The reason those investor accounts are out dated because many operators get more institutional... when they go over 2-4B in AUM... higher splits and fees means less ROI for LPs... the trade off is reliability in terms of counter party risk (stealing your money). However some big institutions use a net zero reversion cap rate, assuming they're selling into a stronger market as opposed to increasing it by 0.5%-1.0%. I remember attending this real estate conference without the usual YouTube influencers and real estate fake gurus. I asked a bunch of institutional operators about their strategies. Their answers were surprising. Most people in Sub 2B in AUM expect the market to dip slightly and use a reversion cap rate of about half a percent.
Take late 2023, for example. We saw cap rates accelerate. Phoenix, Arizona, is a perfect case. Cap rates there jumped from 3.5% to 6.5%, even 7%. That's a 30-40% drop in market value. It all boils down to how commercial real estate works: your net operating income divided by the cap rate determines your property's value. Let me break it down: A property with a net operating income of half a million, at a 3.5% cap rate, is worth around 14 million. But at a 6% cap rate? It's only worth about 8.3 million. That's a huge loss.
This is why your investment model needs to account for cap rate changes. If it doesn't, you're in trouble when rates spike. And that's exactly what happened last year. Diversifying over different time lengths is key to handling these swings. High cap rates are rare, but they do happen. As a passive investor, you've got to weigh the risk and reward.
Operators usually evolve (less in favor for LP). They either go institutional, tapping into large, passive sources of capital, or they change asset classes. For the smaller LP investor, finding the right operator is crucial but if you net worth is under 4M (what I call endgame status) then I would try to find a less institutional operator.
