Are all cap rates the same?

15 Replies

@Logan Reinard

No, cap rates different by the location, property type, property size, prior sale comps, lease terms of current tenants, property class, creditworthiness of tenants, age of the property, population growth, job growth, inventory of like properties etc.

@Charles Carillo Thank you.  What should you aim for for in a single family, duplex, triplex, etc?  Obviously if youre able to get into a duplex for a low price, you would assume fixes are around the corner.  Would that mean you have to get a much higher cap rate so you can put more of that cash flow asside for fixes?

Cap rates are used to boil different apartments or commercial properties to a comparable number; namely how much net income do they bring in versus the cost of the property.

But they don't account for risk, hassle or potential upside. Would you rather have a 10% return on your money in a dilapidated war zone or in a trendy area that continues to improve? The worse the area, the higher cap rate I would demand. So no, cap rates are not all the same.

To piggyback on Andrews point, cap rates are a reflection of the markets view of the risk in the underlying asset and market.  Higher risk properties and markets, like the war zones will have higher cap rates. Complete dumps that are falling apart will have high cap rates. 

Lower risk markets and properties will in turn have lower cap rates.  Areas of high demand, where values and rents rise will have lower cap rates. 

@Russell Brazil @Andrew Syrios great illustrations. From what I’ve found, a lot of less desirable areas produce a better cap rate but may need a bit more fixes down the road and would also not be gaining any value when it’s time to sell unless the unexpected happened and the area turned around. Would you agree with that?

Do either of you invest in less desirable areas? If so what things to watch out for. If not why not?

@Logan Reinard , one important point to keep in mind: with 1-4 unit properties, cap rates are meaningless. Those properties are valued by the residential market, not by the property's NOI. Sure, cap rate may be a handy rule of thumb for the investor, but residential properties don't appraise based on the cap rate.

You're right that typically, cap rates and appreciation are inversely related. Again, this does not directly apply to residential properties. For example, I live in a HCOL area. Duplexes can go for $2MM and simply don't cash flow, technically they have a cap rate of <1%. The residential market is mature and expensive, it's appreciating by ~2% (gross generalization). That obviously doesn't off-set such a low cap rate.

Now once you get to 5+ units, that's a different story.

Originally posted by @Logan Reinard :

@Russell Brazil @Andrew Syrios great illustrations. From what I’ve found, a lot of less desirable areas produce a better cap rate but may need a bit more fixes down the road and would also not be gaining any value when it’s time to sell unless the unexpected happened and the area turned around. Would you agree with that?

Do either of you invest in less desirable areas? If so what things to watch out for. If not why not?

In bad areas a lot of the numbers simply go out the window. They look great on paper but only on paper because the costs to operate the property are often more than the property is worth. It's true in a lot of things that general rules fall apart at the extremes and I think that's true with real estate where very low end and very high end properties are a world unto themselves and you really need to be a specialist in those markets to do well in them.

 

@Andrew Syrios @Jaysen Medhurst It sounds like you are more hesitant towards C class multi-family.  There are a couple up and coming restaurants and shops in the area, but nonetheless it's not a thriving economy by any stretch of the imagination.

https://www.biggerpockets.com/... here is the numbers i ran on it.  If you don't mind checking it out, I'd love to know what you think.

@Logan Reinard , I'm fine with C-class properties. 

A few things about your analysis:

  • 8% for Vacancy is probably fine, unless this is a local average.
  • You're forgetting CapEx. 15% combined with repairs is usually good.
  • Any house electric? For hallways, etc.
  • What about lawn care and snow removal?
  • The listing says water & trash is $210/month, but your pro forma only add up to $158.
  • I'd allocate more for initial repairs, considering the garage needs work.

Overall the numbers look pretty good here. I think your actual cash flow will be closer to $500/month, but that's still a pretty great return. Any opportunity to push rents? Think you could get a few hundred bucks renting out the garage?

@Jaysen Medhurst

• 8% for Vacancy is probably fine, unless this is a local average.

• You're forgetting CapEx. 15% combined with repairs is usually good.

YOU ARE RIGHT. I DID FORGET THAT.

• Any house electric? For hallways, etc.

WHAT DO YOU MEAN BY HOUSE ELECTRIC?

• What about lawn care and snow removal?

GRASS IS EASY. ANY TIPS ON SNOW REMOVAL COST?

• The listing says water & trash is $210/month, but your pro forma only add up to $158.

GOOD CATCH. MAKING SURE YOU WERE PAYING ATTENTION HAHA

• I'd allocate more for initial repairs, considering the garage needs work.

Yeah. That garage looks huge too

@Logan Reinard , if there’s a 5th meter, you have house electric that’s paid by the landlord.

In terms of snow removal, it will vary with the year and size of driveway. I think the best approach is too find a landscaper who also plows. Get a monthly price to do everything in the yard and take care of the snow.

Originally posted by @Logan Reinard :

@Andrew Syrios @Jaysen Medhurst It sounds like you are more hesitant towards C class multi-family.  There are a couple up and coming restaurants and shops in the area, but nonetheless it's not a thriving economy by any stretch of the imagination.

https://www.biggerpockets.com/... here is the numbers i ran on it.  If you don't mind checking it out, I'd love to know what you think.

I am definitely hesitant toward D class, but I would buy a C class. Our whole strategy is basically C to B minus with a few C minuses and B's thrown in for good measure. But for a C class property, I would definitely want a better cap rate.

 

Originally posted by @Logan Reinard :

@Andrew Syrios what do you find the major difference between c class and d class?

It's a bit of a subjective thing of course, but I would say that broadly speaking, C class is a working class neighborhood and D class is basically the ghetto. For example, C class would have a crime level above the national average whereas D class will usually have a crime rate more than double the national average.