I agree. I never said that you should make your investment decision on comps. All I was saying is that comps and rates are representative of the market activity and that typically your investment rate will be within the range of market activity. I’m not telling you average the caps and comps and use those to make your decision. I’m just saying that your activity will typically be within range of the comps and the rates.
In most cases, listing prices are based off market cap rates and sales comps. By saying a lot of agents make the mistake of listing properties for the highest price the market will bear, your acknowledging the listing prices (in most cases) come from market data.
The market is a representation of everyones credit, issues, problems, cash, goals, etc. If your on an extreme side of the many factors, market data will serve no purpose. Institutional investors (especially public REITs) are playing with financing that is damn near free. They also have much more cash than me to purchase a property. Therefore, they can cash flow with just about any property (aka: Lower Cap Rates). The practicality of using market cap rates as my very unique investment cap rate, is nonexistant. Market value is a representation of EVERYONE in the market. Investment value is a representation of ME. I don’t care whatever everyone would be willing to pay, just what I’d be willing to pay, because I am a little different from anyone else in the market.
The problem with using market data to determine a purchase price is that everyones credit issues, financing rates, etc. ARE taken into account. In the real world, we are all unique, we all have a different amount of money, all desire a different amount of money, all would plan on holding a property for a different length of time, etc. A collaboration of everyones specific circumstances may be heavily skewed away from one’s situation. In my case, it is! If I relied on the market to tell me what a property was worth to me, I’d be out of business tomorrow.
Sean,
You seem to have a good handle on appraisal issues, but very little knowledge of the rental property business. The vast majority of buyers are paying near retail. Otherwise, there would be no retail. The prevailing Market Capitalization Rate is based on retail. There are a small minority of successful investors that are buying at a deep discount. If I bought at the market capitalization rate, I’d be out of business, like the vast majority of newbies who try to become investors.
In my market, there are probably 50 duplexes on the market at any given time. Approximately 80% of these duplexes will be priced between $80,000 and $90,000. Approximately 10% will be above $90,000. These will be on the market a long time. Another 10% will be below $80,000 with most of these being between $70,000 and $80,000. At any given time, there MIGHT be 1 property that can be bought at a big discount. The last duplex I bought, I paid $11,000 and then spent about $25,000 on the rehab. The property appraised in the $80’s (I think $82K, but I don’t have the exact numbers in my head). So, I have about $36,000 in an $82,000 property. That’s 44% of the market value. It grosses $900 per month and will cash flow. If I paid $82,000 like the average newbie investor, it would not cash flow and I’d be going out of business like they do.
Many of these newbies hear the same cap rate talk from their realtors that you are talking about. They buy at retail thinking that everybody else is paying these prices. What they don’t realize is that they just bought a negative cash flow property and will soon be out of business at a loss.
I am not in the flipping business, I am in the rental business. I do not have to do a deal to eat and will only do deals when they meet my criteria of 1) less than 70% of market value and 2) a positive cash flow of at least $100 per month per unit using real world numbers. I NEVER BUY AT RETAIL OR AT THE PREVAILING MARKET CAP.
Mike
I don’t believe that we disagree. But what I was saying is that cap rates come in a range within a market…ie 5.5 to 6.75 for a class A office space. You may be right at 6.75 or even 7.20 for your investment value. Thats all I was saying. There is no specific cap rate for any one property type. There is a range and more often than not you’ll be within range.
In my experience as a broker as well as an appraiser cap rates are very rarely used if ever in small residential deals. Cap rates are used in larger commercial properties. If you were going to use a cap rate in small residential transaction you would want to use “Mortgage Equity Analysis” aka “Ellwood model” to derive one. The former is a really involved analysis and not worth the time or effort. But, like I was saying cap rates are really not applicable to those types of transactions.
I don't believe that we disagree. But what I was saying is that cap rates come in a range within a market..ie 5.5 to 6.75 for a class A office space. You may be right at 6.75 or even 7.20 for your investment value. Thats all I was saying. There is no specific cap rate for any one property type. There is a range and more often than not you'll be within range.We're almost on the same page. But my very specific business model is actually quite different than the market. I change vacant industrial buildings (class F-?) and turn them into class A or B office space or some other use. If I were buying an occupied office building for an occupied office building, you'd be right on the money.
In my experience as a broker as well as an appraiser cap rates are very rarely used if ever in small residential deals. Cap rates are used in larger commercial properties. If you were going to use a cap rate in small residential transaction you would want to use "Mortgage Equity Analysis" aka "Ellwood model" to derive one. The former is a really involved analysis and not worth the time or effort. But, like I was saying cap rates are really not applicable to those types of transactions.I'd say the reason for not using cap rates is that most small residential investors are not sophisticated investors. Talking about Ellwood, J-factors and mortgage equity analysis would be overwhelming. But I'm sure you'd agree that for an investor interested in collecting rents, this is the best way to go. Albeit, not always the most practical, certainly the most accurate investment value.
Great thread.
For what it’s worth, as a broker, I tend to gravitate toward pricing cashflow properties based on cap rates than sales comps. I’m probably 60/40 pricing in favor of cap rates. The market’s really changing right now and buyers aren’t just buying things to have them anymore. I live in a fairly wealthy area, and even these guys are starting to think about what they’re buying. Lots of investors in this neck of the woods.
6 to 7 caps sit for a while in this market. Big power centers (80,000 sf +) are surprisingly moving in the mid 6 ranges, but most everything else needs to be 7.5%+ to get much interest from investors these days. 8 caps make people happy and true 9 caps are gone before they get in front of the public.