Cap Rates

[Fernando]

I got this soliciting letter from a broker wanting me to list with him.
He mentioned about cap rates that its NOI/Purchase price.
Prior to mid-2023, investment properties were selling at cap rates between 4.25% to 5%.
Now most leased investments trade between 6.25% to 6.75% depending on tenant credit, lease term, and location.
And when higher the cap rate, the higher the risk.
I didn't considered that concept as much.
In Bay Area, cap rates were always low and that's because there's less risk in owning property here.

 

[George Hatch]

It's not just risk. There are also expectations for the changes in rents and resale values over time.

 

[djd09]

so...areas that are less desirable get higher cap rates....

 

[PL1957]

so...areas that are less desirable get higher cap rates....

Yes. That’s simple, basic economics. The higher the risk, the greater the return needs to be to attract investors. That’s why Iranian bonds are currently yielding 20-30% while US treasuries are at 4%.

 

[Fernando]

Then why are less desirable areas in cities may have lower cap rates than rural areas?
Location, location, and More people/customers in urban areas.

 

[djd09]

Yes. That’s simple, basic economics. The higher the risk, the greater the return needs to be to attract investors. That’s why Iranian bonds are currently yielding 20-30% while US treasuries are at 4%.

marin city was too risky to waive the appraisal...so there is that

 

[George Hatch]

so...areas that are less desirable get higher cap rates....

This is what I said:

It's not just risk. There are also expectations for the changes in rents and resale values over time.

If a bunch of investors think the rents (current cash flow) and/or the resale values (future prices) are going to increase faster in some areas than others then that will result in different cap rates by location. That includes different towns and states and there's actually some math involved as to the returns of/on investment capital.

The way rents vary by location is via the tenants exercising their alternatives. Rental tenants in many areas are highly sensitive to location, quality, condition, features and amenities. The buyers/sellers of those properties in the various areas are compelled to take these trends into consideration, which means the appraisers are compelled to observe/report what those market participants are actually doing.

Matter of fact, even the unit mix is often of effect on the cap rates and income multipliers. Properties consisting of mostly studio and 1bd units tend to generate more income/room than properties consisting of mostly 2bd and 3bd units. But the incomes on the 1bds are sometimes also offset by a higher rate of tenant churn - tenants coming and going more often. I take great care to try to find properties with comparable unit mixes as comparables.

BTW, GRMs do basically the same thing, and those GRMs also vary by property type, property attributes and location and such. There is no ACME Universal GRM.

 

[George Hatch]

Fun fact:
When I appraise multi-family and certain other multi-tenant property types I use the difference in rents from one property to the next to adjust my value indicators. A property that the tenants think is worth 10% more in rents will generally sell for 10% more in the sales price.

The SC grids in the 71a/71b apt forms aren't even adjustment grids. There are no line item adjustments. That's not how they work.

 

[djd09]

U.S. Commercial Real Estate Is Headed Toward a Crisis​

U.S. banks face a reckoning: Over the next two years, more than $1 trillion in commercial real estate (CRE) loans will come due, according to The Conference Board calculations using MSCI Real Assets data. Institutions with the most concentrated exposures, insufficient capital cushions, and limited lifelines from larger institutions or regulators face significant losses.

The damage could metastasize into a full-blown financial crisis if scores or even hundreds of small- and midsize commercial banks fail simultaneously. A worst-case scenario might include contagion to other economies and banking deserts across the U.S.

what were the cap rates during covid...they must of been high for risk sake

 

[George Hatch]

You seem to be missing the point. "future expectations of changes to the income" can be generalized as "risk" but of what? Risk of profit/loss at the occupancy and rental rates. Dollars and cents. Money isn't racially biased. Investment capital seeks maximum returns.

All RE is local but in this region the Covid-era cap rates were actually quite aggressive because the rents were increasing. Cap rates are still lower than the corresponding interest rates. That means the cash flows to the investor are currently lower than the interest rates, and it's not by a little. That means the investors still think there's an upside to the rents.

Our region has rent controls and it's playing havoc with the sales. If one property has lower rents than the model match next door and both are subject to limitations in the rental increases, the property with the higher rents is worth more to the investor than the one with the lower rents. To the point that they can actually sell with different cap rates as well as the different prices.