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Buying on CAP Rate. What’s Right For You?

The most common question I am asked by clients looking to buy an investment property is “what CAP rate can I get something for?” My answer is always the same. “What CAP Rate do you want to pay?” After a brief moment of silence, I am then asked, “what do you mean?”

Here’s what I mean. The market is very efficient. It is rare to find a property that you can buy at a 9 CAP that should be at a 7.5 CAP. Sellers are pretty shrewd. They are not going to significantly underprice a property, and if they do, it will be snapped up quickly. So when looking at a property, chances are the market has set the price. The CAP rates are determined based upon how risky the investment is for the buyer. Tenant strength, lease length, location, occupancy, and condition of property all go into determining what a fair CAP rate for a property should be. So when I ask what CAP rate a buyer wants, what I am really asking is how much risk is a buyer willing to assume.

If a buyer is willing to buy a property that has a short lease term left, or some vacancies, then expect a high CAP rate to reward your appetite for risk. For those who just want a check to come in the mail each month, with little if any management responsibilities, their CAP rate will be lower. The good news is that in this low interest rate environment, even the lower CAP investment properties still provide a return greater than what can be made in most other investments.

So before you call me and have me tell you what CAP rate you should expect, first ask yourself what level of risk you are willing to assume.

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