All Forum Posts by: Immanuel Sibero

@Solon S.

..should that be the only thing calculated in the expenses?

No, cap rate is defined as NOI/Purchase price(Value). The expenses to be included in NOI are "operating" expenses meaning any ordinary/regular payments made to keep the property in operating condition. So estimates of vacancies, maintenance, repairs, utilities, supplies, etc. are examples of operating expenses. Operating expenses do not, however, include financing costs or capital expenditures as these items are not generally considered ordinary/regular operating items.

...Are the real estate agents presenting these cap rates in their pro forma's portraying them accurately?

Never. Pro forma's are never accurate, besides you wouldn't want to go by pro forma's anyway. You should start with actual.

Cheers... Immanuel

@Todd Dexheimer

Shouldn't it be "If you buy a property at a 5 cap in an area that sells for a 3 cap, you may have bought a gem"?

Cheers... Immanuel

@Brent B.

Real estate investment is pretty broad - there is buy and hold, flipping, development, commercial, etc each with their own risk and return characteristics. IMO, you would have to pick more specific segment of real estate investment before making a productive risk vs return comparison to the stock market.

It's important to understand the return structure in real estate before selecting any of the performance metrics thrown around here and use them to compare to the stock market. For example, at least three types of return can be generated from a buy and hold investment: -cashflow, -loan paydown, - appreciation. (Some would add tax benefit as a return but I digress). A cash on cash metric only takes into account cashflow and loan paydown so it doesn't reflect the whole return of the investment. As pointed out before, cap rate is not even a performance metric so forget that. However, IRR does take into account all three types of return so it is a good candidate to use as a comparison metric against the stock market.

As far as risk premium and whether or not you are adequately compensated for the additional risks associated with real estate, well I think the onus is on you. You, the investor, make the assessment whether or not you're adequately compensated for taking on the additional risks. To me this means you, the investor, need to study and educate yourself on the risks inherent in real estate, just as you have educated yourself on the risks associated with stock investments. This is the same process an investor goes through when deciding to invest in Netflix (i.e. growth stock) as opposed to Coke (i.e. income stock)... that is, by studying them and make the assessment of which is more acceptable.

Cheers... Immanuel

So why is no one mentioning the "comps" for these duplexes? You can calculate and analyze the cap rate in your Excel worksheet every which way but loose, if the "comps" do not support your value, you won't have a deal.

@Account Closed probably  found out that cap rate is just not relevant when it comes to valuation of residential properties (i.e. SFRs, and 2-4 unit properties). Some investors still insists on using worksheet to perform cap rate analysis on this type of properties but cap rate is not even the best comparison metric to use to analyze residential properties.

So why is cap rate not a good metric to determine value for residential properties? Because you (the investor) are competing with owner occupants and owner occupants do not use "cap rate" to buy homes, they use emotion!! Emotion beats cap rate any day of the week.

So use "comps" as the starting point of your analysis, save the cap rate analysis for another day. How do you find off-market deals? Well you can find wholesalers in your area of interest... or better yet do what wholesalers do. Send out your own mailing.

Cheers... Immanuel

@Antonio Montgomery

I'm no expert but your calculated 22.26% and 86% are not ROI. If by ROI you mean Cash on Cash (which you should be using), you take your annual residual cash (i.e. profit), divide that by your total cash you paid for the property all in (i.e. down payment, closing costs, plus initial repairs).

You might be missing some expenses: vacancy (i.e. you will have vacancy), ongoing repairs/maintenance (i.e. something will break).

I don't know how a range of  .8 - 1.1 percent to estimate rent can help you with your analysis. The range is just too large. I have a rental that went from $1,200/month to  $1,700/month, but that took 6 years with a the Great Recession thrown in. Can you not get a more accurate estimate on rent from the broker or comparable properties available for rent in the area or maybe rentometer/zillow? 

I know your question is specifically about cap rate. I would say forget cap rate. It's not relevant, much less using it as a guide to incur or forgo repairs/updates. Use Cash on Cash instead, but use the correct formula (annual cashflow / cost of property). Got the feeling that you're over-analyzing this.

Cheers... Immanuel

@Michael Kistner

That's a unique way of looking at it. Maybe the phrase "increasing cap rate" in your post really means increasing the "operating yield" of the property, then yes I agree. Operating yield is a measure of NOI and NOI has a direct relationship with value.

I wasn't really commenting on the mechanics of using the cap rate formula which has been beaten to death on here. Was just commenting on the idea that ".. you can increase your CAP rate and drive the value.." in your original post which suggests that when cap rate goes up value goes up.

The relationship between cap rate and value is actually one of inverse. If cap rate increases value goes down. Here are some references with quotes suggesting the inverse relationship between cap rate and value.

https://homeguides.sfgate.com/using-capitalization...

"..the higher the cap rate, the lower the property’s value"

http://people.stern.nyu.edu/adamodar/New_Home_Page...

"The higher the cap rate, the lower the price."

https://en.wikipedia.org/wiki/Capitalization_rate

"A comparatively higher cap rate for a property would indicate greater risk associated with the investment (decreasing demand for the product, and the corresponding value), and a comparatively lower cap rate for a property might indicate less risk (increased demand for the product)"

https://www.divestopedia.com/definition/4920/capit...

"..the cap rate and the value of the property are inversely related."

http://www.ivycommercial.com/caprate.html

"The cap rate has an inverse relationship to value"

We have veered off a little bit from the original topic, so I'll leave it at this.

Cheers... Immanuel

@Michael Kistner

"...increase the cap rate which should increase the value."

Increase in cap rates does not increase value, it's the opposite actually. California has seen prices/values going through the roof, but cap rates have been compressing, haven't they? What is the cap rate in CA now? 2 or 3?

Cheers... Immanuel

@Shweta Patel

Looks like you're dealing with a mobile home park. If you haven't already, I would do a search on mobile home park right here on Biggerpockets as there are valuation and other issues unique to mobile home parks. You will see there are a few investors here on Biggerpockets that are very experienced in MHP. I would reach out to them.

@Michael Kistner

A value add strategy that you described is actually increasing NOI (i.e. Net Operating Income), not CAP rate. Cap Rate is determined by the market, so an investors can not influence cap rate. Increasing NOI can be achieved by increasing revenue or decreasing expenses or both.

Cheers... Immanuel

Good question @Robert Fornwalt. 

@Denton Beam

Not good enough return for me. The HOA kills it.

Cheers... Immanuel

@Denton Beam

The biggest thing that jumps at me is the spread between cap rate and loan interest rate. CoC is hyper sensitive to this spread. The smaller the spread the faster CoC goes down the drain and vice versa. As I stated before, it's a common strategy to finance a project whereby the loan will leverage a 6% cap rate to an even higher CoC (i.e. upwards of 10%). However, financing a 6% cap rate with a 5.5% loan will have the opposite (i.e. detrimental) effect on CoC, and this is because there is only .5% spread between your cap rate and loan interest rate. Unless there is significant value appreciation that can be expected when you exit or you can negotiate a lower price, 3% on your money is just not worth the risks.

Two ways to lose money in real estate:

- Overpay for a crappy property

- Overpay for an awesome property

Cheers... Immanuel