Cap rate for Multifamily

12 Replies

I am looking to get into Multifamily and based on what I have read it looks like properties with high cap rates is the way to go . however if I am not looking for immediate cashflow , how do you make money in areas like bay area ? does appreciation in property values count for multifamily ? in that case cap rate would have to get lowered for the property price to go up besides rent increase . if we are looking just at rent increase to increase property value with cap rate remaining same then it would not make sense to invest in areas like bay area ? if SFH appreciate i would think even multifamily appreciate without same corresponding increase in rent but with cap rate going down ? For example we have seen condo price increase 3x in bay area over the last 7 years in some areas but rent increase has not been 3x . so multifamily would never give me the kind of appreciation of buying individual units or SFH where pricing is based of rents ?

SFH investing in CA is based almost entirely on speculation. You need deep pockets to be able to supplement your tenants rent in many areas of CA to carry you till you cash out on appreciation.

Your right it does not make sense to invest in the Bay area.

Originally posted by @Sid Naik :

I am looking to get into Multifamily and based on what I have read it looks like properties with high cap rates is the way to go . however if I am not looking for immediate cashflow , how do you make money in areas like bay area ? does appreciation in property values count for multifamily ? in that case cap rate would have to get lowered for the property price to go up besides rent increase . if we are looking just at rent increase to increase property value with cap rate remaining same then it would not make sense to invest in areas like bay area ? if SFH appreciate i would think even multifamily appreciate without same corresponding increase in rent but with cap rate going down ? For example we have seen condo price increase 3x in bay area over the last 7 years in some areas but rent increase has not been 3x . so multifamily would never give me the kind of appreciation of buying individual units or SFH where pricing is based of rents ?

  You’re a bit late to the game. Unless you find a building where you can double the rents, no point in trying to compete in this shark infested Bay Area. 

We recently purchased a building in Oakland where we are more than doubling rents (from $5,500/month to $11,300/month). Doubling the NOI and doubling the value. These are home run deals but are extremely hard to find.

@Sid Naik

I have two clients who are still buying homes in top school neighborhoods initially charging less than the mortgage as rent. The home purchased for him 10 years ago has tripled in value while it is a wash on cash flow. They gained 7 figures in equity. This year another client bought in 95125 one 2/1with 10,000 sf lot wanting to add on eventually the tenant contributes a fraction of the mortgage. 

MF is snatched up in SFBA often with cash with multiple offers regardless economy condition. It provides a steady cash flow for retirees as long as they produce reasonable returns than putting money in the bank. Most do not have or have a very small mortgage.  Most never regret such lower tax rate and equity gain.

@Thomas S. You should either have a solid balance sheet, amazing connection and a lot of times to be able to generate reasonable income returns in the SFBA area. Capital appreciation will be your biggest friend as you live in a very desirable part of the country with a strong economy. 

Nonetheless, if you're starting out I would suggest networking with local investors to develop your network before deciding to invest.

Saj Shah

I am not looking to get into MF right away , I am studying it a the moment . I have had a good ride investing in SFH over the past 8 years with 3x appreciation in bay area . however i will be capped in investing if I don't go for commercial properties . I want to venture out in Multi family but I am surprised if bay area multi family value appreciates only if I can increase rent . In that case I will have to look out of state as rent increases like bay area are elsewhere as well . why pay so much if the upside is limited by rent increase only . I want the appreciation play and if you study the trends carefully it is not gambling just like the last 6-7 years .

@Sid Naik Cap Rates should also be viewed as an expression of risk based on the types of properties you can buy.  Within any given market, the lesser the area, the higher the Cap Rate.   

I am a big proponent of buy and hold in appreciating markets such as LA.  The appropriate use of leveraged appreciation will allow you to build a larger portfolio over the long run that you can cash flow off of instead of chasing yield.  Also the strong upside in rents in these markets will give you increased cash flow that is completely ignored by focusing only on cap rates. 

So the take away here is that appreciation and cap rates move inversely.  The challenge, however, for many investors is the cost of entry.

@Jeffrey Isenberg

"So the take away here is that appreciation and cap rates move inversely".

Yes that is exactly my point . I am looking for appreciation in Multifamily and even in hot markets rents do not rise as rapidly as a SFH appreciation so why buy in an area where there are low cap rates ? Will the rents rise more rapidly and consequently price will appreciate in these areas of low cap rates ? If I am paying high $$ for a property with very less cashflow I am assuming it will appreciate better. is that true ? thats the answer I am trying to find in the context of Multifamily .

@Sid Naik your MF building will appreciate if 1 (or more) of these things happen:

1. You increase rents

2. You decrease expenses

3. The CAP rate goes down (compresses)

Since the CAP rate won't be going down anytime soon, the only way for MF to appreciate is to raise rents or lower expenses. You feel this isn't fair but that's how it is. You need to be able to add value and raise rents in order to make it in this business. People who buy 3% CAP rates do so to park money or to hold long term for appreciation while being negative on cash flow. (or value add to raise NOI and exit the deal)

If your game plan it to buy when CAP rates are 8% and hope they go down to 3% again, you're taking on way too much risk for something that will take 10+ years to occur.

Our business model is to find buildings with significantly under-market rents, in rent controlled cities, and bringing those rents to market. Double the NOI, double the value.

@Sid Naik   I am in agreement with Account Closed especially with respect to point 1 on increased rents.  Can't really speak for the NorCal market, but we have experienced 50% rent increases in our market over the last 5 years.    

Many investors are quick to discount a 4% Cap rate and modest 3% Cash Flow in this market without realizing the tremendous opportunities obtained in the near to mid-term from annual rent increases.   Not saying they will continue at this pace in perpetuity.   However, the underlying factors driving increased demand are not likely to change anytime soon, IMHO.    

@Saj Shah

Thanks  Saj . yes that is what I was looking for . 

3. The CAP rate goes down (compresses) . The first 2 being obvious .

To invests in a market like bay area I believe there is more movement tin cap rates due to 

appreciation and correction after all there should be some benefit to invest in multifamily if cash flow is not ur ultimate aim . Below url cocnfirms movement of cap rate as we reach towards peak prices

https://www.bayareamarketreports.com/trend/bay-are...

Hi @Sid Naik ,

Just to expound on what @Jeffrey Isenberg and Account Closed said about increasing rents, It's also about increasing the income overall that may come in other forms such as laundry, pet rent, parking fees, storage fees, etc. These are the "value add" opportunities many investors look for in commercial multi-family properties that allow them to boost the NOI and force appreciation.

@Eduardo Zepeda

I totally get it about increasing NOI and decreasing expenses . This is applicable across US real estate in any market .

My point is to make sense of investing  in bay area for appreciation the cap rate needs to go down and areas like bay area is where the cap rates moves around quite a lot ( low during boom and up during recession )  compared to say a market like kansas or ohio . If they don't move then I am better off investing in kansas .makes sense ?