All Forum Posts by: Kyle Marcotte

@Spencer Hilligoss:

In my opinion KPI's are important to give you a general sense of a property. They help you set a basic criterion when you are first staring your underwriting of a deal and they make it easier for you to pitch a deal to people interested in investing in the deal. If I had to choose some must have metrics, I would say DSCR and CoC are perhaps the most important to me because I need to be certain that there is some element of buffer from the risk of losing the property in the event of a market shift or an unexpected issue in the structure of the property that causes vacancy or expenses to rise. At the end of the day our job as investors, in anything not just real estate, is to not lose money and focus first on taking care of the downside and worst-case scenario. Once I insure some level of safety, then I look to other KPI's such as IRR and overall annualized returns to see if the risk I am taking on will have a measurable reward.

HOWEVER, the main point I was trying to make with my initial post is that while KPI’s such as the cap rate are important and have a valuable place in our underwriting and decision making, they are not everything. The spread sheet can only tell you so much of the story. You have to have an understanding for the specific property and map your projections based on what that specific property will allow you to do as far as increasing revenue and decreasing expenses. It is an ever-changing ecosystem of humans that you are purchasing after all, not just a set of numbers on paper. When you look at it from this prospective, then I believe you are able to see the true nature of the risk that you are taking on.

This means what is the demographic of the tenants in your property, where do they work, what is their general income level, how will your increases in rents and fees compare to the neighboring apartments etc...? Questions and thoughts of this nature, to me, are the most important part of understanding an apartment complex, and the risk associated with it. If you do not consider these things, then your KPI’s will not be accurate and will fall short; thus, upsetting any investors you may have promised said KPI’s to.

Appreciate the words y'all @Tj Hines, @Ben Leybovich, @Bjorn Ahlblad, @Brian Burke looking forward to being more involved in the BP community!

Ok, Cap rates are important, however they are such a small part of your decision-making process. The amount of times I hear “I only buy 7 cap deals” is maddening. If you really think evaluating commercial multifamily apartments is as easy as looking at a cap rate and then saying yes or no, you’re delusional. That would be like Warren buffet saying, “oh yeah, I just stare at the Earnings per share on a stock and if it’s not x then I don’t buy.”

Cap rates are one part of a large equation. You have to consider the potential upside such as rental increases, RUBS additions or other forms of supplemental income (make sure the local sub-market will support these additions) that the complex in question is currently not taking advantage of. You have to look at the expenses and decide why are they are either too high or too low and how can you change them with an effective business plan. ALSO, running the business plan by your property manager or potential property management partner, prior to you even submitting an offer. You have to see if the business plan is going to actually be possible to carry out. All of your projections mean nothing if the back-end partner can’t actually make them a reality.

A cap rate is merely one lever in the value formula of: NOI/Cap rate = purchase price. When you consider the exit sale, you'll see that if you increase your NOI during the hold period the low cap rate actually benefits you and has the effect of making your sale price even higher. Low cap now becomes a pro not a con.

A cap rate is a metric of price, but it’s also an indirect assessment of risk. The lower the cap rate the more demand and the more potential exit buyers you have available to you. If you buy a 10-cap deal in the middle of Idaho it may be a good upfront at the buy, but if anything happens to the industry in the town your vacancy will sky rocket and then you’re left with an apartment that no one in the world will buy from you. Bottom line: you get what you pay for.

In conclusion, cap rates are an important thing to take note of but please do not stop your analysis at the cap rate. Please consider the whole picture and please do not say that you “only buy 7 caps hands down nothing else.” Open your mind and be flexible with new information on a case-by-case basis.