How Important are Cap Rates?

7 Active Real Estate Investor Opinions on the Importance of Capitalization Rates

The capitalization rate (or cap rate) is a specialized aspect of real estate investment. That’s why I posed the following question to several leading real estate investors: How strongly do you consider cap rates when evaluating deals?

Here are seven active investors’ opinions on how important capitalization rates are in real estate investing:

  1. Ryan Groene said “I like to treat (cap rates) like I treat my trash . . . it normally ends up in the garbage.” As a value-add manufactured housing investor, a deal with a low or even negative in-place NOI doesn’t have a cap rate that translated into other important metrics like cash-on-cash return, internal rate of return, debt, and capital required. However, he says that cap rates are more important on the sale of the property. He bases the exit cap rate on the historical cap rates for manufactured housing, which is between 8% and 10%. Overall, he cares about cap rates, but it will not stop him from investing in a deal with a 1% cap rate if the terms are great and he hits his desired returns.
  2. Garrett White is of a similar opinion. He doesn’t place much emphasis on in-place capitalization rates in real estate deals (i.e., the cap rate based on the current net operating income), because, depending on how much value-add is present, he can buy a property at a really low cap rate and still make it a solid deal. Cap rates mean the most to him on the exit. To determine the exit cap rate, he looks at the range of the historical cap rates rather than the 10bps per year expansion rule that is common.
  3. Elisa Zhang only considers the entry cap rate in order to compare it to the exit cap rate. For most of her deals, the exit rate is set to be at least 1.5% to 2% higher than the entry market cap rate of similar deals in the same submarket.
  4. Tyson Cross also agrees with Ryan, Garrett, and Elisa. He said that the capitalization rates in real estate is one of the most misused metrics in commercial deals and is widely thought of as the standard for measuring properties. In reality, the importance of the cap rate is varied based on the property type and location, and you should put more emphasis on the cap rate upside after executing your business plan (i.e., the exit cap rate or cap rate at refinance).
  5. Todd Dexenheimer also believes that the cap rate is a misused metric, but for opposite reasons. To him, cap rates have been downplayed in the current market and are very important when the market shifts to a buyers’ market. Commercial real estate is generally valued based on cap rates, so he says that not considering cap rates when evaluating deals is a mistake. With that said, he also added that you need to factor in many things when looking at a deal and that a good deal varies from investor-to-investor based on their personal goals. These important factors include cash-on-cash return, cash flow, internal rate of return, debt service coverage ratio, the overall business plan, market factors, and the likelihood of being able to achieve the projected results.
  6. Ash Patel also believes that cap rates are important, specifically on non-commercial real estate that is fully leased and triple net leases. If the non-commercial real estate is partially vacant, the cap rate should reflect the current occupancy. For gross leases and value-add, cap rates should be considered more of a benchmark.
  7. Gwyeth Smith, who admittedly is just starting out, fell somewhere in the middle. He understands capitalization rates in real estate shouldn’t be used as the only factor to qualify a deal, but it still has its uses. For example, he used the cap rate as a negotiating tool on a recent deal. However, the most important factor to him is the debt service coverage ratio, because if the deal meets Fannie Mae qualifications, it validates his underwriting to a certain extent.

If you’d like more information regarding entry and exit cap rates, the best real estate investment strategies, and so much more, tune into the Best Ever Show daily!

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Overcoming 6 Obstacles Faced by Aspiring and Growing Real Estate Investors

Anyone who has looked into investing in real estate has found that there are frequently investment barriers that must be overcome. I am often asked: What is the biggest obstacle you faced either when you started investing in real estate or as you grew your business?

This is such an important question that I reached out to some of the top investors in the field to see what they had to say.

1 – Tracking Passive Investors

Allison Kirschbaum is an established real estate investor who is trying to scale her business. The biggest investment barrier is keeping track of all the new investors her company meets without having them fall through the cracks.

There are many CRM providers who offer tracking services, but they can be quite costly, especially if you are just starting out. That’s why I created my very own investor tracker, which I am willing to give out FOR FREE. Not only does this spreadsheet allow you to keep track of potential and current investor information, but it also automatically creates data tables to track the cities with the most investors (in terms of people and dollars) and the sources that generate the most investor leads. You can even use this tool for tracking the money raising process for a specific apartment deal.

If you are facing a similar obstacle as Allison, email info@joefairless with the subject line “Money Raising Tracker” to receive my custom investor tracker spreadsheet.

2 – Finding Deals in an Expensive Market

Two investors are finding it difficult to locate qualified deals in their local market. Sarah May lives in the highly competitive Denver market, and Killian Ankers also lives in an expensive real estate market. Both are open to start investing in real estate in an out-of-state market, but among their investment barriers would prefer to remain local, because they know their home markets like the back of their hands.

My company faced a similar obstacle in 2017. My target market is Dallas, Texas, which was and remains highly competitive. Our solution was to get creative. We found an on-market opportunity that was highly publicized and marketed by a broker, which resulted in an ever-increasing price. Instead of walking away from the deal, we had our broker reach out to the owner of the apartment community across the street, and we were able to negotiate and put the property under contract at a significant discount! If we had only purchased the on-market opportunity, it wouldn’t have made financial sense. But due to the cost-saving associated with purchasing two apartment communities on the same street, we were able to close on both.

On the other hand, if you do decide to pursue investment opportunities in a market outside where you currently reside, finding credible, experienced team members is a must! This process begins by selecting and evaluating a market, and then interviewing and hiring a property management company and a broker.

3 – Shiny Object Syndrome

Micki McNie is facing an obstacle to which everyone can relate – focusing on a single real estate strategy. Shiny object syndrome befalls investors of all experience levels. The near infinite number of potential investment strategies can paralyze an aspiring investor. Then, the longer you’re in the industry, the more people you build relationships with, which naturally results in being presented with a greater variety and volume of new and exciting investment opportunities.

How does the aspiring investor decide which investment strategy to initial pursue to avoid investment barriers? Well, I think you need to identify the root of the problem first. Are you truly struggling with selecting the best investment strategy or are you just using that as an excuse to not take action? If it is indeed the former, pick the investment strategy that aligns most with your current interests and unique skill sets and show up EXTRAORDINARY, always keeping in mind that investors have had success in every investment strategy for the past 50 years! If it is the latter, you need to learn how to identify and crush your fear barriers!

How does the established investor overcome investment barriers and avoid chasing after opportunities that are outside of their skill set? Accountability! And if you’ve found that holding yourself accountable is a challenge, outsource that responsibility by either starting a meetup group (social approval is a powerful way to keep you on track) or hiring a mentor.

4 – One Person Team

Neil Henderson has hit a barrier in growing his business because he’s trying to wear too many hats at once. He’s a loyal employee at his full-time job, father, husband, underwriter, marketer, capital raiser, negotiator, and thought leader. Similarly, Vince Gethings struggles with finding the time to operate his business as he adds more units to his portfolio and balances his remaining time between family and work.

Whether you want more time to explore other non-real-estate-related passions or spend more time focusing on the long-term vision of your real estate business, the way to overcome investment barriers starts with outsourcing and automating some or all of your business, in addition to building a solid, trustworthy real estate team.

5 – Us!

Curtis Danskin believes that the number one obstacle keeping real estate investors from starting and scaling their business is themselves! They know what actions they need to take, but – for whatever reason – chose not to.
To overcome this challenge, identify the self-sabotaging behaviors in which you are partaking and implement strategies to rid ourselves of these bad habits.

6 – No Experience or Money

Scott Hollister just got his start investing in real estate lacks the experience, net worth, and liquidity to enter the real estate arena. He’s already identified a solution, which is pursuing seller financed deals, but doesn’t know where to get started. In particular, he doesn’t know how to find seller-financed opportunities.

Fortunately, success leaves clues. Here’s how an active real estate investor was able to close on seven seller financed deals.

Another strategy for those whose primary investment barriers center around lack capital is house hacking, where you purchase a two to four unit property with a low down payment owner-occupied loan and live in one unit while renting out the others.

Do you need help overcoming obstacles? Whether you’re just getting started or you’ve been in the biz for years, consider applying to my Private Real Estate Program and take the next step towards financial independence.

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Joe Fairless