MLS listings show cap rate based on NOI, not the market?

Question

I've started looking at multifamily properties in Phoenix Metro on the MLS, and noticed a strange thing. All of the books and podcasts I've consumed talk about cap rates being tied to the market itself, and the cap rate is used along with the NOI to generate a market value of the property.

On the MLS, I believe the Cap Rate that is shown is calculated by the NOI and the listing price.

My thought is that the overall market cap rate should be used to generate an offer price based on operations.

What do you think?

Ben Leybovich · Answer

Neither matters. If you are paying a function of the marketplace Cap, then in essence you are saying - whatever returns every joe schmoe is getting, I'm good with that. Obviously, this is silly...

And if you go by seller's Cap, then you are saying - the seller would never lie, and I'm just going to go by what seller says the NOI is. This is obviously also nonsensical...

What do you think the NOI will be when you own the thing? What rate of return are you satisfied with? Put those together, and that begins the conversation about how much the opportunity is worth to YOU!

The rest is nonsense :)

Jeff Bethke · Answer

Michael Seeker Yup, I'm currently revising my SFH spreadsheet for Multifamily where my COC return drives the purchase price. Thanks for your feedback!

Jeff Bethke · Answer

Michael Seeker

Thanks Michael, understood.

Here's another one. I just spoke to my lender regarding this as well, since they will need to verify property value in order to underwrite the loan. He said they will not use a market cap rate for anything under a 4-plex. They will use comps just like a SFH.

So, any thoughts on how to do my analysis then? Do market cap rates for 10-unit or 20-unit apply to a duplex or 4-plex? Or do I need my agent to run multi-family comps which I assume requires more time than for a SFH.

Account Closed · Answer

"What rate of return are you satisfied with?"   Really Ben? :-)

If you don't know the market values then all the searching for "your rate" is gonna do is have you wasting your time in a lower cap rate market or overpaying in a higher cap rate market.

How is this any different than picking out a random sale dollar per sf and going into random markets trying to buy without knowledge of the market $per sf?

Account Closed · Answer

Just for some clarification the seller chooses an "asking" price, not a sales price.  The cap rate on an asking price is merely a marketing tool.  There is no reason to compute this as the only cap rate that is real is derived from closed sales.

@Michael Siekerka stated,

"then decide if the price makes the particular property worth pursuing or not."  What "price" are you referring to?  If you are confident in the NOI then why not just make your offer based on the market cap rate?

Michael Seeker · Answer

Anything up to 4 units is considered residential property and many commercial lenders will even use comp analysis beyond 4 units and reserve CAP rate valuation for larger complexes.

I believe you answered your own question regarding how to do your analysis.  You said you want 12% COC, so figure out what price can be paid for a particular property to achieve that (factoring in financing, your expected NOI, etc.).  Then try to work with the seller to make that a reality.  You may find that your 12% COC expectation doesn't work on a particular property (so you pass) or it may not work in a specific market or part of town you want to invest in.  If that's the case, then you need to get really agressive about how you find deals, expand your investment area or lower your expectations.

Jeff Bethke · Answer

@Ben Leybovich

Hi Ben, thanks for your input. I'm trying to understand your first point about "joe schmoe" returns. I agree that different operators can extract varying levels of value from the same property. This would move the NOI up or down, agreed. But then how to you put a price tag on the property? Isn't market value determined by the market cap rate? How else would you arrive at the market value, especially for the lender. They need to know that should I default on my loan, they can sell the property and recoup their money.

At the end of the day, I refuse to accept the seller's pro forma, I will verify. I refuse to accept the listing price. What makes sense to me is that my offer price would be based on what I feel the NOI currently is and some multiplier, which would be the cap rate in the area.

Regarding rate of return, I feel this is different than cap rate because it includes the financing information. personally I'm looking for a minimum 12% COC return. Cap rate affects property value/purchase price, which affects debt service, which affects my return.

Thoughts?

Michael Seeker · Answer

@Jeff Bethke - there are two ways to look at it...as the buyer and as the seller.  The seller is going to choose the sales price, calculate NOI then determine what CAP rate that equates to (sometimes they will tweak the NOI to make the CAP higher).

The buyer on the other hand will want to look at the NOI and market CAP rates (or desired CAP rate) then decide if the price makes the particular property worth pursuing or not.

The market CAP rate does not exist without somebody transacting property at a set price.  Many of these transactions get averaged to come up with a "market CAP".  Not every property ties directly to the market CAP for various reasons.  There are many components to a property that cannot be measured off of NOI alone which is why you will find properties that sell above or below the market CAP rate.

MLS listings show cap rate based on NOI, not the market?

Most Popular Reply