All Forum Posts by: Account Closed

Explain how "cap rates are all about risk NOT ROI".

Cap rates provide useful information about the opportunity costs for certain investors. An investor in an area with a higher market Cap rate is going to have a higher ROI all other things being equal.

Credit loss/ vacany risk is built into income statement projections which determine NOI-- meaning that this is built into Cap rate calculations across the board.

I would argue that the market is willing to pay more because of asymmetries, and among other things, premiums for certain qualitative geographical factors (Hawaii has a nicer climate than Cleveland Oh, for example)- not because a family in Cali is "more able to pay" than a family in Kentucky. 

I just think it's so incredibly dangerous to imply that lower cap rates are somehow desirable, all things being equal. I understand the idea that high cap rates in bad neighborhoods justify the inherent risks of those areas, but, that introduces other exogenous variables independent of of mere "dollars in, dollars out" calculations. It's one thing to argue that the situation is more complex than "dollars in, dollars out", but to imply that lower cap rates are "better" is absurd. That's like arguing that a T-bill is better than a stock because it has a lower return. The goal isn't to minimize risk, alone- and, as I have suggested briefly, I don't necessarily think cap rates adequately reflect risk across markets. 

Which is why I was arguing cap rates are implicit indicators of risk. A stock investor wouldn't say that the ROI primarily reflects risk, merely that assets with a higher expected ROI are "riskier". All I'm saying is, let's call an apple an apple. Cap Rates are discount rates- they are rates of return.

Also, you do realize that if the risk is higher, than the expected return is also higher. Meaning that higher cap rates are inherently "more profitable". 

Anyway, contrary to what I posted above, I would argue that differing cap rates ACROSS markets have FAR MORE to do with asymmetries than risk.

 I don't think that properties in Lexington are inherently more/less risky than properties in Atlanta, or Las Vegas, or New York etc. The asset class is the same. 

@Bob Bowling

How do you figure cap rates are "measures of risk"?

I suppose implicitly that may be the case since cap rates are essentially discount rates of perpetual NOI and higher rates would imply more risk, but it seems like you're being sloppy with terms. If anything, cap rates reflect higher or lower market opportunity costs.

Also, if cap rates reflect the market price of a given NOI, a higher cap rate is certainly "more profitable" than a lower cap rate for the same asset because it implies that we were able to buy the asset for less, or charge more rent for the same price.

Finally, higher interest rates should put downward pressure on home prices because they "soak up" available credit. Additionally, higher interest rates imply lower expected inflation.

Would it really matter for tax purposes? 

I had to pay the premium in full upfront, so I accounted for it as "prepaid insurance". 

@Ed L. 

 Thanks for your reply!

That's reassuring.

I'm going to have to rip out the drywall and get a professional remediation company to come in. 

Thanks!

So I just purchased a fix and flip REO property.


There is some mold in the laundry room of the house along with termite damage in a pile of logs against the back of the house (no termites were actually found inside the house).


Neither of these problems are going to be costly fixes. I'm not particularly worried about that since it looks like this rehab will come in way under budget.


The problem is insurance.


Will insurance companies issue me a vacant house/ builder's risk policy/ homeowner's policy if there are mold and termites?


If not, will my house have to sit uninsured for several days while I fix the problem?


Thanks,
Patrick 

@George C. 

The property was an REO so the disclosure sheet was black.


Either way, I want to know what kind of mold to remove any potential liability down the road. The due diligence period hasn't expired yet so I can still get out of the deal if it's going to be a costly mold remediation. 


The basement (where the laundry room is) is pretty "mildewy" would you recommend I get a dehumidifier and stick it down there? 

@Gary Hert 

I want to confirm that the mold isn't toxic.

Will the swab test indicate whether it's black mold?


I was planning on getting an air quality test after it's been ripped out. 


Thanks,
Patrick 

@Travis West


Wow that was really above and beyond the call of duty!

Thank you so much, I really appreciate you taking the time to write all of that.

You just proved yet again why BP is such a fantastic resource. 

I'll check with my real estate agent/ lawyer about the local laws.

I've got an inspector coming out soon to do a swab test. I'm planning on hiring someone to rip it out, and put in new drywall. 

That's good news about the sale price. Honestly, that's what concerned me most.

Once again, thank you very much!

-Patrick 

We found mold in an REO that I have under contract.

Fortunately it's not black mold, and is only in a small laundry room in the basement.


After I rip it out, drywall, do I still have to disclose to potential buyers that there was mold?


Will this lower the potential sale price?


Thanks,
Patrick