The equity stack for our next purchase is over-subscribed. I can take a minute to collect my thoughts. This will be short and to the point, but hopefully, you’ll get value!
Three Advantages of Low Cap Rate Markets
The Cap rates are compressed all across the country, as you know, as they have been. When the interest rates came up about a year ago, the cap rates did not inflate. Now that the interest rates are coming down, the cap rates are not compressing meaningfully. It seems we’ve found a baseline where relative to the fundamentals, the cap rates are “happy”.
The cap rates have been low, are low, and my guess is that they will continue to stay there.
There are those who complain about it. Personally, I love it, and there are 3 main reasons as to why:
Reason 1: Low Cap Rates Are Hard to Underwrite
Most investors don’t know how to underwrite low cap rates. This creates an unfair advantage for me 🙂
Reason 2: Cap Rate is Low for a Reason
Cap rate is a measure of market sentiment. The more people pay for the NOI, the lower the resulting cap rate. By definition, therefore, a low cap rate is indicative of high sentiment.
What drives sentiment in investing? Two things – safety, and returns.
Question: Why would you want to invest anywhere else? Is it the safety that bothers you, or the returns? Cause, I am Okay with both…I love knowing that I am in a top-tier market!
Reason 3: Equity (and Cash Flow)
You are probably saying to yourself right now – what returns?! There is no cash flow in a 5% Cap market…
My response to that is two-fold. First, people going to such a market don’t need cash flow. These folks already have more money than they know what to do with, and they are primarily looking for safety.
Secondly, you are not one of them. So, you buy assets at 5% Cap, which you can improve to a 7.5% Cap, at which point two things happen. One – you can cash flow 7.5% Cap just fine. And two – you’ll sell to one of the folks in the first category at 5% Cap, and make a huge margin.
Buyers want safety and stable returns. I want buyers when I am ready to sell, the more the better.
Low cap rates scare a lot of people away, which creates an opportunity for those of us who learn to capitalize on such an environment.