Why is it so difficult to find a great deal on an apartment building in a major metro area these days? Why are profit margins tightening in the best markets for single-family rentals? The answer is fairly simple; cap rates (unlevered yields) on these assets are compressing due to increased investor demand. As the economy and real estate prices have improved, investors have a renewed appetite for risk and are willing to accept lower returns.
Multifamily and single-family home rentals stellar performance post credit crisis coupled with their relatively low barriers to entry versus other real estate product types has attracted a sea of new investors and hedge funds. Case in point, in California it is difficult to acquire a solid, well located apartment building for higher than a 4.5 cap rate, which is roughly a 22 multiple on net income…ouch. Best of luck to buyers at 4.5% yields with minimal upside that need to refinance their loan shortly after Yellen stops sipping the kool-aid and the 10 year treasury yield jumps 200+ basis points.
Of course, inflated pricing for rental real estate certainly isn’t unique to California. It’s not uncommon for fully marketed, high quality apartment deals in major metro areas to receive 10+ offers. This level of competition drives values to unstainable levels.
Download Your FREE copy of ‘How to Rent Your House!’
Renting your house is a great way to enter the world of real estate investing, but most first-timers (understandably) have a lot of questions. Fortunately, the experts at BiggerPockets have put together a complimentary guide on ‘How to Rent Your House’. All the skills, tools, and confidence you need to successfully rent your house are just a mouse-click away.
A Logical Path…
Asset bubbles are a manifestation of our competitive drive and follow a logical path:
- Cap rates that were unacceptably low just a few months ago start to win deals;
- Pricing expectations recalibrate;
- Cash flow returns are sacrificed for the allure (expectation) of appreciation;
- Investors get anxious to get in the game (buy something) and start stretching to win deals;
- Ultimately, the margin for error becomes too tight to withstand negative cash flow surprises (ex: unforeseen major capital items);
- Deals fail, lenders foreclose and so begins the down-cycle.
In highly competitive markets investors succumb to “animal spirits” and are not appropriately compensated for risk.
Don’t get me wrong, I love to compete, (I’m a beast at Hearts and most card games only grandmothers enjoy) but I hate real estate bidding wars. I’ve often thought it was funny when a broker would congratulate a buyer for winning a highly contested deal. Out of 30 people vying for this property, you were the one willing to pony up the most cash – Congratulations??? Of course, investors can still make money on competitively bid deals, especially if there is a value-add story, but I think we can agree that it’s a lot harder to take home the Prom Queen when you’re one of countless suitors vs. the only guy that showed up to the party.
Ignore the Crowd
Clearly, we all would prefer less, not more competition. Yet, few investors take the next logical step, which is to target investments that garner little (if any) investor attention. This tendency for investors to stick with the crowd, even as valuations skyrocket, encouraged me to pursue one of the most profitable and underrated investments in the world. This magical investment is….. “drum roll please”……mobile home parks.
Wait, what? Did he say mobile home parks? I know, I’ve probably just lost your attention. But that is precisely my point. Who in their right mind would want to invest in mobile home parks? Can you think of real estate with a worse public reputation? Imagine how popular I am at cocktail parties, “what do you do for a living?”…“Mobile home park investing.” “Um, interesting. Oh, I think I hear someone calling my name, nice meeting you trailer guy.” Thankfully, we don’t buy mobile home parks to impress people. We invest in parks for numerous reasons and I’ll cover those in detail another time, but I’ll share two for now.
1. We take pride in providing our tenants with affordable housing, which is a desperately needed service in a country with more than 46 million people living below the poverty line.
2. We (and our investors) are cuckoo for cash flow and Mobile home parks typically generate remarkable cash on cash yields.
These superior returns are largely driven by limited investor competition.
There just isn’t wide spread investor demand for these assets, nor are there many companies with the expertise and desire required to acquire and operate Mobile Home Parks. When we make an offer on a park, we are usually one out of a few bidders and often we’re the only bidder as many of the deals we pursue are off-market. It’s tough to overpay for a property when you’re the seller’s only option. We like bargains, we hate competition and we’re a bit contrarian, which is why we love mobile home parks.
I know what you’re thinking: why share this info? If more people are aware of the benefits to owning mobile home parks, won’t there be a sudden influx of investors that will erode returns? I seriously doubt it. Mobile home park investments are not really a secret; they’ve been around for decades and they are a lot harder to operate then most investment gurus would lead you to believe. Plus, my goal is not to convince you to become the next mobile home park tycoon. Rather, my goal is that you’ll look at your own real estate business or investment strategy and think how you can be a little more anticompetitive.
Perhaps that means focusing on a niche real estate investment. Perhaps that means making offers on properties in emerging/growing cities where few investors are looking. Perhaps that means you’ll stop waiting for a broker to send you “the perfect deal” and start mailing unsolicited offers on your target properties. Whatever it means to you, just be careful when you find yourself pushing price or terms on a fully marketed, competitive deal as top tier investors rarely outbid their way to the success. Your ultimate goal should be to “steal” deals not just win them.