Understanding Cap Rates in Multifamily Real Estate!

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This Money Monday$ we are discussing the meaning and importance of cap rates!

VIDEO TRANSCRIPTION

00:08
she is
00:09
all over that she’s laughing at us
00:10
welcome back everybody monday mondays
00:12
every monday 3 30 central we talk about
00:15
a bunch of different topics spend about
00:16
20 minutes talking about said topic and
00:19
the last 10 minutes is open q a yeah
00:21
the q a is the most important folk or
00:23
part folks so
00:24
if you have questions comments you know
00:26
you want to give us you know maybe a
00:28
subject that we should talk about on a
00:29
future
00:30
show please drop in the comments hit us
00:32
up we want it to be interactive
00:34
you know and that keeps down on the
00:36
amount of talking that ben has to do
00:38
absolutely but welcome back to monday
00:40
hope people had a good weekend
00:41
yeah we missed the last one or two right
00:44
you know last one was the holiday right
00:46
it was a holiday it was a holiday last
00:47
night it was like july 24th man that
00:49
feels like that was like a century ago
00:51
that was literally last week well it’s
00:52
because we had a raise we had a big deal
00:54
we were working through
00:55
that week so i think that’s probably why
00:57
me and you felt it a little bit because
00:58
a lot
00:58
went on but we’re done we’re done we’re
01:00
done with said raise you know
01:02
excited about that deal here in houston
01:04
you guys probably saw it if you follow
01:06
us
01:06
who are we partnering with i just gotta
01:08
at least gotta plug that brandon turner
01:09
and brian murray our capital some good
01:11
friends and
01:13
you know collectively between them and
01:14
our other partners we got the deal done
01:16
so 23 million dollars raised and
01:19
ben’s having to call back about 2
01:20
million of investors and tell them sorry
01:22
a little bit over no we’re not doing
01:25
that
01:26
my friend but what are we talking about
01:28
today
01:29
we’re talking about cap rates and it’s
01:30
actually a good time oh my gosh
01:32
we were just talking to a broker about
01:34
cap rates no less than 10 minutes ago
01:36
and we were disgusted about how low they
01:38
actually are
01:39
we’ll only discuss it whenever we put
01:40
our buyer hats on that’s true we feel
01:42
fantastic whenever we put our seller’s
01:44
hats off yes
01:44
luckily the first half of that call was
01:46
about the sell side of things then we
01:47
had to put our buyer’s hat so what’s
01:49
what’s the
01:49
we’ll get into what a cap rate is but i
01:51
want everybody to think through this
01:53
right
01:53
when you’re a seller you want your cap
01:55
rates to be
01:56
low when you’re a buyer you want your
01:59
cap rates to be
02:00
high and we’re going to get into why
02:01
that is so take everything as
02:03
we’re talking about it wouldn’t have
02:05
that in the back of your mind right
02:06
so we’re talking about cap rates and how
02:09
does that play into analyzing
02:10
multi-family properties
02:12
and really i think you do a good job
02:13
kind of describing what a cap rate is
02:15
right you know kind of breaking it down
02:17
you know as a way to value property yeah
02:19
so i’ll go ahead and kind of dig into it
02:21
right
02:21
so how do you know the question is how
02:24
do you value something
02:25
right if i’m trying to value a phone i’m
02:27
probably looking at what the same phone
02:29
sells to other people
02:30
right if i’m trying to value a house i’m
02:32
going to look at what other similar
02:34
houses in the neighborhood sell for
02:36
now if i want to value a piece of
02:37
commercial real estate
02:39
i can go see if there’s a similar
02:40
property the problem with commercial
02:42
real estate it’s hard to find
02:43
similar right there’s not enough density
02:46
right you don’t have a million
02:47
properties
02:48
in one mile like you do you know with
02:49
houses right you have a whole
02:51
neighborhood to look at right hold two
02:52
neighborhoods
02:53
commercial real estate it’s more spread
02:55
out we all know real estate is very
02:56
location specific
02:57
and on top of that every property is a
02:59
little different this property is
03:01
two square feet two floors this is a one
03:03
floor
03:04
this has got you know two bedrooms this
03:06
one has all one bedrooms
03:08
yeah the commercial side so they’re very
03:09
different so said cap rate is that
03:12
compton continuity right a way to value
03:15
a piece of commercial real estate
03:16
and it’s really about valuing commercial
03:18
real estate based on its revenue
03:20
that’s that’s in a nutshell what to
03:22
think about so cap rate helps you
03:23
understand
03:24
what is this piece of real estate valued
03:25
and i’m valuing it based on what money
03:27
it actually generates
03:28
right and so what’s the equation for cap
03:30
rate it is noi divided by
03:32
valuation right so a cap rate just the
03:34
simplest way to think about a cap
03:36
what it actually means though is let’s
03:38
say ben has a farm right
03:40
that looks like a farmer he wears boots
03:41
occasionally right now
03:43
on his farm he is making you know he has
03:46
some equipment that he has right he pays
03:48
the government taxes for the land
03:49
and you know let’s say he’s got a bunch
03:51
of farm equipment and he’s got monthly
03:53
bills to pay right now if i buy that
03:55
farm from ben
03:57
right i’m going to buy it on a cap rate
03:58
and it’s basically saying okay if ben
04:00
sells it to me out of 10 cap
04:02
right if i do what ben is doing all i’m
04:03
doing is switching ferrous for ben
04:05
ferris is going to make 10 return on
04:08
that property
04:09
ignoring debt ignoring everything else
04:11
right just i’m going to give ben a
04:12
million dollars and i can expect to make
04:14
a hundred thousand dollars
04:15
you’re one if all i did is did exactly
04:17
the same thing as ben i wake up the same
04:19
time as ben i go to bed at the same time
04:20
as ben i use the same machine
04:22
machinery has been nothing different
04:24
right now that’s a 10 cap
04:25
now one thing one thing just let’s pause
04:27
there because you brought up a very very
04:28
good point right
04:30
it is not does not take into
04:32
consideration your loan
04:33
or what we call in commercials it’s just
04:34
saying all cash that’s what we want
04:37
all of that stuff as multipliers it
04:38
starts giving you leverage and some
04:40
other benefits right
04:41
but now let’s say ferris knows how to
04:43
add more value
04:44
ben was farming tomatoes and i’m like
04:46
you know what we should farm
04:47
our oranges right because i can drive
04:49
more revenue right
04:50
now that property’s making 200 000 right
04:53
because i sold oranges
04:54
instead of tomatoes i’ve doubled the
04:57
revenue
04:58
i’ve actually increased the cap rate or
05:00
actually you know improved the
05:01
collections which increase the value
05:03
right and now i can go sell to the next
05:04
guy and again if that guy just did
05:05
exactly what i did
05:07
you know he’s going to get that that two
05:09
hundred thousand dollars right so cap
05:10
rate helps you compare different
05:12
properties that aren’t necessarily like
05:13
for like it’s
05:14
basically based on on on uh revenue
05:16
right so now let’s unwind all that right
05:18
so it’s
05:19
noi right net operating income divided
05:21
by value
05:22
so if my ny goes up my and my cap rate
05:24
stays the same
05:25
my value is going up right if cap rates
05:28
compress right we’ve been seeing a lot
05:29
of capri compression
05:30
we bought deals in seven cap markets two
05:32
years ago that now our five cap markets
05:34
are forecast
05:35
so compressed means getting smaller so
05:36
if you guys think about the equation so
05:37
if this piece of the equation changed
05:39
right so cap rate equals noi divided by
05:42
value so if the cap rate
05:44
if the only thing that changed was the
05:45
cap rate right the market got tighter so
05:47
now that
05:48
seven became a five well guess what my
05:50
value changed significantly it actually
05:51
went up
05:52
right because now you’re dividing by a
05:53
smaller number to solve for the value
05:55
right so that’s cap rates in a nutshell
05:58
right
05:58
and the other there’s other things that
06:00
help you juice your deals like we’re
06:01
talking about leverage some of the other
06:02
stuff but cap rate ignores all that it’s
06:04
all your fixed cost
06:05
right all the above the line costs right
06:08
that kind of go into that
06:09
and one thing to also take into
06:10
consideration folks right that farm
06:12
that maybe you know ferris is going to
06:14
buy for me that’s in texas right
06:16
that same farm might be the same thing
06:18
might even might even
06:20
farm the exact same thing but it’s in
06:22
california right
06:24
my 10 cap deal even though it’s the same
06:27
dang thing
06:28
is probably going to be like a four cap
06:30
or five cap deal in california
06:31
why is that though right because it’s
06:33
driven by the mark that it market that
06:35
it’s in
06:36
and really people like well how do you
06:37
determine what the market cap rates are
06:39
gonna be
06:39
it’s real i would say the brokers are
06:41
probably the best person to really call
06:43
what market cap rates are and so you
06:45
just need to be talking to
06:47
to the local brokers that are doing a
06:48
bunch of deals right they’re going to
06:49
say yeah
06:50
c-class deal and houston is going to be
06:52
you know four and a half to five cap
06:54
which is exactly what it is right a
06:56
b-class deal is probably four to four
06:57
and a half
06:58
you know a is probably somewhere in that
07:00
four range you know that’s what it is
07:02
and that’s because they’re trading at
07:04
that valuation right now and they know
07:07
and so the broker themselves are going
07:08
to be the ones that are really going to
07:09
be able to tell you
07:11
that you know ultimately what the cap
07:13
rate is
07:14
so wanted to point that out because you
07:16
could have that exact same farm but
07:17
they’re in two different markets and
07:18
ultimately the cap rate that you’re
07:20
determining that value on is ultimately
07:22
going to be
07:23
a lot different yeah right you know and
07:25
so you know i mean we we use this both
07:27
on is does this make sense going in or
07:31
what is our what’s our stabilized cap
07:32
rate going to be that’s probably the
07:33
more important number for us
07:35
right because some of our deals are
07:36
value-added they’re not going to stay
07:37
this is where it’s interesting right
07:39
in some markets a value-add deal might
07:41
be a lower cap
07:43
so let’s let’s use example let’s say you
07:45
have a little rinky dink apartment
07:47
right in the heart of manhattan yep
07:49
right let’s say that property owned
07:51
produces a thousand dollars a year
07:53
right someone may pay you a one cap for
07:56
that deal
07:57
yep even though manhattan might be a
07:58
three cap market why well because they
08:00
know if they demo it and build something
08:01
else they can get
08:02
significantly more noise absolutely
08:04
right and so cap rate is just kind of an
08:06
indicator but there’s really other
08:08
things to think about around
08:09
okay because as you know there’s another
08:11
actually really good example is debt
08:12
as debt has gotten cheaper people are
08:14
willing to pay tighter caps
08:15
right because they’re looking at that
08:17
that spread they’re really playing
08:18
arbitrage right
08:19
cap rate is kind of a way to play
08:20
arbitrage on debt yeah right and so a
08:22
cap rate helps you just
08:23
understand so let’s pause there because
08:26
this is a creative way this is actually
08:27
one
08:28
i mean we look at this quite a bit
08:29
actually right you know if your interest
08:31
rate is higher than the cap rate you’re
08:33
going into
08:34
you’re probably not going to be making
08:35
any money right whereas on the inverse
08:37
of that
08:38
right if your cap rate’s high and your
08:40
debt is low you play that spread which
08:42
is what he’s talking about arbitrage
08:44
right
08:44
and that’s that is a thing you can you
08:46
can you can literally go and try to do
08:48
the numbers right now remember the value
08:50
because cap rate does not include debt
08:52
service so let’s say you’re buying it at
08:53
a
08:54
five cap and your interest rate is three
08:56
well you’re getting two percent
08:57
of a spread on that deal plus the
09:00
leverage so you actually you know you’re
09:01
that’s how you get from a two percent
09:03
spread to an eight percent return
09:04
right yes because now you’re leveraging
09:06
up in eighty percent so if you take the
09:07
two percent divide it
09:08
you know by point two i think the math
09:10
and that will get you to that eight
09:11
percent that you try to get to right
09:12
bottom line spreadsheet this out folks
09:14
is
09:14
it’s actually a thing and it’s very
09:16
important big math in our head
09:18
not all of it i like to use the
09:19
spreadsheet what is two divided by one
09:21
two divided by one two smart guy that’s
09:24
why i partnered with this guy
09:25
i wasn’t quite sure if it was a half or
09:27
what you know but anyway
09:29
so you can use this you know as a way to
09:31
really right off the bat
09:32
start figuring out hey is this gonna
09:34
make sense right um so
09:36
that’s kind of how we use we use cap
09:38
rates in several different ways once
09:40
again
09:40
going in cap rate what’s a stabilized
09:42
cap rate after say year one after we’ve
09:43
done our value add
09:45
and then ultimately on the back end
09:47
what’s our exit cap
09:48
so that’s probably one of the most
09:49
important things right and ultimately
09:51
probably the mo
09:52
one of the most difficult to determine
09:54
because nobody has a crystal ball
09:55
where are cap rates going to be the the
09:57
rule of thumb used to be
09:59
every year that you held onto a property
10:01
you should you should add 10 to 15 basis
10:03
points to your cap rate right so
10:05
for example if you bought it at a five
10:06
cap you’re holding on to it for five
10:08
years
10:09
and you’re going to add 10 basis points
10:10
each time you’re going to be selling it
10:12
at a five and a half
10:13
cap right and then you just you divide
10:16
that by you know the noi is then divided
10:18
by the cap rate and that’s going to
10:19
determine what the value of the property
10:21
is
10:22
and that’s important and ultimately what
10:23
your returns are going to be and what
10:24
you’re going to show to your investors
10:26
so the exit cap rate is a very you know
10:29
difficult thing to determine right you
10:31
know
10:31
typically we just err on the side of
10:32
being conservative even though
10:34
this last couple years cap rates have
10:36
been going down right we don’t
10:38
anticipate them to go down
10:39
indefinitely you know ultimately you can
10:41
only get to zero and it’s gonna be
10:42
hovering there it’s never gonna be
10:43
negative
10:45
but um they could compress a little bit
10:47
more who knows it really
10:48
determines on i think interest rates and
10:50
inflation absolutely right
10:52
but then also the inflation is the other
10:53
one right so even though cap
10:55
even interest rates may go up cap rates
10:57
may stay the same why because the
10:58
revenue so if you think about the math
11:00
equation guys
11:00
i wish i had a whiteboard i could draw
11:02
on but again if cap rates
11:04
went up but my revenue also went up
11:06
because of inflation
11:08
right they cancel each other out and
11:09
inflation right folks rents
11:11
will be going up is what he’s talking
11:13
about right you know and so that’s
11:14
something to kind of determine
11:16
so what does a new multi-family investor
11:18
need to know when it comes to cap rates
11:20
right i think that that’s one of the
11:21
first things you need to get familiar
11:22
with
11:22
you need to talk to the broker that’s in
11:24
the market that you want to be in where
11:25
cap rates trading at that will give you
11:27
a rule of thumb as to where you’re
11:28
are you buying a good deal a bad deal
11:31
maybe it’s a
11:32
low cap like fair said but you’ve got a
11:34
lot of upside
11:35
you know throw that that going in cap
11:37
right out the door and look at what your
11:38
stabilized cap rate’s gonna be
11:40
right you know um so some of the biggest
11:43
misconceptions some of some of these
11:44
questions kind of came in ahead of time
11:46
in the industry when it comes to cap
11:47
rates um then it’s the end-all be-all
11:50
you know we do a lot of value-add plays
11:52
and we’ll have people constantly ask
11:54
what’s the going in cap rate
11:56
right we had that several times on those
11:58
last raise right
11:59
it’s not a stabilized deal right now
12:01
it’s a nice looking property it’s got a
12:03
lot of great potential but it’s not
12:04
humming a hundred percent
12:06
stabilization and where it should be so
12:09
it’s trading at a lower cap rate than
12:10
traditionally it would be in that market
12:12
right so that’s probably the biggest
12:15
misconception is that going in cap rate
12:17
is like the end-all be-all of all
12:18
metrics and i say no
12:20
really what you’re looking at is your
12:21
stabilized you know cap rate right what
12:23
is it gonna look like after year one
12:24
maybe even after year two
12:26
right if you’re able to take that four
12:27
four and a half cap and now it’s a six
12:29
and a half seven cap
12:30
that’s pretty good on a stabilized cap
12:32
rate all right
12:34
so we talked about what cap rate
12:36
compression is right folks that’s just
12:37
cap rates are getting lower
12:39
and that’s been happening the last
12:41
couple years we don’t know if that’s
12:42
gonna that trend is going to continue
12:44
once again it really determines on
12:46
inflation as well as probably where
12:47
interest rates are going to go
12:49
and nobody has a crystal ball but cap
12:51
rate expansion
12:52
could potentially happen you know where
12:54
they’re getting higher
12:56
i don’t anticipate multi-family going
12:58
back to being a seven eight nine cap
12:59
you know asset class it’s just not going
13:03
to happen there’s too much demand for it
13:05
because that also plays into cap rates
13:07
right the amount of
13:08
money and demand for multifamily is has
13:11
increased substantially over the last
13:12
five years
13:13
and that’s driving the prices up cap
13:16
rates down
13:17
so man we talked about a lot on cap
13:21
rates
13:22
but let’s talk let’s talk about some
13:23
open q a right you know anybody got any
13:25
questions comments questions
13:27
please go ahead and add it into the chat
13:29
right we’re here to answer them
13:31
and you know we can talk about cap rates
13:33
talk about anything else people want to
13:34
talk about
13:35
right and so let’s see so trevor says
13:39
good afternoon
13:40
hello hey trevor seeing you a few weeks
13:42
ago yeah and we’ll see him here next
13:44
week what’s going on next week ben
13:45
oh we’re excited infant miami
13:49
coming up miami so if you are located in
13:51
the we only got a few
13:53
we only got a few seats left that’s
13:54
actually very true we’ve gotten a lot of
13:56
interest and so it should be
13:58
should be fun should be in a lot of new
13:59
people so if you have been to our
14:00
commerce previously
14:02
the one nice thing about this one is
14:03
it’s different faces right and we all
14:04
know
14:05
multifamily is about people it’s about
14:07
relationships and growing together and
14:08
partners and deals and all that so
14:10
it’s you know half the businesses
14:12
numbers half the businesses are
14:14
relationships folks right
14:15
you know it’s a one-day event we’re not
14:16
selling anything there’s a ton of
14:18
networking opportunities in fact we’re
14:19
even
14:20
we’re integrating even a bigger part to
14:22
make sure that people network because we
14:23
know that there are some shy people out
14:25
there
14:26
um it’s july 24th in miami we have a lot
14:28
of people that are coming in early
14:30
staying late you know making a vacation
14:32
out of it why not
14:33
it’s miami it’s july folks have a good
14:35
time so check it out
14:38
mfinvestornetwork.com
14:40
coupon code disrupt get your 100 off
14:43
this is not a sales pitch
14:45
there’s really only a few seats left uh
14:47
they’re really
14:48
capping us out so look forward to that
14:50
check that out uh we look forward to
14:52
hopefully meeting some of our our
14:53
viewers
14:54
in person for the first time you know we
14:56
haven’t had a whole lot of in-person
14:57
events you know for about 18 months so
14:59
we’re really excited about this one
15:00
all right let’s keep going all right
15:02
we’re going we’re going chad
15:04
says uh hello ben and ferris we’re all
15:06
watching here from mexico thanks chad oh
15:08
you guys are having fun checking us out
15:10
on the vacation
15:11
let’s see so amanda amanda larson hey
15:14
amanda how are you doing
15:15
we missed last week came out and said uh
15:18
what do you generally use to calculate
15:20
you’re going in cap rate t12 t3
15:22
t1 honestly so i’ll answer that question
15:25
i care more
15:26
about my year one cap rate than my going
15:28
in in a lot of ways
15:29
now going in it really depends on the
15:32
property
15:32
some properties if there’s not much i
15:34
can do i’m probably looking at a t12
15:36
right if there’s there’s a value upside
15:38
they’re actually pushing rents they’re
15:39
doing upgrades maybe t3
15:41
yeah brokers right now are really just
15:43
needing t1s and three threes
15:44
brokers don’t care about the t12 like
15:46
it’s irrelevant to them on the you know
15:47
they’re just pushing
15:48
everything based on t3s and d1s right
15:50
yeah that’s kind of the market that
15:52
we’re in right now
15:53
yeah and you gotta you gotta that’s
15:54
that’s true i’ll say that as well right
15:56
you know in a lot of the deals right
15:57
you’re you’re gonna take a t3 the
15:59
lender’s probably gonna take a t3 on on
16:01
income
16:01
probably t12 on expenses so just realize
16:04
that that’s kind of how the lenders are
16:06
looking at it even the bridge lenders
16:08
so you know but they’re not going to get
16:10
too caught up on cap rates
16:12
um you know people could say oh you
16:14
bought a two cap you’re overpaying not
16:16
necessarily right you know i think it
16:17
all depends on the story
16:19
and what is the business plan um after
16:21
you buy it right
16:22
if you’re gonna put five million bucks
16:24
into it right you know
16:25
after that year one or year two after
16:27
you’ve done the work
16:29
what is your cap rate right then and
16:30
there that is really what i would say is
16:32
the most important metric
16:33
right versus the going in but uh still a
16:36
great question
16:37
you know i think that people tend to get
16:39
so fixated on it
16:40
um you know and in the value-add game
16:44
versus say a yield play
16:45
it’s not as important of a metric so
16:48
let’s see
16:49
trevor says looking forward to seeing
16:50
you in miami looking forward to seeing
16:51
you there as well
16:53
all right so let’s see so ali on youtube
16:55
says
16:56
oh are you guys a private equity firm
16:59
kind of
17:00
yeah i mean i guess what’s the uh what
17:02
is the private yeah what is a private
17:03
equity company right we raise equity
17:05
with private investors to go buy
17:07
and acquire multi-family we are a
17:09
private equity company
17:10
no no we are not we’re not trying to be
17:11
condescending i think it’s
17:13
it’s a term that’s thrown around by a
17:15
lot of institutions a lot of people
17:24
absolutely let’s see so any more
17:25
comments questions please go ahead and
17:28
ask them we’ll answer them live
17:30
otherwise we can wrap it up a little bit
17:32
earlier well that race is an important
17:33
thing
17:33
what are we talking about next week
17:35
we’re going to give people another
17:36
minute or two
17:38
then ben’s always talking it doesn’t
17:39
have to be next week he’s talking next
17:41
week today tomorrow
17:42
two minutes from now i’m just so excited
17:44
about talking caprich
17:46
you know yeah all right let’s keep going
17:48
then okay
17:49
so what’s coming up next week folks the
17:52
top three questions to ask before buying
17:54
multi-family real estate oh
17:56
what are they ben what’s the going to
17:58
find out next week yeah
18:01
no i mean you’ll probably want to close
18:03
one to me one of the questions probably
18:04
what is the
18:05
the value add story don’t give away all
18:07
the sneakers
18:09
i don’t know you know but now
18:13
shut up no no no we’ll get into some of
18:15
those plus more right you know there’s
18:17
there’s a ton of questions ultimately
18:19
you need to really get familiar with the
18:20
market that’s probably the most
18:21
important thing
18:22
and understanding what are the economic
18:24
drivers there but we will get into the
18:26
secrets of those three
18:28
next week absolutely what time are we
18:30
doing it
18:31
same time as always 3 30 central on
18:34
monday
18:35
see you then so we’re going once
18:38
twice all right let’s call it a wrap
18:40
then we’re calling it a right now

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