Cap Rates: How to get accurate Cap Rates in Southern California

[Matthew G.]

First off I'm a newbie.

I'm searching on loopnet for MFP 4-6 units in Orange County in the $1-$1.5M range. It appears that even when I'm reviewing the pro formas for properties within a quarter mile of each other the cap rates are very different (up to 2% difference at times).

I'm trying to do some pre due diligence before I consider contacting the seller and ask for rent rolls etc. but it appears these brokers are just adjusting the Cap Rates to justify their asking price.

Further for most of these properties I'm seeing when I calculate loan payments for the year with 25% down I'm not even close to cash flowing.

Am I missing something?

Is investing in orange county strictly based on speculative appreciation of the property in lieu of 60% down payment to cash flow?

Maybe I should look for a larger property in a better market in another state? However since I live in So Cal I wanted to purchase my first REI property close.

Any thoughts? Anyone have solid ideas on how to find accurate cap rates? I want to value the property myself based on prior performance but clearly need to understand how these rate fluctuate so much.

Thanks

[Derek Carroll]

Try calling some appraisers. That's what I often do. Or find someone with access to software like reis, real capital analytics or costar.

[Jake Kucheck]

Matt,

Really glad you came to BP with this. You are correct that the brokers are doing exactly what you suggest, which means their cap rates are mainly BS/marketing. You have to do your own analysis of whether their historical rents are going to be indicative of what you can get in the future.

As for OC as a speculative market... yeah it probably is. Or an arbitrage market. What it isn't, though, is a cash flow market. It also isn't correct to say that your property will "cash flow" better if you put 60% down instead of 25% because that ignores the opportunity cost of your capital being utilized in other investments. A rental property is only good as the rent it can bare, regardless of how the purchase financing is structured.

In order to understand cap rates, the most important thing you need to have a very good feel for is market rent. Not advertised rent, not "incentive" rent (i.e. tenant gets two free months but signs above market lease for remaining months so seller can sell a better "cap rate"), but true market rent. Once you have a good feel for that, you can back out pretty much everything else to determine whether or not you are looking at a good deal. Odds are if it is multi family in OC and you found it on LoopNet, you are not.

[Will Barnard]

You are likely having trouble finding cash flow in these units because the area really does not support real cash flow. To get it, you will likely have to go out of the area and perhaps out of state. The desert cities here in So Cal will have better cash flow opportunities.

[Jeff S.]

You wrote 4-6 units, Matthew. Be careful, since 4 units and under is residential and will generally be priced by comps and not cap rates. Don’t mix apples and oranges.

I agree with Jake. It’s not an accurate cap rate survey you need but an accurate rent survey. From here, and a decent estimate of expenses, you can back into cash flow (or the lack thereof in OC) and determine what the property is worth to you. That’s what you really care about, not cap rate. If you’re reasonably close to the asking price it could make sense to make an offer.

Don’t be surprise if nothing makes sense for cash-flow however, especially if you’re looking at LoopNet. By the time properties make it to these sites, the brokers have already shopped them to everyone and their brother. That is, before you decide to move far from the area, make sure you have the right relationships in place to source your deals.

[Matthew G.]

Originally posted by @Jeff S.:
You wrote 4-6 units, Matthew. Be careful, since 4 units and under is residential and will generally be priced by comps and not cap rates. Don’t mix apples and oranges.
I agree with Jake. It’s not an accurate cap rate survey you need but an accurate rent survey. From here, and a decent estimate of expenses, you can back into cash flow (or the lack thereof in OC) and determine what the property is worth to you. That’s what you really care about, not cap rate. If you’re reasonably close to the asking price it could make sense to make an offer.

Don’t be surprise if nothing makes sense for cash-flow however, especially if you’re looking at LoopNet. By the time properties make it to these sites, the brokers have already shopped them to everyone and their brother. That is, before you decide to move far from the area, make sure you have the right relationships in place to source your deals.

Thanks Jeff,

It's amazing why anyone would invest in this market unless they only care about appreciation. How would you estimate valuation on a property even if you know that true rents and accurate expenses without using CAP rate?

I'm still wrapping my brain around how someone could purchase these properties and think it's an investment.

[Karen Margrave]

@Matthew G. We build spec new construction. We relocated to southern California from far northern California where prices were much lower. Why? Because when the market crashed, we knew it was going to be far worse than any recession we'd ever gone through. We also knew that the first place that would rebound would be southern California, and we wanted to get in on the market.

Southern California has a lot going for it. For one, people from around the world love California. It's one of the most popular places on earth. The weather here is perfect year round. There's an extremely broad based economy, with high wage earners (that can acutally afford the higher rents) . It's a hub for shipping having the port in Long Beach, etc. We have world class universities and medical facilities, along with every type of amusement, recreation, cultural and natural resource imaginable. The unemployment rate is 5%.

All of those things combine for high demand. That demand is what drives up prices, rents, etc., and gives stability to the market.

You may not have the cash flow you can get in another state, but no other state is California. Like it or not, what we have here no other state comes close to, and it will always be a popular area for business, tourists, and living. Those are the things that help real estate increase in value, and protect investments.

@Jeff S. I disagree on LoopNet. We list commercial projects on LoopNet and Costar first, not last. There's no other good sites on the web, and no listing service with MLS that beats the exposure for commercial properties.

[Thomas Alexander]

#1, don't EVER use a brokers financial data on a property. #2, don't EVER invest in a MFP in California. Partner up in a Sponsor/Investor deal and take your money out of state. If distance is an issue for you, you have a gem right across the state line called Las Vegas. You asked for good cap rates and there you will get them. Don't take my word for for it. Due some Due diligence on your own in other markets and it will make you laugh at our market here in California. Unless you are doing creative offices or MOB's, just completely forget about this state...

[David Jacques]

I've said it a couple times but with small scale rentals and residential in general, cap rates really shouldn't be anything more than a quick gut check. It's useful on Loopnet because you can quickly determine the NOI of the property (if unlisted) if you have the broker's cap rate and a suggested purchase price. The credit worthiness of Mr and Mrs Craigslist Renter is almost impossible to aggregate since it will vary wildly. It's more acceptable in a commercial deal because you can generally judge the credit worthiness of a Starbucks or Subway or whatever and have a reasonable guarantee that you'll receive your rent money.