Cap rates across the country

[Dante Devine]

Hello BP, fellow investor located in LA looking for good multi family deals. I have a question. Can't one look at average cap rates across the country and make a pretty good decision on where they should invest? Cap rate is pretty much your ROI if you were to buy all cash right. So since financing is pretty much standard across the country, your only other variables would be taxes and insurance. All other variables were accounted for inside your NOI. I can simply choose a market based on cap rate if cash flow is my only objective. Please let me know if I'm looking at this wrong. If I am on the right track, where can I find a good source that lists cap rates by city?

[Tom Mole]

@Dante Devine, with all due respect, you are surely looking at this wrong. Cap rate alone does not tell you enough to know if an investment is a good deal or bad. You wouldn't decide the quality of a deal on the asking price alone. Cap rate is a guideline only.

In general cap rate is used in establishing the property value in commercial (5 units or more) investments. This is partially because apartments can be notoriously hard to comp using the methods for residential property.

It seems like high cap rate automatically means "high ROI" and it might, but it usually means "high risk". Low cap rate sounds like "low ROI, which is sometimes true, but it usually means "low risk". High risk areas often have low income, unreliable tenants. Cost of acquisition is low, so the actual return is often lower than low cap rate in a better area, especially considering the lower physical and economic vacancy rates.

When looking for multifamily properties you're on the right track to get the market cap rate, but resolve that down to the neighborhood level. Then look carefully at the expenses and rent rolls. A  cap rate on a property out of line with the market is usually a red flag.

Finally, trust your seller's broker, but verify everything. Often they minimize the vacancy rate by ignoring late payments or how the occupancy is high only because the rents are below FMR. Far too often the broker makes a mistake figuring cap rate based on the asking price. If the cap rate goes up, either the price went down or the NOI went up magically.

I hope this helps. Let me know if you have any questions about this rather long, tedious post.

All the best.