What is a good Cap Rate?

[JustAskBenWhy]

Hey, guys!

I just published an article on my blog titled - What Is a Good Cap Rate. There is an awful lot of misconceptions about the concept of Capitalization Rate, what it is, and how to properly use it.

If you are interested in real estate, which you should be, CLICK HERE and learn.

Feel free to ask, if you have questions!

 

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[SteveO]

Hey, guys!

I just published an article on my blog titled - What Is a Good Cap Rate. There is an awful lot of misconceptions about the concept of Capitalization Rate, what it is, and how to properly use it.

If you are interested in real estate, which you should be, CLICK HERE and learn.

Feel free to ask, if you have questions!

You could write an entire chapter on this subject. I have had the cap rate discussion so frequently and it becomes annoying. Cap rates are also easily manipulated.

Great post!!!! Way to summarize a topic that is usually so misrepresented. You brought this down into a simple statement that is very powerful.

I love a good pro-forma cap rate when I am selling. Otherwise, don't even pay them any attention.

I want to know what the building will cost me, what the repair and holding costs will be, and what I can sell it for. I use a cost per unit to do most of the calculations. Simple!

 

[Sauce]

You could write an entire chapter on this subject. I have had the cap rate discussion so frequently and it becomes annoying. Cap rates are also easily manipulated.

Great post!!!! Way to summarize a topic that is usually so misrepresented. You brought this down into a simple statement that is very powerful.

I love a good pro-forma cap rate when I am selling. Otherwise, don't even pay them any attention.

I want to know what the building will cost me, what the repair and holding costs will be, and what I can sell it for. I use a cost per unit to do most of the calculations. Simple!

This is a great post! I wish we could breath some more life in to this part of the forum.

@SteveO I know we have talked about this in the past. Can you shed some more light on this? One SteveO rule of thumb was to use $3,000-$3,400 per unit as the operating cost for apartments. Does this include taxes, insurance, maintenance, etc? What other per unit metrics do you use?

@JustAskBenWhy do you use any general rules of thumb when evaluating a mid size (less than 50 units) projects?

 

[JustAskBenWhy]

This is a great post! I wish we could breath some more life in to this part of the forum.

@SteveO I know we have talked about this in the past. Can you shed some more light on this? One SteveO rule of thumb was to use $3,000-$3,400 per unit as the operating cost for apartments. Does this include taxes, insurance, maintenance, etc? What other per unit metrics do you use?

@JustAskBenWhy do you use any general rules of thumb when evaluating a mid size (less than 50 units) projects?

The rules of thumb are kind of nonsense. What's important is to underwrite the exit, and to underwrite the cash flows. @SteveO outlined a simplified approach - here price per door at front, and here's price per door at exit. The delta is the profit.

My thinking is to underwrite the exit scientifically. Here's the stabilized NOI 3 years from now. Here's the CF escalation for the hold. Here's the NOI at exit. Here's the discounted Cap Rate at exit (this is where the guess is, cause we don't know). And here's the justification for the exit price... And here's the deal IRR based on all of the above cash flows and assumptions.

Now, I don't know that it's necessary to get that granular on small assets. But, when buying 100+ doors, 1% miss on CF in year 2, which compounds for 6 years, can lead to a vastly distorted NOI and exit valuation assumption. So, I think that on big projects, we have to get very precise. @JScott - I am thinking your model is similar, right?

 

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[SteveO]

My thinking is to underwrite the exit scientifically. Here's the stabilized NOI 3 years from now. Here's the CF escalation for the hold. Here's the NOI at exit. Here's the discounted Cap Rate at exit (this is where the guess is, cause we don't know). And here's the justification for the exit price... And here's the deal IRR based on all of the above cash flows and assumptions.

These are the calc's that I use to justify my cost per unit on sale. I also do a set to show what the property would run at in it's current condition if I were operating it. My spreadsheet covers 5 years. Hold times are usually 1-2 though.

 

[SteveO]

@SteveO I know we have talked about this in the past. Can you shed some more light on this? One SteveO rule of thumb was to use $3,000-$3,400 per unit as the operating cost for apartments. Does this include taxes, insurance, maintenance, etc? What other per unit metrics do you use?

I agree with @JustAskBenWhy that rules of thumb are generally useless. The one that gets tossed about frequently is the 50% rule. This is where you could assume 50% expenses in any evaluation.

The rule that I discussed with you only holds true for my operations in Phoenix with a standard property averaging $750 rents. Time has shown ME that that is about what it will cost. There are many variables. Does the property have a pool, larger or smaller square footage, large areas of grounds that need to be watered/maintained, flat roofs, etc....

But yes, in general I use $3,200/unit/year. That does include all expenses including normal cap ex. I add capital improvement costs up front for items that need to be addressed.

 

[JustAskBenWhy]

I agree with @JustAskBenWhy that rules of thumb are generally useless. The one that gets tossed about frequently is the 50% rule. This is where you could assume 50% expenses in any evaluation.

The rule that I discussed with you only holds true for my operations in Phoenix with a standard property averaging $750 rents. Time has shown ME that that is about what it will cost. There are many variables. Does the property have a pool, larger or smaller square footage, large areas of grounds that need to be watered/maintained, flat roofs, etc....

But yes, in general I use $3,200/unit/year. That does include all expenses including normal cap ex. I add capital improvement costs up front for items that need to be addressed.

My experience of OpEx is higher $$ amount, and % of GOI. likely because AZ is all considerably newer than Mid West Can't wait to get the hell out of here. Working on it...

 

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