Why Do Investors Keep Overpaying On Properties?

Why Do Investors Keep Overpaying On Properties?

Multifamily investor · Boston, MA · Member since 2017 · 281 posts · 521 votes

Overbidding is the opposite of being a conservative investor. It happens when you buy above the market rate, compared to similar properties in the same general area. Another telltale sign of overbidding is when you purchase a property at a higher cap rate than market cap rates.

Capitalization rates (which are calculated as net operating income divided by purchase price) show what your return would be if you paid cash for the property. The lower the cap rate, the higher the price you’ll pay for the property. Higher cap rates usually lead to higher returns, but a cap rate that is too high can be an indicator of risk in the investment. The national cap rate for multifamily is 5%.

Here’s something to think about: You may be overbidding on a property if you ignore signs that you should be more cautious in your investment approach. This can happen when an investor is new and inexperienced, and only sees the upside to a real estate deal while ignoring inherent risks.

A Closer Look At The Current Cycle

Has the multifamily cycle peaked? Some experts think it has. But there is still a strong demand for multifamily properties, along with a shortage of quality properties available for purchase. The factors that pushed multifamily property prices higher and caused investors to start overbidding are still in place. These factors include more retiring baby boomers electing to rent rather than purchase new homes, and millennials who are also choosing to rent rather than buy single-family homes.

So Why Do We Still Witness Overbidding?

Throughout my career in real estate, I’ve witnessed several key reasons why investors still overbid at this late stage of the cycle. Foreign investors are still bidding on U.S. properties, which is helping to drive up the price on multifamily properties, as well as contribute to overbidding. For foreign investors, making 3% cash-on-cash is better than 0.5% in their home countries. Institutional investors are also driving up prices by purchasing properties at higher prices, not only in the primary markets that they’re used to, like New York, Los Angeles and Chicago, but in secondary markets as well. They mainly make money on fees, and they have the power to lower their investors' expectations when it comes to returns. Hence, they are able to overbid.

Interest rates are at historic lows, which makes financing more attractive, and that fact allows investors to offer higher prices. In addition, novice investors are overbidding simply because they want to own real estate, and they are willing to do whatever it takes to acquire properties.

Another factor driving prices is the 1031 exchange. This tax-deferred exchange permits a seller to trade their asset for a similar one and defer their capital gains tax until the sale of the next asset — or even further down the line. So sellers are under pressure to acquire new properties and will do whatever is necessary to buy one, including overbidding, so they won’t have to pay high tax on capital gains.

Lastly, many investors are overly optimistic, thinking that higher rent premiums will help to justify the price they’re willing to pay for the property. That’s simply not the case. Many investors and apartment owners will attest to the fact that when rents are raised beyond the market average, tenants will elect to move.

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Russell BrazilBusiness Member
Moderator
Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
6y

Are people over bidding, or are you misjudging values?

By definition, the price a property sells for is the market price. So however high or low a property closes, that is the market price. 

See this reply in the discussion

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  • Bryan MitchellPro Member
    Rental Property Investor · Columbus, GA · Member since 2016 · 634 posts · 337 votes
    6y

    @Ellie Perlman Another reason is out of fear or feelings of scarcity. If everything is “overpriced “ and you keep making offers that are never accepted over several months, you get anxious and follow the herd and overpay.

  • Realtor · Dallas - Fort Worth Metroplex, TX · Member since 2016 · 1k+ posts · 925 votes
    6y

    @Ellie Perlman. 100% agree. It's madness. We are seeing it in the MF arena as investors but also as a Realtor working with investors I see it in the SFH and small MF's markets especially duplexes right now. I am writing contracts all day long and my clients are getting out bid most of the time. It is mindboggling how many times we've seen other investors pay over ask for a class C (mainly) duplex. Putting their new investment at a.5-.6% rent ratio. Clearly it will not be cash flow positive for that investor anytime soon, if ever.

  • Bryan MitchellPro Member
    Rental Property Investor · Columbus, GA · Member since 2016 · 634 posts · 337 votes
    6y

    @Russell Brazil You make excellent points. I recall in 2006-2008 I was looking for investment properties in Atlanta. I couldn’t find anything that made sense to me. So, I continued to save, hustle, and save some more. Then in 2011, I restarted my search after returning from a military mobilization. There were many more properties available and at very reasonable prices. I bought two over the next two years. Point being, I encourage others be patient and be persistent. It worked for me.

  • Real Estate Investor · Springfield, MO · Member since 2017 · 1k+ posts · 2k+ votes
    6y

    I'm a little surprised the conversation has gotten this far with little to no direct talk of opportunity cost (OC).

    I don't believe in "overpriced" / "underpriced" as a concept unless you are talking about commodities.  Real estate is NOT a commodity: every location is different, even within a building itself.  The pent house commands more rent than the basement, usually.  We only know if someone "paid too much" (if ever) years after the fact.  And I'm not sure we know even then.

    Rather, I think we do well to talk about OC: "I only have enough money to buy apartment X for $Y, or I can buy investment Z for $Y. Which one will I take?"  Then if that choice accomplishes the investor's goals, the term "overpaid" becomes irrelevant.

    Could I have bought it cheaper?  Possibly.  But that is true of almost anything.  Let's pretend Bob owns a 100 unit apartment complex and he has it listed for $10 million.  If I buy it today and it cash flows positive, did I overpay?  What if I had waited 10 months and meanwhile he has a life emergency, needs cash quick, and he would have dropped the price to $9 million?  Did I overpay at $10 M?  Nah, that's silly to look at it thru the lens of the future and the "what if?"

    That's why I believe opportunity cost is the key factor to look at.  I have $X to invest and this range of choices.  Which one do I believe will best help me reach my goal, whether that's cash flow, appreciation of the asset, parking cash for safekeeping, enjoyment of the utility the asset brings, etc.

    I know a person who paid $1,000 for a bottle of bourbon.  Did he overpay?  As compared to what?  What if he makes $1M income per year?  $10M income per year?

    Me?  My bourbon costs $45 or less.  

    Set your goals, go forth, and conquer!

  • Dan DiFilippoBusiness Member
    Real Estate Broker · Fayetteville, NC · Member since 2020 · 251 posts · 244 votes
    6y

    @Ellie Perlman solid breakdown - well done! There is one other thing I'd mention which is, yes, we're getting a lot of foreigner investors, but we're also getting a lot of domestic investors pivoting to real estate from their asset class. I've touched on this elsewhere myself, but the comparative yields are have caused real estate to be finally sucked into the bubble. Cash investors tend to limit their exposure to it because it's illiquid, labor intensive to manage, has several risk exposures, and needs to be leveraged to get competitive returns, which means it requires a long term capital commitment. But because price to earnings was so steep (even Pre-COVID), real estate actually came to have a natural edge over the more liquid securities markets. I've said for a while though that we are looking at a real flattening of the economy as we have continually weakened. Ultimately, returns are a function of underlying fundamental growth mixed with a risk profile. And I think what we've been witnessing is that underlying growth withering and taking everything down with it.

    Brookdale Property Management
  • Peter TverdovBusiness Member
    Developer · New Brunswick, NJ · Member since 2015 · 1k+ posts · 2k+ votes
    6y

    Combo of foreign money, interest rates at zero and 1031 exchange. People have to put their money somewhere. What's better? 0% in the bank or 5% in a building that will likely appreciate in value every year on top of making you 5%?

  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    6y
    Originally posted by @Kai Van Leuven:

    @Russell Brazil

    Could not disagree with you more. The market is so inefficient that to say that something sells for market price is short sighted. It sells for what someone is willing to pay. Assets that are "thinly" traded like real estate have tons of factors that weigh the buy/sell price. Those include marketing, emotion, perception, status, and then some quantitative measurements as well (lol). Look at what is required to be a "well marketed" property on the MLS, professional photos, 3-D tours, staging with mini furniture, a write up done with some jazz hands or something that will make you want to smell roses. If you can tell me which one of those 4 add value to a property, like actual value to the buyer, I would be all ears.

    There once was a time when a 3.5 megapixel camera was all you needed to “show off” a house.

     I wouldnt call 6 million sales and data points per year something thats thinly traded. All those factors you mentioned are factors in the market. Just because someone is willing to pay more for a property than you does not change the fact that the price a home sells for, is by definition the market price of the property. This is a definition, its not an opinion. 

  • Investor · Cherry Hill, NJ · Member since 2016 · 860 posts · 324 votes
    6y

    @Ellie Perlman

    I think one key factor is opportunity zone benefits as well

  • Rental Property Investor · Hendersonville, NC · Member since 2016 · 446 posts · 412 votes
    6y

    Great information! I definitely think we do see overbidding, but I also would say that the cap rate doesn't show everything. Someone could buy at a below market cap rate, but see some large value add opportunity to boost NOI that the data doesn't capture.


    Especially on the smaller multi-family, you are very dependent on the buyers situation.  In our area, non-investors will buy a duplex and house hack, just to afford to live here, driving up the prices beyond a traditional investor will pay, but it is still potentially a good investment for them.  Same could be said of a high income earner looking to diversify and buy something all cash, completely okay with a smaller unleveraged return.  Everyone values their investments differently.

  • Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes
    6y

    Markets change and price change with it. Sometimes people are making a mistake but at some point an investor has to recognize this is a shift in market price and sentiment. Remember all the people calling for tops 2017, 2018, 2019,2020? 

    Some investors might be happy with lower returns given the value of the dollar and what interest is paying in their checking account. There are certainly things sold that make me scratch my head but it is what it is. Value is worth what someone is willing to pay for it.

  • Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    6y
    Originally posted by @Erik W.:

    I'm a little surprised the conversation has gotten this far with little to no direct talk of opportunity cost (OC).

    I don't believe in "overpriced" / "underpriced" as a concept unless you are talking about commodities.  Real estate is NOT a commodity: every location is different, even within a building itself.  The pent house commands more rent than the basement, usually.  We only know if someone "paid too much" (if ever) years after the fact.  And I'm not sure we know even then.

    Rather, I think we do well to talk about OC: "I only have enough money to buy apartment X for $Y, or I can buy investment Z for $Y. Which one will I take?"  Then if that choice accomplishes the investor's goals, the term "overpaid" becomes irrelevant.

    Could I have bought it cheaper?  Possibly.  But that is true of almost anything.  Let's pretend Bob owns a 100 unit apartment complex and he has it listed for $10 million.  If I buy it today and it cash flows positive, did I overpay?  What if I had waited 10 months and meanwhile he has a life emergency, needs cash quick, and he would have dropped the price to $9 million?  Did I overpay at $10 M?  Nah, that's silly to look at it thru the lens of the future and the "what if?"

    That's why I believe opportunity cost is the key factor to look at.  I have $X to invest and this range of choices.  Which one do I believe will best help me reach my goal, whether that's cash flow, appreciation of the asset, parking cash for safekeeping, enjoyment of the utility the asset brings, etc.

    I know a person who paid $1,000 for a bottle of bourbon.  Did he overpay?  As compared to what?  What if he makes $1M income per year?  $10M income per year?

    Me?  My bourbon costs $45 or less.  

    Set your goals, go forth, and conquer!

    Erik got me thinking of compared to what, which is an excellent point. 

    Compared to passive paper or equity returns is what I compare to.  I am not doing tenants and toilets (or flips) for less than a 5 or 6 cap, period.  My OC is easily beating that with less work unleveraged in a different asset class than RE altogether.  

    When the market cap dropped to 4-5 (from 10+ at purchase)  I became a seller.  When market value and insurance estimated cost to rebuild meet, I'm grabbing a chair. 

    To the OP question of why it seems other investors are overpaying? They're not typical BP investors is why. Their goal and purpose are different. 

    I asked the listing agent of several 'new level of expensive' quads in my area she sold who the heck is buying them.  She said the buyers are mini syndications essentially seeking a tax haven.  2 boomer couples get together and buy at a 4 cap then put it under a PM that drops their annual to 3% if they're lucky. So what. They want a store of value and tax losses anyway. 

    Overpaying to a min return or else I'll buy stock investor like me is someone else's tax and estate planning tool. Know why you are investing and stick to your criteria. 

  • Robert EllisBusiness Member
    Developer · Miami, FL · Member since 2014 · 3k+ posts · 1k+ votes
    6y

    Interesting take on the situation.

  • Rental Property Investor · Portland OR · Member since 2018 · 2k+ posts · 3k+ votes
    6y

    I think that being in the game is better than not....  sure, i could wait for the mythical “good deal” (priced at 2011 prices) but what about the cash flow I am missing out on while I wait for this unicorn?  there is clear and real opportunity costs and every minute you own a good asset is another minute you are making money. 

    Each investor will have their own goal and reasons for investing: some want to find the unicorn and flip and make quick money.... others want steady cash flow with no headache of a gagillion repairs or having to reno each unit.... still others live off the cash thrown off by the investment.... 

    For example I buy new builds and happily pay the price to not have to do repairs all day.... 

    This is what is so great about RE  there are so many ways to do it    

    Finally, I dont think it is helpful to always be banging the “dont over pay” drum - this just scares off folks who could benefit at least, by the experience of being in the game.....

  • Rental Property Investor · Fort Collins, CO · Member since 2015 · 158 posts · 327 votes
    6y

    1031s and foreign investors have outbid me in the past, for exactly the reasons that @Ellie Perlman described. Another reason I'd like to add to the mix is short-term rentals, which have the potential to gross far more revenue than long-term rentals. A buyer planning to AirBnB can justify a significantly higher price than the rest of us. COVID may reduce that factor going forward.

    In my market, the biggest problem driving prices higher isn't so much investors willing to overbid on new properties as it is an unprofitable rent-to-price ratio across the market. Cashflowing a new property is impossible if one pays anywhere near MLS pricing, unless you run the numbers incorrectly, which some newer "investors" may be doing. I also see more and more existing investors who are settling for, or even celebrating, terrible ROI on their rentals. I see two primary reasons for this:

    1. Deferred maintenance, and lots of it. It's easy to say you're cashflowing when you haven't had capex for over a decade, but your equity ROI is probably negative.

    2. Bad ROI math. So you acquired for $50k and are making $10k/year in total return. Great! For year 1, anyway. But if your gains are mostly equity, and years later you have $200k in equity and still only $10k/year in new return, your ROI is terrible now. You might think it's good if you're still imagining that you're only $50k into the property, but you're not. Those of us celebrating their paid-off $300k SFRs that cashflow $10k annually and appreciate at $10k annually would be better off in stock, where you average the same $20k total post-tax return, all in cash, and with no management effort whatsoever.

    But all of this overpricing might be a moot point soon if it's true that a quarter of the country's renters won't be able to make payments once the government's COVID spending stops. Throw in a foreclosure boom, and those of us with capital are about to find deals aplenty.

  • Specialist · Cleveland, OH · Member since 2018 · 1k+ posts · 666 votes
    6y

    @Ellie Perlman In my market we always buy below the appraised value with double digit net caps,,,, typically 3 x ( my personals are all 4, 5 xs ) the national avg . 

    Good Luck 

  • Investor · NorCal · Member since 2015 · 282 posts · 240 votes
    6y

    The Fed just pumped 3 trillion into the economy, and more trillions are coming. These funds have to go somewhere. Stashed in the bank, earning only 0.1% interest and 3% inflation it’s a big loss. Buying real estate with 3% cap makes more sense, plus possible future appreciation and also a “free” depreciation deduction on your taxes.

  • San Antonio, TX · Member since 2019 · 930 posts · 836 votes
    6y

    @Russell Brazil

    Not to argue, 6 million is a lot of data points, but compared to stocks, that isn’t very much.

    Case in point, the day is only half over and a single company, Chevron, has traded 9.8 million shares today.

  • Member since 2020 · 201 posts · 118 votes
    6y
    Originally posted by @Jim Spatzenfeld:

    The Fed just pumped 3 trillion into the economy, and more trillions are coming. These funds have to go somewhere. Stashed in the bank, earning only 0.1% interest and 3% inflation it’s a big loss. Buying real estate with 3% cap makes more sense, plus possible future appreciation and also a “free” depreciation deduction on your taxes.

    Those funds are used to rescue big companies from bankruptcy and hardly reach the real economy. Governments allocate "rescue money" first to rescue the rich. It is like oxygen masks falling inside a plane cabin "wear your mask first before helping other passengers". The rich are first when it comes to being rescued.

    By the way, the dollar is going downhill against the euro.

  • Investor · Shakopee, MN · Member since 2014 · 219 posts · 88 votes
    6y

    People are "overpaying" for properties right now.

    They are also "overpaying" for company stocks.

    The reason for this is we are currently in a period of time where we haven't hit the realization of the massive weakening of the dollar that is taking place over the next 5-10 years.

    We don't have a housing bubble, or a dot-com bubble. We have a dollar bubble.

    Best thing to do during a dollar bubble is to borrow it and buy tangible assets. Some are choosing stocks.

    Right now price of a Big Mac is $5.71 which could be considered a bubble in itself, but what is happening is the current value of the dollar is over-inflated and will decrease substantially in the next 3-5 years.  

    Say the dollar is 25% over-valued right now, people buying a house at $400,000 are really only going to feel like they paid $300,000 for it in a few years.  We'll have $7.25 Big Macs by about 2023.  But those are harder to keep. Better off buying houses or stock.

  • Flipper/Rehabber · Colorado Springs, CO · Member since 2016 · 502 posts · 167 votes
    6y

    How do you know who's bidding/buying? I can't get ANY such information from anyone, least of all my broker. Considering doing a direct mail outreach but the amount of work involved, compared with crap results in a hot sellers market, slows me down. I offered $20K over list on one real nice SFR and was still outbid. The properties I like are attractive to financially well-off buyers. Also the 420 situation here is creating many cash buyers. So I look at the listings but I'm sitting out, since I made about 10 offers in 2 months for a complete waste of time. Glad the brokers are doing well, they are now putting up one photo of the curb view of the house and very little description. In this market that's all it takes.

  • Rental Property Investor · Wilmington, DE · Member since 2020 · 35 posts · 19 votes
    6y

    @Corby Goade

    Great insight. Can you elaborate a little more with how experienced investors seek equity in the long run.

  • Nicholas U.Pro Member
    Member since 2020 · 65 posts · 44 votes
    6y

    I disagree with the people who state that it isn't "overpaying" to some extent.  

    I have stated before that it looks like we are in a real estate bubble on some of these properties.  In my area, properties that go on the market go off incredibly fast, but I have been in many of these properties.  If the idea is to hold for cash flow or long term growth then they are overpaying because the properties need a lot of repairs.  If it is simply to buy and hopefully sell a few years down the line in the hopes of real estate appreciation then someone will eventually come out a big loser because at some point the roof is going to cave in, the foundation needs repaired, or the electrical needs updated.  

    So in the end it depends on what people are getting into.  If your hope is to put 20-25% down get some cash flow for a couple of years, sell and get 10-20% property value growth, and then move on to the next property (1031) this is the riskier route and are the people paying more.  Right now it is working out but it is like people investing in the stock market without knowing anything.  Ya you might get lucky and make a good return or you might really get kicked in the teeth.  

  • Nicholas U.Pro Member
    Member since 2020 · 65 posts · 44 votes
    6y
    Originally posted by @Erik W.:

    I'm a little surprised the conversation has gotten this far with little to no direct talk of opportunity cost (OC).

    I don't believe in "overpriced" / "underpriced" as a concept unless you are talking about commodities.  Real estate is NOT a commodity: every location is different, even within a building itself.  The pent house commands more rent than the basement, usually.  We only know if someone "paid too much" (if ever) years after the fact.  And I'm not sure we know even then.

    Rather, I think we do well to talk about OC: "I only have enough money to buy apartment X for $Y, or I can buy investment Z for $Y. Which one will I take?"  Then if that choice accomplishes the investor's goals, the term "overpaid" becomes irrelevant.

    Could I have bought it cheaper?  Possibly.  But that is true of almost anything.  Let's pretend Bob owns a 100 unit apartment complex and he has it listed for $10 million.  If I buy it today and it cash flows positive, did I overpay?  What if I had waited 10 months and meanwhile he has a life emergency, needs cash quick, and he would have dropped the price to $9 million?  Did I overpay at $10 M?  Nah, that's silly to look at it thru the lens of the future and the "what if?"

    That's why I believe opportunity cost is the key factor to look at.  I have $X to invest and this range of choices.  Which one do I believe will best help me reach my goal, whether that's cash flow, appreciation of the asset, parking cash for safekeeping, enjoyment of the utility the asset brings, etc.

    I know a person who paid $1,000 for a bottle of bourbon.  Did he overpay?  As compared to what?  What if he makes $1M income per year?  $10M income per year?

    Me?  My bourbon costs $45 or less.  

    Set your goals, go forth, and conquer!

    There is always a market value in any sector of the economy.  You could be willing to pay $100,000 for an individual stock of Tesla but it doesn't mean that is advisable.  

    I agree that some people might value properties different than I do, and as such is willing to pay more than me, but your apartment example that little to do with Opportunity Cost and more to do with the sellers value of the property .  The choice of buying the apartment and forgoing the other opportunities you could have done with that money is the Opportunity Cost.  You could choose to buy the apartment instead of buying a short term CD.  You value the idea of investing in the apartment over the short term security of a CD, but the question is buy how much?

  • Corby GoadeBusiness Member
    Investor · Boise, ID · Member since 2014 · 3k+ posts · 3k+ votes
    6y

    @Terry Harris Thanks! Nice to hear from someone a bit more openminded! There are lots of investors who bet on appreciation and forced equity and they don't give a second thought to cash flow. I work with those people all of the time. A simple scenario- I just did a deal with a client who bought a SFH in my market, rented it out, basically breaking even for a year, and just sold it for a $60k profit in one year, basically all appreciation. Imagine if you did that 10 times? 100 times?

    On a larger scale, syndicators buy large apartment buildings and hotels in appreciating areas all of the time, paying investors back based on the equity growth in the property. 

    Finally, there are tons of people in my market, myself included, who buy SFH and small multis and ride the appreciation for a year or two, then to a cash out refi based solely on appreciation. It's essentially a BRRRR without the rehab.

  • Rental Property Investor · Wilmington, DE · Member since 2020 · 35 posts · 19 votes
    6y

    @Corby Goade

    Wow! Never looked at it that way, or the way experienced investors do. Thank you for the information.

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