What is your MINIMUM required Capitalization (Cap) Rate?

[Marco Santarelli]

Although I'm not a big fan of using the Capitalization (Cap) Rate to analyze a property, it is a number used by many investors as a quick one-dimensional metric.  It is also one that is more commonly used in the commercial space.

Of course, investors have different subjective expectations of what a "good" or "minimum" cap rate is.

So I'm doing a quick poll via this post:

What is your MINIMUM required Capitalization (Cap) Rate?

[Bill Gulley]

Thought I put two cents in this thread, guess not. 

I agree that Bob is going down the right path. as I mentioned recently in a similar thread comparing stocks to real estate, before your cap rate is viable you need to look at apples and apples, not apples and oranges. 

If you take Chapter One of The Principles of Real Estate, you'll see that while real estate in different classes may be similar but no two parcels are identical. That means the risks are not identical. To obtain a fair cap rate you need to look at opportunity costs of alternative investments, being the same or nearly the same, that's very hard to do in real estate. 

Your cap rate will never be the same as mine, my actual expenses won't be identical to yours, in fact, mine won't be the same every year. Our cost of money isn't the same, our opportunity costs are not the same, our NOI won't be the same, out tax position won't be the same and forced or market appreciation won't be same same.

A seller tries to sell historical income setting a price. That's like selling me a used car showing your costs to operate it with the maintenance you did or didn't do and then expect me to pay a price based on your past experience, the second hundred thousand miles won't be like the first hundred thousand miles. While this is apples and oranges to real estate, the theory is the same, in assuming my future experience will be like your historical performance. 

Lenders and appraisers have more market information than investors and much of that is shared. An appraisal is an opinion of value as of a certain date, it's not the market value until a price as been obtained in an open market transaction. Past transaction show trends, not absolutes. An appraiser will not say the cap rate for this property must be 10%, they are more likely to say that a 10% cap rate is comparable to what other investors obtain for similar properties. 

Your cap rate analysis is more of a psychological barrier that a true financial barrier for pro forma assumptions. Picking a number as your cap rate and then adjusting income and expenses to arrive at that number is useless. The market set the income and only actual expenses set operating costs, fine for looking in the rear view mirror once in awhile, but I have to see or understand what's ahead as what is applicable to me in the future to my desired profits. 

I do want to see fixed costs of a current owner, some of them will be applicable and other expenses may not be. Current rents only gives me a picture as to the current day and the near future as leases expire. Beyond that I have to look at the market and management expertise to profit. 

I consider estimated net operating income, I never consider the owner's cap rate or even try to guess at my future cap rate, it's irrelevant. When buying, consider net income, forced and market appreciation, tax implications, management requirements, debt service and known fixed costs. 

If a property isn't a real pain to manage, pays for itself and doesn't eat any hay, has cash flow for operations, doesn't really cost you anything, then it's a good deal! 

Cap rates are fine for liquid investments, inventory management, use of funds, allocations to equity, but not to real estate, at least until you get to very large numbers and can accurately identify use of cash and opportunity costs within the market. 

But, many like playing with their financial calculators.... LOL! :)