Is your Cap rate 3% above your cost of capital?

[Jeff Kehl]

I was listening to an Old Capital Podcast today and they had what I thought were some fascinating guests, Vino and Mangesh Patel. They started out investing in hotels in the 80's and switched to B & C value-add apartments in the 2000's. I love interviews with people like this that have been doing this kind of thing for longer than podcasts have been around because I think there's a lot to be learned from their experience.

Vino at one point said that a rule of thumb they followed was that the cap rate of the property they were buying had to be 3%+ above what they were paying for financing. So, for instance if they were paying 5% for capital, they would only look at 8 cap or above properties. 

He also said, for that reason, they stopped buying properties in 2012 and pivoted to developing apartments from the ground up.

Arguably, they missed a lot of upside with that rule. A ton of money has been made on B-C value-add apartments in the 2012-2016 period because of the tremendous demand and rent growth. 

However, I thought it was an excellent reality-check for me specifically because so many of the properties or syndications I look at recently are sooo far from that standard. I looked through one today where the cost of capital was pretty far above the current cap rate. Their profits are all dependent upon getting people to pay more for stainless steel appliances and granite counters. This will continue to work until it doesn't and then I think it will get ugly.

So, to help us BP members, investors and syndicators alike I would like to encourage everyone to look at this metric.

It's a bit hard to calculate because it's not just the amount you are paying on your bank loan but rather that plus the amount owed to the investors on a syndicated deal. If it's your own personal equity it should be the theoretical rate of return you would like but obviously that is less risky.

So my challenge to the BP community is, tell me what these numbers are in your latest deal, be it syndication, partnership or something you just bought. What cap rate did you pay, what was your cost of capital and what was the spread?