Dreaming of 8 caps. Am I crazy?

[James Kojo]

I've just started my search for 10+ unit MFRs. I've set my criteria at an 8 cap in B areas. Is that realistic or do you think I'll have to reset my expectations? I'm looking in multiple out of state markets, but I'm concentrating on secondary markets in MSAs with growing population and shrinking unemployment. Thanks! James

[Brian Burke]

@James Kojo, probably not going to happen unless you are looking in tertiary markets. The highest cap rate in the US for B class in a primary market according to the CBRE cap rate study for the first half of 2017 is Cleveland at a range of 6.75 to 7.75.  Most primary markets range from 5% to 6.5% for B class. 

Certainly there are needle in a haystack exceptions from getting lucky or off-market deals with an unsophisticated seller. These reports tend to report overall average data. That said, in all of the trades I'm involved in (ones where I've fully underwritten the asset and subsequently learn what price it traded or I bought it) have come in line with the market stats found in this study, or close to it.

But the larger question is why are you looking for an 8% cap rate?  Or any cap rate, for that matter?  Cap rate should have very little to do with your acquisition decision other than to underwrite your exit price. An 8% cap rate is not better than a 5% cap rate nor vice-versa. Cap rate is nothing more than a measure of how buyers are valuing an income stream. It says nothing about how many dollars will be in your pocket after you've counted your chips when the casino is closed. 

Higher cap rates tend to be found in markets with less rent growth, less stable occupancy, weaker fundamentals, tertiary markets (where there are fewer buyers--and will still have fewer buyers when you want to sell), lesser tenant quality, less availability of financing (higher down payments and/or higher interest rates) etc.  buyers place less value on that stream of income for those reasons, thus higher cap rates. 

Lower cap rates tend to be found in markets exhibiting the opposite characteristics of those mentioned in the previous paragraph. Buyers place more value on those income streams because they are more likely to grow larger and remain consistent. Thus, lower cap rates. 

Who wins?  Well, that depends. But the answer isn't as simple as saying, "8% cap rate?  Yeah, I want that!"