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Updated about 6 years ago, 09/14/2018
Who's Buying 4-5 Cap Properties?
My question is simple: Who is buying these 4 cap and 5 cap properties? I know its someone because they are being sold... quickly. But who?
Must be the Mom and Pop investors moving up from their SFR's to multi-families...driving up prices as they compete against other Mom and Pop MLS lurkers.
On a related note, I purchased a few 5 cap properties in Los Angeles back in 2010. They are now 2.5 cap properties, but they've been the best financial decision I've ever made. If I never found this website and educated myself, I'm pretty sure I'd be on the hunt to move up to a larger 4-5 cap multi-unit property instead of finding ways to better utilize the cap gains I've made.
4/5 cap, even 2/3 cap is quite common in CA.. lol.
In Seattle, I buy 5 cap properties.
Originally posted by @Jay Hinrichs:
Originally posted by @Sanjeev Advani:
My question is simple: Who is buying these 4 cap and 5 cap properties? I know its someone because they are being sold... quickly. But who?
Everyone who is buying blue sky performas on 7 to 9 caps and has no real history.. by the time reality sets in they are buying 4 to 5 caps they just don't know it yet.
Exactly, I run the numbers all the time on properties advertised by the seller as 7-8 cap and they usually leave things out of their numbers like repairs, CAPEX, management or they claim 100% occupancy. These properties all sell quickly in my market. Either the buyer doesn't know or doesn't care. The ones with the highest cap rates always have the most deferred CAPEX. I know many buyers like run-down properties because they see a way to "unlock value". The problem is how much value does replacing siding or rebuilding a parking lot add? Even remodeling the units often doesn't raise rents significantly, because you don't change the square feet or location - the two variables that drive most of the value in real estate.
In coastal markets, the multifamily market tracks the condo market, and there is typically a discount when you buy multifamily. So for example, one can buy a 5 cap, and after all expenses related to a condo conversion are accounted for, one can have say a 15% profit margin. If one buys the multifamily and holds for say 5 years, and then exits through a condo conversion, one didn't make 5% yearly, but more like 8% annually. (that is totally ignoring any appreciation during those 5 years.) Coastal market buyers often think in terms of a condo conversion exit.
@Adam Drummond those are great numbers. Whats the area like out there in Greenville?
@Russell Brazil I can understand that, but if the property is returning negative cash flow with a low cap rate what is the purpose of that purchase? Assuming the loss on the property is not large enough to offset any sizable tax basis.
@Joseph M. I completely agree with you that properties that are sold at a 4-5 cap aren't going to be purchased unless there is a value add play there, but my question is more based around, what if this is already an improved and stabilized asset at 4.5 cap? You would earn a negative cash flow, and there is no real upward mobility in rents in the area. Just doesn't make sense.
As far as gentrification in Bakersfield, we are seeing some gentrification in Downtown Bakersfield. Let me know if you want more details!
Originally posted by @Sanjeev Advani:
@Russell Brazil I can understand that, but if the property is returning negative cash flow with a low cap rate what is the purpose of that purchase? Assuming the loss on the property is not large enough to offset any sizable tax basis.
A 4-5 cap property is not a cash flow negative property. Now the means by which you purchase it, using leverage might make your particular situation cash flow negative...but the asset itself is not. By borrowing you introduce the risk of leverage to the equation which is independent entirely of the asset. Further, everyone's borrowing situation is completely different. One person might have the ability to borrow at 4%, someone else might have to pay 15%. Neither of which have anything to do with the asset in question.
I though would much rather buy a nice asset that is cash flow neutral on purchase, and have an asset that is going to grow in value over time, and have rent that will grow over time, and which will have high quality tenants and little to no problems....than have a high cap rate problem which never goes up in value, has stagnant rents, a problem tenant base and continuous problems.
With patience, that low cap rate property, because of strong rent growth will cash flow more with time if you have the patience, and typically your total return will be considerably higher.
But Im a low risk investor. I'll leave the higher risk properties to others
- Russell Brazil
- [email protected]
- (301) 893-4635
- Podcast Guest on Show #192
Originally posted by @Dawn Curry:
Low cap rates are correlated to low risk and vice versa. You’re saying because of low cap rates generally are homes in a hot market and are A properties whereas your more depressed properties typically have higher cap rates - tenants, property itself, neighborhood, etc?
Yield in any investment vehicle is typically a reflection of the risk of the asset. Take dividend stocks. A boring insurance company like Aflac with a yield of 2.22% is the market viewing this as lower risk than a telecom like Verizon yielding 4.5%. A junk bond yielding 10% is higher risk than a US Treasury bond yielding 3%. A building with a 10% cap rate is higher risk than a building yielding 4%.
- Russell Brazil
- [email protected]
- (301) 893-4635
- Podcast Guest on Show #192
Yeah in that case it doesn't seem to make much sense unless they are just betting on appreciation/speculating or hoping for a lot of rent growth.... which hasn't been a terrible strategy in a market like L.A
In L.A I see a lot of properties being marketed as "great income property" that would actually result in the buyer losing a lot of money each month. So these aren't even 4-5 caps.
I can't see buying them unless it's some kind of future development play and they figure at least they are getting some income, even if it doesn't cash flow.
Interesting about Downtown Bakersfield, that is good there's been some gentrification. I have relatives in Bakersfield but not sure how often they are in Downtown. I saw that downtown Bakersfield was selected as an "opportunity zone" recently as part of the latest Fed government tax plan. https://www.bakersfield.com/news/opportunity-zones-provide-chance-to-increase-private-investment-in-our/article_7d6edc20-8539-11e8-b51f-5b83cd1713cd.html
Originally posted by @Sanjeev Advani:
@Adam Drummond those are great numbers. Whats the area like out there in Greenville?
I bought this property off market about 10 months ago. It is an older gentrifying neighborhood near downtown greenville. Even though my neighborhood is still a work in progress... people are paying about $200 sqft for a remodeled house there. Greenville is a crazy market, and has been for a minute. Investors are scooping up most any thing they can get there hands on. It's hard to find anything that's on the market as an investor. I always look off market. How long will it last??? who knows!
adam
I think a lot of this has to do with the buyers wealth number.
I tend to find those with higher numbers look more at appreciation growth, less headache, high quality location. The IMMEDIATE to short term yield is further down on the list of objectives.
You have to understand these people are not 500k trying to leverage up. These are people making 500k to 1 million a year or more and have net worth of 5,10,20 million or more etc. They already have crap tons of cash and more then they need to live on. The thought process totally changes from a mainly quick yield discussion. With rent and equity growth they can keep 1031 exchanging or refi to pull more equity out to reinvest and grow cash flow.
In the beginning I used to think more about cash flow only but now it is secondary to how I can grow equity with a property by future upside and re-position BUT not in such a way it is a massive headache of epic proportions to get that yield.
- Joel Owens
- Podcast Guest on Show #47
I am currently looking in the 5-6% cap rate range. I'm looking for a place to park some cash that will diversify an equity portfolio. I have an existing business and don't want to deal with all the headaches that I assume come with a 10% cap rate property. I'm not looking to get rich from this property, but have some downside protection from other assets. I also do not intend on highly leveraging it, therefore, it will be very cashflow positive.
@Jason Miller In your situation I can understand the thought process. High quality assets generally have low cap rates, but also lower risk and higher quality tenants. Parking your money there makes sense if you have an excess cash flow. Where are you looking for properties?
I am seeing people buy for below 4 cap in LA, and at times I think it's very silly. Athough I have seen some that need work & are in improving areas, so maybe they can make it work? I was lucky enough to find a deal where we bought at a 4.6 cap in a highly appreciating area in LA where the property needed some fairly simple improvements (floors, bathroom, paint), and we bumped the rent by about 15% from what the prior tenant was paying just a few months earlier, and added good equity relative to what the renovations cost. Might refi and use as a BRRR. However, I am back on the market for another one and finding that even pulling another one like this off is very tough. I do plan on diversifying for cash flow out of state, don't like all eggs in the appreciation basket.