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Investment Real Estate

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.

Categories
Investment Real Estate

Has the Fed Become a Real Estate Investor’s Best Friend?

The Federal Reserve’s recent commitment to keep interest rates low the next two years delivered a surprise gift to real estate investors. This policy to keep both short and long term rates low has eliminated the threat of higher borrowing costs and thus, reduced pressure for sellers to lower prices to provide higher returns to compete with higher risk free rates.

This pricing support has come at a much needed time for many investors holding properties that are just starting to recover from the great recession, and concurrent drop in valuations. With CAP rates continuing to drop along with interest rates, sellers are finding some demand at lower CAP rates then the recent past. This is underpinning valuations for all commercial real estate.

Most economists had expected the Fed to slowly raise interest rates in 2012, which would have forced real estate sellers to lower prices, weighing down commercial valuations across the board. The surprise announcement that the FOMC would keep the federal funds rate at between 0 and .25% until mid-2013 removed this uncertainty.

But is it a good thing? On the surface, most experts agree that this effort by the Fed will help keep commercial real estate values from dropping further, and may spur a gradual increase in valuation. Some, however, fear that buyers of class A properties in strong markets will overpoay, and start new asset bubbles in select markets.

What everyone does agree on is that this latest move by the Fed will support Commercial real estate transaction activity through 2013.