The Top Markets for Multifamily Investing Right Now

[Jonathan Twombly]

I just saw someone touting the "Top Markets" for real estate investors, based on their high cap rates.

Nearly every market on the list would also be on a list of "fastest declining rust belt cities".

There's something really important to remember about cap rates.

Cap rates aren't just a number indicating the unleveraged return an investment.

They also reflect the market's assessment of the risk of the investment. The higher the perceived risk, the higher the cap rate must be. This is known as a "risk premium" - the market demands more return to take on more risk.

The fact that cap rates are high in these areas - at a time of historically low cap rates - has to tell you something about the market's view of these areas.

Just because assets look cheap in these markets doesn't mean they are cheap. They're only cheap compared to markets that investors feel have better fundamentals, including strong population growth and healthy economic outlooks.

If you find a market with strong fundamentals AND high cap rates, you have a buying opportunity. But that's not what's going on here. Here, you have investors desperate to generate returns, venturing into markets they wouldn't have touched with a barge pole just a couple of years ago. And they're declaring themselves geniuses for doing so too!

If a market has assets trading at a 10-cap right now, in this time of historically low cap rates, what do you think happens to cap rates there when the market returns to normal, as it always does?

And what happens to the value of assets there when that happens?