All Forum Posts by: Immanuel Sibero

@Chris H.

This property would be a good case study of valuation using cap rate comps vs. sales comps. I'm assuming it's a duplex so it's normally valued using recent sales figures of similar properties (i.e. other duplexes or single family houses). For me to make an offer on this property, I would ask a realtor to "comp" this property and set my offer based on the comp data. I could calculate the property's cap rate all day, but it would not guarantee that I would arrive at a legitimate offer.

For example, suppose I use the cap rate method and come up with 90k. I could offer 90k but it's very likely I would get outbid because my offer would be too low, so what's the point of making the offer? Suppose I use the cap rate method and come up with 150k, it would be silly for me to offer 150k when the asking is 134k. So you can see that the cap rate method of valuation here is just irrelevant.

I will add that , in theory, you could calculate this property cap rate and compare it to the cap rates of other similar properties to see which one is likely to give you the best performance, but when you go down this road there are other metrics that are even better to use. So in conclusion when you're evaluating 1-4 unit properties, don't even use cap rates, they're just irrelevant.

As far as offering 115k for this property? I don't have enough info to say if it is a good offer. It depends on:

- what the comps say

- estimate how much repair is needed since it's an "as-is" deal

- estimate the income after verifying all revenue and expenses data

- determine if given all the risks associated with this property, it still performs better than other investment opportunities I may have available (i.e. stock market, bond funds, gold, bitcoin, etc.)

Cheers... Immanuel

@Alexander Zurn @Chris H.

Correct, in general cap rate comps are used to value MF. But using your example, an MF with 2 units are normally valued using sales comps instead of cap rate comps. This is true for MF with up to 4 units.

The perception that it is tough to find MF deals in a sellers' market when looking at MF with 2 to 4 units is precisely because they are valued using sales comps, so they compete with single family homes.

The "true" MF (i.e. 5 and more units) are always valued by the numbers (cap rates comps) whether in hot or cold market.

Cheers... Immanuel

@Vera Herlihy

I'm surprised your searches didn't find anything. There are lots of discussions on cap rates and LTV right here on Biggerpockets. I would also check out wikipedia.com, lots of good information, especially on the definition of cap rates.

@Chris T.

I listened to the podcast you posted. The presenter emphasizes cap rate as a measure of performance (i.e. how much income is generated from a dollar of purchase). This is a limited view of cap rate. Cap rate does much more than that, it's more of a measure of desirability of a property and even risk.

Early in the podcast the presenter stresses the importance of NOI to comprise of only "operating" revenues and expenses and that capital expenditures (i.e. roof) should NOT be included in the cap rate calculation. However, later on in the podcast the presenter uses an example of a recently sold property with a 5% cap rate and compares it to a property that he is evaluating. He then goes on to say the property he is evaluating needs a new roof, so he's going to factor that into the cap rate of the property that he's looking at. Well, this is totally inconsistent with how he had described Cap Rate just minutes before.

Capital expenditures should NOT be factored in to cap rate, just as he had correctly stated early on in the podcast. IMO the podcast is misleading.

Cheers... Immanuel

@Eric DeVito

Neither one is sufficient measure. Be aware that CoC and Cap rates are snapshot, one-time metrics so they do not reflect the overall performance of the property. These metrics can be useful to screen properties. But once a property passes your screening, then look at the the more robust metrics such as ROI and IRR.

Since you're asking about CoC and CAP I'm assuming commercial properties so as far as performance numbers investors like to see (assuming passive investor in a syndicated deal such as apartments), how about - 10% CoC or greater, 20% ROI or greater, double your money in 5 years or less??

Cheers... Immanuel

@Demarcus Owens

I think you're on the right track. House hacking with an FHA loan is definitely a sound entry point into REI. As mentioned by another poster, the 203k option is worth looking at as it can be a way to add value. Beware of other requirements related to FHA loan such as PMI insurance and owner occupancy of the property.

Also, another point regarding a comment on cap rate buyers. Single family houses up to 4-plexes are generally priced using sales comps, not cap rate comps. So there should not be a concern that you would have to deal with cap rate buyers when you try to sell a duplex, triplex or fourplex.

Cheers.... Immanuel

I may be overlooking something here but this is a scenario where the expected yield/return (i.e. cap rate, if you will) is not even enough to cover the cost of capital (i.e. cap rate is 4.50% and interest rate is 4.75%). There must be another reason to even consider this project; something like if you could sell the building for 30 mill in 5 years (i.e. the appreciation game, which may be more common in CA).

Cheers... Immanuel

@David Lilley

David, that is correct. But I wouldn't buy the asset with all cash (who would?) ... so it makes that definition rather academic. But you are correct.

I see you're from Dallas, I have been going to multifamily meetups around DFW, learning a ton in the process, maybe I'll run into you sometime :-)

Cheers....  Immanuel

I'm a newbie, but I have learned to take things with a grain of salt (... and tequila at times). When it comes to cap rate, I have read a lot of posts attempting to define and describe it. Bob bowling's and David Faulkner's writings have been the ones that make sense to me. I understand what cap rate was originally designed to do (as David pointed out) but in practice I see cap rate being defined and described the way it was NOT originally designed to do.

I keep running into posts where the "experts" would define cap rate as follows:

"The capitalization rate is the rate of return on a real estate investment property based on the income that the property is expected to generate. The capitalization rate is used to estimate the investor's potential return on his or her investment."

When questioned, the experts would say the definition comes straight out of Investopedia (http://www.investopedia.com/terms/c/capitalizationrate.asp?lgl=lg-mt) .... Well great! I guess newbies should just take it at face value since it comes from the "experts" and it's a copy and paste straight out of Investopedia. But I question that definition because of the writings that I have read on BP (i.e. Bob's and David's in particular). As David pointed out cap rate was not even designed to measure return. You can certainly use the cap rate formula backwards and make it calculate return but it's still a poor measure of return.

Consider Wikipedia's definition and description of cap rate - https://en.wikipedia.org/wiki/Capitalization_rate

"Capitalization rate (or “Cap Rate”) is a real estate valuation measure used to compare different real estate investments. Although there are many variations, a cap rate is often calculated as the ratio between the net operating income produced by an asset and the original capital cost (the price paid to buy the asset) or alternatively its current market value."

Wikipedia goes on to describe various uses of cap rate and none of them measures return or performance. Based on my reading here on BP, I think Wikipedia's definition and description of cap rate are more in line of what I understand cap rate to be. Soooo, why do the experts keep perpetuating cap rate as a measure of return? Turns out the answer is simple... because when you google "cap rate", Investopedia comes up at the top!!! <Ugh>

Another point about the misuse of cap rate as it relates to turnkey rental house operators (also pointed out by David). I see many turnkey rental houses right here in Dallas (i.e. where I live) being advertised with 8 CAP. Well 8 cap can be pretty eye catching for folks in California and some other places but the prices they're trying to sell the houses at 8 cap are higher than the comps in the area. It's like the turnkey operators are banking on the investors not doing their homework and just purchase the house because it's an 8 CAP .... after all, it's a good return right? cant get anything even close to 8 CAP in California right?

Cheers.... Immanuel

@Jason Kori

If you're talking about single family houses, what people are saying (or should be saying), is that Cap Rate is irrelevant in determining the value of those houses. House values are determined by comparable sales not cap rates. Some investors may decide to calculate Cap Rate to determine whether a particular SFR is a good investment, well... if SFR cap rate floats their investment boats then how can that not be a great thing? If you sold a "true" 12% Cap Rate SFR rental at a premium, it didn't sell because it was a 12% cap rate, it sold because the sales comps in the area support that price, regardless of whether you thought you got a premium.

The reality is you can calculate Cap Rate on anything that spits out revenues and expenses. During the summertime on certain weekends, my little girl sets up a lemonade stand out in the front yard. Turns out she has revenues and expenses from selling lemonade, so this summer I'm going to calculate the cap rate of her lemonade stand. For all I know, she might have been dying to find out her cap rate. I just need to find a way to break it to her that her cap rate is NEGATIVE. 

Hmmm negative cap rate, well that's a new one... <G>

Cheers,

Immanuel

@Peter Abualzolof

...If you, however, are financing a purchase (through a bank loan, let’s say), you will need to include the annual cost of financing your property as an operating expense...

The above is a quote from the blog. Annual cost of financing a property (i.e. interest expense) should not be included in NOI as it is not an "operating" expense. Interest expense is an expenditure related to the capital structure of the a rental business, not the operation of said business.

Now if you are in the business of lending and borrowing money, then that's a different story. In this case, interest expense would be an "operating" expense.

Cheers... Immanuel