How do you know if you’ve fallen for the bait of high cap rates? Hint: Take the hook out.
Transcript: Hi this is Jeff Brown the “Bawld Guy”. Today we’re going to talk about cap rate. What’s cap rate? It stands for capitalization rate. What that means is you simply take the net operating income of your property. What net operating income is, is what’s left after all vacancies and all, every dime of expenses, is taken away; that’s net operating income, has nothing to do with any loan payments you have to make. You make loan payments from net operating income. Hopefully, net operating income is a bigger figure than your total of payments every year. So, cap rate is defined as taking your net operating income, we’ll just call it NOI, and divide it by what you paid for the property. So, if you have a $30,000 a year NOI and you paid $300,000, your cap rate is 10%. Another way to look at it is if you paid $300,000 cash for the property, your cap rate is exactly equal and synonymous with your cash-on-cash return. Cash-on-cash is the dollars that come into your hand divided by what you put into the property in cash. Sometimes that cash is down payment and closing costs, sometimes that cash is you just wrote a check for the property and add some closing costs. So here’s what we’re going to do. We’re going to look at why I tell people stop being infatuated with super-high, double-digit cap rates. Let’s take a look at the number one reason. Why are cap rates high on residential income properties, especially the ones I like most which are one to four units? First of all, if you have a cap rate that’s 13 1/2% you have to ask yourself why it’s been on the market for ninety seven days? Are you the only brilliant investor in that zip code? No, you’re not. The smart investors passed on it because it’s a dog. High quality properties don’t sell for double-digit cap rates. Don’t let anybody tell you they do. I’ve been around for forty three years and the next one I see that’s very well located, and very well located means I’d put my eighty three-year old mom to live it in alone. That kind of sets the bar, right? You don’t find those with 10 to 15% cap rates. That means you have to buy high-quality neighborhoods. You’re not going to build your wealth on average and below average neighborhoods. You’re not going to build your wealth for retirement on bad quality neighborhoods. Stop thinking you are. It’s a pipe dream. The books lie. They don’t tell you what they’re putting up with. They’re putting up with poor quality tenants, higher vacancy rates, and, oh, by the way, when they finally do a spreadsheet after their first three years of ownership they found out that that 15 cap was actually 9.3 because their expenses were way higher, their vacancy rates were way higher not to mention the wife has threatened to leave him if they don’t get rid of it. Now look, I’m not trying to be a downer here, but stop worshipping at the altar of high cap rates. Start worshipping at the altar of super high quality buildings, high quality locations, and anything that attracts high quality long-term tenants. In the end, you’ll come out ahead of the people that fell for the bait of the high cap rate that was a myth anyway. My name if Jeff Brown. I’m The BawldGuy. Thanks for joining me today. I’ll see you next time.