What's a good cap rate & what's a bad cap rate - weigh in

General Real Estate Investing
1

Maybe the question should be a little more accurate. For days I have been searching out topics on cap rates. I’ve read a lot of references that are opposite of each other on “What is a good cap rate?” and “What is not a good cap rate?”.

Even Robert Kiyosaki was not clear with his explanation of cap rate.

Two questions to try and clear this up: (all things being equal)

  1. a 1.0 cap rate is “…” and would say “to buy or not buy” this property?

  2. a 10.0 cap rate is “…” and would say to buy or not buy this property?

2

Here is one of my past posts regarding cap rate:

There are lots of posts on cap rate on here. Multi-unit buildings generally have cap rate calculated on them. Cap rate is a building’s NOI / market value. So as a buyer you want the cap rate to be larger because you’ll be getting a bigger NOI for the cost of the property. As a seller, you want to get the lowest cap rate you can because that means you’re getting a premium price on the value of the property.

How you view cap rate depends entirely on which side (buying or selling) you’re on.

3

I’m sorry this is so long but vague answers need lengthy clarifications.

So justin0419 since sellers are creating low cap rates and buyers will only buy high cap rate units, sellers will never be able to sell multi unit buildings and buyers not finding high cap rate multi unit buildings will never buy. No multi unit buildings are selling.

A few years back I was a business broker. Your explanation is similar then to what I was seeing in small businesses wanting to sell.

Owners pull every cent out of their business by the end of the each quarter or the end of year to reduce taxes and even show a loss. Then comes the day they were tired and wanted to sell to do something else or retire.

Buyers want businesses that make money. Even though they know business income is the Owners Discretionary Income and even the buyer as an owner would pull all the discretionary money out as well buyers when doing due diligence see the last 3 years of tax and financials in the negative or break even point they will not buy the business because the business itself shows no profits. A business not showing profit over the previous 3 years will be hard to get a business loan for.

I’m looking at a MH park with a negative cap rate of -27.3. He wants around $650K for a park with 120 lots only 40 rented with no amenities in a medium size rural city. I have been by the park a month ago and saw only 25 MH’s. No matter how you run it the new owner will fall about $4K short of paying for just the loan. Then you also have no up keep money, no funds for improvements and, no owner’s income or money for a manager. Even if you can manage to get new renters in a park with no amenities just outside of town, and by the way the town has 3 other parks within the heart of the city, you would need 20 more new renters to create a positive cash flow to cover expenses and modest improvements.

For this owner to get to a low positive cap rate his asking price needs to be around $330K. This figure is supported by the business rule of thumb that companies like Gulf Coast Financial uses to establish MH park valuations on selling prices for MH businesses.

The owner has had several buyers withdraw from the deal. I don’t need to get all the taxes and financials to see the owner has a problem. My proforma’s and financial analysis data base threw up a red flag.

If you have a negative or low cap rate MH park (apartments, etc.) you have a business that is not profitable and will have a problem selling the business when that business shows no profit. It will not attract buyers. It would have attracted buyers back in the late 80’s when companies bought bad businesses as a tax break but those days have ended.

Back to cap rates. A business that is a little below average on cap rate will have a chance to sell. It means there’s a management problem or changes needed within the organization. Which brings me back to my topic questions. To you, is a 10.0 cap rate high or low, or is 15.0 cap rate high or just higher? You don’t have to answer that. But……

Now, I’m especially interested in your answers to the 2 questions in my topic.

4

All property has a value to a seller and a value to a buyer. In order for a sales transaction to be made, there has to be a compromise of those values if the seller places a higher value on the property than the buyer. In regards to cap rate, the seller has to run a complex to at least have a high enough cap rate that would be attractive to a buyer.
That being said, that MH park owner is obviously priced in the stratosphere. Also sounds like he owns just the land and no trailers. Sometimes you just have to use common sense. I don’t need a calculation to tell me that MH park is a horrible deal. There are two storage unit facilities for sale where I am. They want 1.65MM for one and 1.75MM for the other one. In order to even make the mortgage payment on a 30 yr loan, you’d have to keep those places almost totally full the whole time. Once again, a horrible deal.
I don’t think making a blanket statement about X is a good cap rate, but Y is not is entirely accurate. What if a complex/MHP/etc has a high cap rate, but has tons of deferred maintenance because the owner just collects the check and won’t spend any money on the property?

5

NOI has nothing to do with the cap rate. The cap rate it a combination of debt costs, return on equity, growth in value, equity build due to amortization & selling expenses. NOI is simply an expression of revenue minus operating expenses. The capitalization rate does what it says, capitalizes the income stream into a present value based on your assumptions of debt costs, return on equity, growth in value, equity build due to amortization & selling expenses.

I have posted dozens of posts in this forum on this topic because, it is probably the most misunderstood topic in real estate.

VanDyne, I would recommend searching my posts on cap rates and reading them. If you have any specific questions I am glad to help.

6

What is a good cap rate varies upon what the business is.

I’d have to get a darn high cap rate for an auto parts store that did not include any real estate.

I’d take a very low cap rate or even a negative cap rate on a low return business that included valuable real estate.

Cap rate is dependent upon price and price to me depends upon the condition of the property. I can pay more for a turn key and I have to pay less for a business with a lot of expensive deferred maintenance. No matter what the income is, those repairs must be made and that has to be figured as part of the cost of purchasing.

I want a purchase where I have potential to increase the income, but I will not pay extra for income that I can generate with my own hard work. I pay for the existing income.

Personally, I will not use cap rate at all. I have never seen any business offered with an honestly evaluated cap rate. The number the listing agent gives you is worthless.

Your answer is: you are asking for an answer that doesn’t exist. There is no rule to tell you which cap rate is good and which is not

7

Can we just keep it simple…8%-14% across the board…

8

That’s what I’m, kind of, getting at guys (you all). I played the devils advocate on this because one posting referred to a low cap rate as better than a higher cap rate and vice versa.

justin0419: I’ve read many of your cap rate postings.

Cap rate being similiar to a business profitability rate. It depends on the industry and depends on what you’re trying to accomplish and since cap rates have no standard maybe we need to focus on the things that help determine the risk factors.

There is one commonality to any buy or sell whether a business, real estate or cars. Buyers set the value or price. A MH park owners may establish an emotional price for the sale of their MH park or even come up with a price with the help of a realtor. But, in the end it is the buyers in the market who are setting the actual value.

Advice take it or leave it: Leave some money in your real estate business. This means if you own an apartment complex or MH park these are business entities in themselves not just a piece of real estate. Money left in the business will show profitablity and make the business more attractive to buyers especially new buyers to the industry. Unlike selling an individual piece of property like a single MH or single family home or a 4 plex. Complexes or MH parks are truly a business and must be positioned to sell. This must take place at least 3 years in advance to putting it up for sale. The owner must create value during the years prior to putting the business up to sell as well as positioning it in the areas specific to what is important to the buyer.

Buyers shouldn’t just be looking at current Net Operating Income or Return On Investment or Cash on Cash which ever method you use. Buyers should also be requesting the past 3 years to 5 years of taxes and financials of the MH park or apartment complex. Then, I’d physcally visit it, more than once. I tare the business apart doing my type of audit as well as the true reason for the sale i.e is there a gov’t entity wanting change in the property condition or outstanding fines etc. You know those things that come up after the sale that can cost you big. I think you get what I’m saying. Take plenty of due dilegence time.

Treat your investors money as if it were your own. And, I for one am a pretty stingy with my money. To lose someone elses money would make me feel even worse than losing my own money.

I’ve worked in both real estate and business. Having a real estate license for several years, as a business broker selling businesses and in executive management.