When Cap Rates Are Lower Than Interest Rates 

Excellent education...thank you...I was stuck!

@10th grade drop out Good point and that's one of the reasons why he used an example without financing. I mentioned in a comment above that this advice about rent appreciation is only specific to multi family. It would not work for another asset class like STNL &MTNL.

@@blessed7fold What is STNL & MTNL?

@@RandalColling Single Tenant Net Lease/Multi Tenant Net Lease

@@blessed7fold My commercial leases have incremental increases per year.

This is why he mentioned creative financing like OWC at say 4.5% using his example or a master lease agreement....the point being you need to work the numbers and exit strategy and if the CAP rate doesn't then adjust your offer valuation too because no matter what the comps say, it is only worth what makes the most business sense and if there is no win win, move to the next deal....it is only limited to the negotiating parties skills...

Cap rates rarely increase. Over the past 20 years, it's very hard to find an increasing cap rate area just about anywhere. One possibility would be an area that completely collapses due to a freak situation, such as if what happened to East Palestine Ohio due to the train derailment contamination. If an area suddenly went from thriving to struggling, then it's possible for the cap rate to drop. But so long as you choose your areas wisely, the likelihood of a drop in cap rate is slim to none. Even during COVID cap rates didn't drop, despite a global pandemic. Sure, cash flow is very helpful, but it's not always as essential as you may think.

@@CommercialPropertyAdvisors Cap rates go down during good economies and go up during bad economies. The last 10-15 years have been strong, so we've seen cap rates come down for several years, but a recession could push rates back up towards historic averages.

@@CommercialPropertyAdvisors But Cap Rates do change, Many areas that I have looked at from 2018 until 2021 were 7 cap areas, then as interest rates were still dropping "seems all the sudden" the same 7 cap areas were 4.5 and 5 caps even the commercial properties such as the Auto Zones, Wal-Greens, etc are still low cap 5 with not much time on lease. The multifamily that were 7 caps now trading with low interest rates "3%" started going to 4 Caps and either not cash flowing or very little. Now as Interest rates and cap rates now increasing "interest rates 6%" and cap rates still low but must start coming back up will wipe out any equity increases these investor had buying these non-cash flowing deals. When time to refinance these loans "5 to 10yrs", with these higher interest rates and cap rates will make the asset price drop in value and be very hard to get financing on a property that may only be worth 75% of the original value. The property must CF in most cases at purchase or soon after or I believe the investor is sitting up for failure. Even the CF can be wiped out by increasing cost but that is inflation and why rents must increase. Lots of investor are buying without cash flow or very little the must be very careful, but seems that is who we are competing with these days. Thank You very much for the response.

​@Commercial Property Advisors What happens when the risk free rate of return rises much higher then cap rates? Who wants to invest in lower yielding investments and then take a lot of risk on top of that?

In most markets in US for multi-family, I wouldn't bet on cap rates going up.

Yep. 5% per year is ridiculous!! Very optimistic assumption. That's where this video misses the mark and goes off the rails. I love Peter, but we have to be more conservative. 3% a year would be more realistic and even then rents are flatlining or even starting to fall in many markets. You have to be careful.

​@TheHvk Before the 'Great Inflation' hit us 5% rent appreciation was conservative but like you said rents have been raised so much in the last 12-18 months that there is no spread left in most multi family markets. Rents are going to go flat if not fall at some point. This information is not up to date with where markets are right now.

Rising rental rates are ultimately a function of supply and demand.

I agree, my question is what was the value add for the tenants to justify a 5% per year rent hike?

Thank you for watching!

NOI is Net Operating Income and is calculated BEFORE Debt Service

@@CommercialPropertyAdvisorsYour a great teacher! It’s easier for me to learn from people like you. I wish my teachers in school provided thorough step by step explanations like you.

They account for it upon purchase with a plan as to the break even point or when they will exit.

They do, the best way to find out are large brokerage firms. Cap rate measures what investors are willing to pay for an NOI. So you need to know how much were properties sold for. Or you can pay for Costar but that's too expensive just to find 1 answer😂

Both husband and wife must work and no more than one child per household. The only way to make it in today's economy. Otherwise the homeless and drug addiction trend will continue to grow.

The lower the interest rate, the higher the cash flow because the debt service is lower.

Good question! I explain that here: www.commercialpropertyadvisors.com/commercial-real-estate-terms/#cap

Well said! These were our thoughts exactly. Nothing was said about the multiple years of negative cash flow. Elephant in the room.

Yes, this $2M example would have negative cash flow if 30 % down at 6% over 30yrs, WHY would anyone want to have a negative CF as an investment I can do that in the stock market or 401K. Buy good deals with a positive CF, remember the deal need to work for you as the investor and the seller or it is just not a deal!!

Great point guys. This is why he didn't want to include financing in his example.

The video would have had to be double in length to handle the cash flow break even point, etc. This was a simplified example of a multi-family deal to illustrate how you can intelligently invest when cap rates are lower than interest rates. Typically, the investor must account for the early negative cash flow at the time of purchase if their plan is to own long term. Multi-year negative cashflow is rarely sustainable.

@@CommercialPropertyAdvisors I fine trying to keep videos a reasonable length but it seems like a some mention of negative cashflow was warranted. This wasn't the point of the video but is still an important consideration. Maybe even mention as a teaser for a follow-up video :) Based on some rough numbers, negative cashflows could last 7-12 years which is a lot longer than most investors can stomach. And I'm probably coming across more harshly than I intend. I appreciate your videos but I think this one missed a really important point that could completely change the main conclusion of the video.

I'm seeing rents increased due to migration from the bay area.. Just depends which counties you're looking at..

@@davidferro6773 Rents are softening even in markets that have done great the last couple years. There will always be some markets that go up, but we're likely seeing a national-level decline in rents. This decline may not last long but that's hard to predict.

Rising rental rates are ultimately a function of supply and demand.

​@@CommercialPropertyAdvisors And the WSJ reported this week that "rents fell in every major metropolitan area in the U.S. over the past six months through January, a trend that is poised to continue as the biggest delivery of new apartments in nearly four decades is slated for this year". So definitely not clear how much rents will be able to increase for the next few years. Obviously not all markets and properties are equal though, so I'm sure there are still viable deals.

@@mikedulrich Class A luxury apartments have experienced some changes since that is what builders are building. Our world of investing is Class B and Class C apartments, the sandbox we play in, continues to have strong demand and limited supply.

Commercial Real Estate Investing for Beginners (www.commercialpropertyadvisors.com/book) is a great fundamental text on the subject. My videos provide wisdom above and beyond that book.

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