RE: Income properties – residential multifamily properties.
When someone tells me they are looking for a 10 CAP deal I always cringe. Then I weigh the effort to educate them verses the potential of a deal. It is almost as tough as explaining why great commercial and multifamily deals in my County are hard to find and harder to see at a glance. To make it worse, most MLS listings claim an incorrect CAP rate, and are based on proforma incomes and incomplete expenses.
The first thing CAP rate totally misses is the cost of money, which is historically low. It doesn’t factor in the cost of borrowing. Now, if they say they are buying cash…the job just got harder. Why someone would use cash when they can borrow at a rate substantially lower than their rate of return on every dollar is another issue.
Secondly, what buyer's really want is a consistent and predictable cash-flow, a good rate of return on cash invested and a reasonable opportunity to improve returns over time and therefore gain appreciation over years.
The major contributors to this “perfect” investment (in no particular order) are building condition, suitability to the planned use, neighborhood, vacancy rates, market conditions, scarcity (hard to replace) and cost of money. This may well lead our buyer to see that a lower CAP rate is in fact a much better purchase.
I will use Whatcom County as an example to make this point. Whatcom has a strong market for multifamily and commercial properties. It has not been overbuilt and boasts steady employment. Bellingham proper benefits from Western Washington University. Proximity to Seattle and Vancouver BC also contribute to a healthy economy.
- Multifamily Cap rates range from 5%-8% and rentals range from $.70 the 1.70 per foot. The lowest CAP rates are near the University and running 5.5-6.5%. This area is densely populated with few opportunities for new construction. Vacancy rates hover near 0%, buildings are generally well maintained, annual rent increases are common, and leases are annual with parental guarantees. Waiting lists are common and risk is minimal.
- In outlying communities multifamily CAP rates are higher and rents are lower per foot. The demographic changes to family and units are larger, while density is also lower. Vacancy rates are slightly higher but still under 5%. The average CAP for good properties with most of the right qualities is about 7%
Higher CAP rates than those above, in our County, usually mean poorer locations, substantial deferred maintenance, and occasionally bizarre income proposals. Trailer parks, cabins in the woods and mixed properties (homes and other residences on the same lot)rents by the room etc. Invariably these properties have hard to verify income and expense, sketchy histories and serious occupancy issues.
The old adage that “if it looks too good to be true, it likely isn’t” applies in Whatcom County. If you are looking for a good multifamily investment Whatcom County is a great place. If you are looking for a 10 CAP be ready for an earful and watch your wallet.
This blog doesn’t deal with flipping or rehabbing properties because the rate of return is invariably poor and the risk not for the dispassionate investor. Flipping and rehabbing is a hand’s on effort and fast appreciation is the only reasonable goal.
Post your thoughts and questions! Make it a great Day!
Doug Foster - Feb 2014 360-920-1114