Cap Rates at 3%, Interest Rates at 0% (Libor), worth investing?

[DongHui Patel]

Syndicates are paying at 3% cap for properties, they are paying interest on the property at 4ish % including buying caps etc.

For cash flows- if your debt is at 4.5% and your cap is at 3%, youre negatively leveraged. So coupons are not going to come to fruition. 

Once the interest rates go up, how is this sustainable for disposition? 

Interest rates go way up, you cant really exit with a good profit?

Someone prove me wrong?

[Brian Burke]

@Nick B. is right--today's pricing is predicated on revenue growth.  Revenue growth isn't tied to interest rates, it's tied to supply and demand in the rental market, plus what other comparable properties are charging.  

Here's an example:  We bought a property last year at around 4% cap.  Rents were about $940.  The deal made sense, because our analysis of comparable properties plus our experience in the market led us to believe that we could achieve $1,090 rents if we made some light renovations to the units.  We were right, we were immediately renting units at the goal rent.  This means that soon our income would be increasing, and thus this "cap rate/interest rate spread" concept was out the window.  If you were to look at our income a year later and recalculate a yield on cost it would offer a really nice spread over our mortgage interest rate.

Fast forward to now--we are actually renting units for around $1,600 (that's not a typo)--which is a 70% increase and we've only owned the property for 12 months.  This is why people are now buying at 3% cap rates...they are seeing the out of control rent growth and they know that the revenue stream is growing--rapidly.

Remember--cap rate has nothing to do with investment performance.  It is simply a thermometer that reads the market temperature.  When the market is hot, cap rates are low because buyers are willing to pay a premium for an income stream, typically on the belief that the income stream they are buying will be larger tomorrow than it is today.  If the market is soft, cap rates go up because buyers aren't willing to pay as much for the income stream, usually because they think that the income stream isn't going to go up much, if at all, or might even go down.  

If you are trying to correlate interest rates and cap rates you're missing the point.  They are related, but more like second cousins, not twins.