler cracks and you are in for a $28,000 plus expense? Where did the cash come from if it is not flowing enough from the property for example.

Bill F. · Answer

That's most likely the answer. You are better, smarter, faster, more handsome than everyone else here on BP...

OR

Maybe 9 Caps work as your minimum because you are looking at small buildings (20-30 units) in a market that doesn't have a lot of investor demand. Both those factor could reduce competition for these assets thus forcing the seller to give the buyer more return.

To get an accurate answer, we'd need to know:

-where you are looking

- what Cap rate you are talking about, pro forma, stabilized, reversionary

Some reasons why people buy at a 6 Cap:

-Path of progress play

-High income/ net worth investor looking to diversify into a real asset for capital protection that provides some tax advantages.

-Portfolio play

In other words they have totally different goals than you...

BTW, a lack of anyone refuting your claim is not proof that your claim is correct. You are the one making the assertion that 6 Caps don't "work", so the onus is on you to back up your statement with facts, NOT on others to prove you wrong.

David K. · Answer

Well no one has shown me a sub 6% cap rate property that works. OK come on guys..... are you guys pulling my leg here. Maybe I am just older here are perhaps wiser.

What sane investor buys a property at 6% or lower cap rate UNLESS you KNOW INCOME is going up immediately. In most cases that pushes DSCR to ratios banks will not laon at - at least you will be forced to pour more cash in for a down payment.

Lets say, you are buying a nice piece or property. So what, you are still behind and you are likely going to lose it in the next recession.

At 6% cap rate or below, in this already pushed up market, I say pass - you can make more in the stock market. Remember guys, even if you are using management for your property, you are STILL working for it when you buy property.

Your Min Cap Rate requirement on a 20-30 unit residential?

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