Do Investors Buy/Sell SFR using cap rates or comps?
Member since 2019 · 4 posts · 0 votes
Hi all,
I was curious on everybody's perspective whether buying or selling single family rentals use a Cap Rate valuation, or a more traditional $/sqft with comps. On on hand it seems $/sqft makes sense, but if it's strictly a rental and has a long track record, I can see Cap Rate making sense too. Thank you in advance for all input on this.
Brad
I would never look at Cap rate for a SFR rental or homestead. You look at market comps because that is what an appraiser will look at. CoC ROI is what I want to know when analyzing a property for a client but market comps would be the way to determine an offer price.
Hi all,
I was curious on everybody's perspective whether buying or selling single family rentals use a Cap Rate valuation, or a more traditional $/sqft with comps. On on hand it seems $/sqft makes sense, but if it's strictly a rental and has a long track record, I can see Cap Rate making sense too. Thank you in advance for all input on this.
Brad
Usually cap rates come into play in the 5+ unit real estate because youre using the cash flow to analyze return, this also doubles as a way to value the building. Rather with SFH when youre buying and selling you'll analyze cash flow, but the value will be determined by comparable.
@Bradley Raynor It really depends on the area your house is in. If the rental is in a low income area and rents are say $500 a month but the appraised value is 30k, it may be advantageous to sell it using a cap rate assuming another investor would be willing to pay the premium for turn key (but it cant be financed because of the appraisal). If rents are $500/mo but appraises for 75k..... you get the point. It is not typical to sell a SFR using Cap rates.
Generally we comp out SFH homes using the price per sq ft metric. That's how most appraisers are going to assign value for lending purposes. However, we also look at total cash on cash return. Cap rates are tough on SFH because everyone runs their numbers differently. So someone may be selling a "10 cap" but they may self manage and not account for any property management or reserves.
I would say most of the investors that I have worked with are looking to hit a specific CoC return on their purchases rather than a cap rate.
So we will run ballpark price per sq ft comps to make sure our offer price is still in line with market and appraisal value, but the cash on cash return is what drives a lot of people on whether a deal is worth pursuing or not.
Technically, there is no such thing as a CAP Rate on single family. This is a metric that is typically used for valuing multi family properties. Although it's origins are in multi family, people often use it as a measure of return on single family rather than a method of determining value. Appraisers will always use the market approach rather than cost approach in their valuations of single families. The CAP rate assumes a cash purchase. If you are financing, a better measure is cash on cash return or total return on equity.
Technically, there is no such thing as a CAP Rate on single family. This is a metric that is typically used for valuing multi family properties. Although it's origins are in multi family, people often use it as a measure of return on single family rather than a method of determining value. Appraisers will always use the market approach rather than cost approach in their valuations of single families. The CAP rate assumes a cash purchase. If you are financing, a better measure is cash on cash return or total return on equity.
John, I think you misunderstood what I was saying. I agree that it is not a return, however, when people apply it to single family properties, that's how they typically use it. They view CAP rate as a return when in fact, it is a number used to determine value. If we want to be technical, individual properties don't have CAP rates. A cap rate for a similar class of property in a similar location is determined and is what then determines the value of any similar commercial property.
I agree that a cap rate is used to value commercial properties but do not agree that it is a return. That would be like saying a GRM is a return. Also cap rates do not include financing since that is not an operating expense. The cap rate will be the same with financing or not. Cash on cash and ROE are return measurements.
I would never look at Cap rate for a SFR rental or homestead. You look at market comps because that is what an appraiser will look at. CoC ROI is what I want to know when analyzing a property for a client but market comps would be the way to determine an offer price.
@John Erlanger We are saying the same thing. People mistakenly use the term CAP rate on single family homes. It has gotten so common place that nobody even questions it anymore. I may not have said it clearly when I said that individual properties don't have CAP rates. What I was trying to say was that an aggregate market CAP rate is determined which is then used to determine values.
Technically, there is no such thing as a CAP Rate on single family. This is a metric that is typically used for valuing multi family properties. Although it's origins are in multi family, people often use it as a measure of return on single family rather than a method of determining value. Appraisers will always use the market approach rather than cost approach in their valuations of single families. The CAP rate assumes a cash purchase. If you are financing, a better measure is cash on cash return or total return on equity.
John, I think you misunderstood what I was saying. I agree that it is not a return, however, when people apply it to single family properties, that's how they typically use it. They view CAP rate as a return when in fact, it is a number used to determine value. If we want to be technical, individual properties don't have CAP rates. A cap rate for a similar class of property in a similar location is determined and is what then determines the value of any similar commercial property.
I agree that a cap rate is used to value commercial properties but do not agree that it is a return. That would be like saying a GRM is a return. Also cap rates do not include financing since that is not an operating expense. The cap rate will be the same with financing or not. Cash on cash and ROE are return measurements.
Yes you've confused me a bit. So you are agreeing that investors that pretend that a cap rate is a return are incorrect even on a SFR? I can point you to hundreds of YouTube videos where people, even posters on this board stubbornly and incorrectly claiming that a cap rate is your unleveraged return. There is one that is asking for tens of millions of dollars of investor money on this forum (beware folks). That is scary!
Cap rate comps come from individual sold buildings. What would make you think they don't have a cap rate? Now before we go down a rabbit hole that number won't be the market cap rate which basically reflects the individual buildings cap rates. So buildings may have sold between 8.7% to 9.2% and investors will generally say that properties in that market sell at a 9% cap rate. Now if you want to value the NOI that you are buying you will look at the cap rates from buildings/NOI's that are closest to what you are looking at. It may even be a superior building to all the comps and the buyer can rightly command a 9.4% cap rate or it could be inferior to all the comps and you should not pay 9% but closer to 8.6%. Of course most small investors are not going to have the individual comps so they are going to be looking at a survey reported 9% comp and negotiate from there.
Maybe I'm misreading this but it seems backwards to me. If the subject building is superior to all the comps then the seller should be able to command 8.6% cap rate (i.e. higher price) and conversely, if the subject building is inferior to all the comps then the buyer can negotiate to 9.4% cap rate (i.e. lower price).
Cheers... Immanuel
Agree with Tyler on CoC and IRR for deciding if it's a good deal. I do use Gross Yield as a quick was to get a feeling for whether it's worth looking into something. Regarding Comps I have mixed feelings. From a cash flow perspective either the deal looks good at the asking price or it doesn't. In a hot market something can be cheaper than the properties around it and still a bad deal. And knowing you're getting a good purchase price is kind of baked in to being happy with the IRR. If you hadn't guessed I'm not big on banking on appreciation.
Hey Brad, it took me a while to wrap my head around all of this. If you want to talk it through with someone, let me know. (disclaimer, I'm not saying I have it all figured out :) but getting there)