How does buying overpriced apartment buildings make sense?
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[{"id": "ggu1odu", "text": "Forward rent growth, but yes there\u2019s a ton of overvalued shit out there.", "replies": [], "depth": 1}, {"id": "ggu1w0y", "text": "Like you said, cap rate doesn\u2019t account for capital structure of deal leverage might alter return metrics. Maybe it makes sense from a building appreciation standpoint since that is also a factor in an investor\u2019s return\n\nThe argument between private/public real estate has been around for some time. Honestly think it\u2019s just a matter of preference even though there are some interesting papers out there that argue private real estate investments underperform on a risk-adjusted basis compared to public RE\n\nEDIT: less abstract- your building may be a 2-3% cap currently but that may be because they\u2019re expecting rental rev and building appreciation in the future. Someone else more experienced in MF can chime in", "replies": [], "depth": 1}, {"id": "ggu29tk", "text": "At a certain point you start thinking in decades. It may seem over valued now but a lot of rich investment groups just need somewhere to park their money and ultimately use for tax purposes. \n\nLike my mentor says, there is real estate and then there is REAL estate.", "replies": [{"id": "ggxgzhl", "text": "Someone get this guy a job at blackstone", "replies": [], "depth": 2}], "depth": 1}, {"id": "ggu2f7c", "text": "How do the REITs get the same income and returns? The REITs are buying the apartment buildings.", "replies": [{"id": "ggu742b", "text": "Someone smarter than me please answer this. I'd like to know too.", "replies": [{"id": "gguiby2", "text": "Me three", "replies": [], "depth": 3}], "depth": 2}, {"id": "ggukcst", "text": "They typically offer less return than buying directly. The investor gets liquidity and hands off work. I imagine most people here still enjoy the direct hands on process so the premium isn\u2019t worth it for REITS", "replies": [], "depth": 2}], "depth": 1}, {"id": "ggu42ck", "text": "Depends on where you are starting from.  If you have ten's of millions in the bank, then 2-3% return in the short term works.  The goal is to preserve wealth.\n\nIf you have some money and need back financing, like many of us, those returns are unacceptable.  The goal is to grow wealth.\n\nAll depends on your starting point.\n\nPlus, there is also a lot of dumb money jumping into real estate these days.", "replies": [{"id": "ggu7b5o", "text": "Concur 100%. In world of small multifamily and duplexes, dumb money, much of it made in Tech Sector, is driving up prices paid. \n\nAt other end of spectrum at the highest end of multifamily cost wise, its the really smart people, mostly parking money in a safe asset at a very crazy time.", "replies": [], "depth": 2}], "depth": 1}, {"id": "ggu540d", "text": "1-3% cap rate + 1-3% rental income growth + 1-3% property value appreciation\n\n= a nice long term stable return", "replies": [], "depth": 1}, {"id": "ggu5ptc", "text": "I am one of the guys who buys the sub 4% cap rate buildings in Canada. \n AMA", "replies": [{"id": "ggu7ev7", "text": "Why d you do it?", "replies": [{"id": "ggurtxq", "text": "If I buy something at a 3 cap as is but rent is 50-75% under market the value add is crazy. I don't care about current value, I care about post renovated/ stabilized NOI.", "replies": [{"id": "ggut3qm", "text": "Very good albeit situationally specific point.", "replies": [], "depth": 4}, {"id": "ggvkib0", "text": "I\u2019m curious why your sellers aren\u2019t just pricing in the value add in. As in instead of selling to you at a price based on an in-place 3% cap (with under market rents), sell to you at a proforma 3% cap (assumes market rents). Therefore much higher price. That\u2019s the favorite game of sellers in my market (major US east coast MSA) and there\u2019s so much money here chasing every deal, buyers will go for the proforma 3% cap. I\u2019d be interested to know in what markets there are still true value add deals w/o all value add already priced in.", "replies": [{"id": "ggw2zrr", "text": "What size asset class are they doing this on? \nKeep in mind our value add is not cookie cutter, we generally spend around 25-35% of the building value in renovations then need to spend weeks and months negotiating cash for keys in a very tenant focused province so,luckily for the ones who can create the value, there is no real ability to sell based on future projected rent since you're not \"supposed\" to be able to get there with the current tenant base. \n\nKeep in mind also our financing environment, although rates are a joke, is purely balance sheet driven so it isn't rare for me to get 50% LTV on the way into a deal then have to source money for soft and hard costs. Again same as before, horrendous on the way in but man does the cash out refi, when it works, hit oh so good.", "replies": [{"id": "gh1s31e", "text": "Gotcha. Mostly referring to class B+/A- multifamily. I really wouldn\u2019t call it value add, but the sales brokers market it as such which is the root of my question. They call everything besides brand new trophy construction \u201cvalue add\u201d to sell the dream of pushing rents and adding value. To basically sell for more than existing financials would support. \n\nSo to your point, yea sales brokers in my market will say \u201cvalue add\u201d and just mean the very cookie cutter minor renovations and pushing rents as leases roll. Honestly a sales ploy more than anything as rents never seem to increase at the rate the OM proformas suggest haha. Just doing their job to sell  the building for $55mm instead of $50mm because they convince yield hungry buyers they should underwrite based on adding value, even if there\u2019s very little to add. \n\nSounds like you have robust strategy that actually does add value in a way other buyers aren\u2019t able to... which gives you a unique advantage. That answers my question. Thanks!", "replies": [], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "ggu5rcv", "text": "Diversification - real estate is often looked at as a hedge against inflation, even if going-in returns are low.  Most pension funds and endowments are required to own a % of real estate, and multifamily is typically seen as pretty safe amongst peers.\n\nScale - it may be a 2% cap now, but perhaps the buyer has its own management company or some other path to expense reduction.\n\nRisk - as 2020 has shown, multifamily is one of, if not the most risk averse asset class compared to its peers over time (office, retail, land, etc).  People will always need a place to live.\n\nWealth preservation - the folks buying 2-3% caps aren\u2019t buying to get rich, they\u2019re buying to preserve the wealth or capital they\u2019ve already accumulated.\n\nThe easiest answer is because the demand is there, and that\u2019s what investors have to pay to win the deal.", "replies": [{"id": "ggu7len", "text": "I think this answer belongs on top. I forgot about inflation boogeyman. All you young redditors in the RE game - no biggie if you aren't familiar. Just wait.", "replies": [], "depth": 2}, {"id": "ghyy1nn", "text": "Is it really the lowest risk asset class anymore though?  I think that depends on what state you live in.   I would say medical trumps any residential SFH or MFH and there are numerous industrial segments that can be extremely lucrative with low(er) risk.", "replies": [], "depth": 2}], "depth": 1}, {"id": "ggu99vy", "text": "A few years ago I used to buy buildings between 2.5% and 5% cap rates. These were distressed buildings in NYC. The mortgage was usually around 4.5% so initially they were losing money at the beginning. We would then flip the entire building (this would entail vacating the entire building through evictions or buying Tenants out) and then we would gut renovate the entire apartment (sometimes add a bedroom)(stainless steel appliances etc). Then we would move new Tenants in and triple or quadruple the rent roll which would in essence triple or quadruple the value of the building. Then do a refinance and just cashflow. Keep on doing this and you have a nice portfolio. Obviously, things had to change when they enacted the new rent laws last summer.", "replies": [{"id": "ggubj3q", "text": "Good luck evicting anyone in Ontario if they're paying rent. Leases automatically go month to month (at option of tenant, not the landlord, so you can't give a simple 30 day non-renewal) by law. \"No pets\" clauses are unenforceable. Security deposits are illegal (last month's rent is ok). Etc.", "replies": [], "depth": 2}], "depth": 1}, {"id": "ggubz1s", "text": "Simple:  in Canada you can get a 10 yr CMHC mortgage for 1.9%.  That\u2019s fixed for 10 years.\n\nAt a 2.5 cap that\u2019s a 0.6% margin in the first year.   Over 10 years rent will increase by inflation at minimum and there is an excellent chance several of those years inflation will surpass your mortgage rate.\n\nThen there is rent increases when units turn over.", "replies": [], "depth": 1}, {"id": "ggui5qa", "text": "I bought my first 3 multifamily building 8 years ago at like 30 CAPs,  yes 30. then its slowly gone down, can still make 8caps work, but yes I assume rent growth.", "replies": [{"id": "gguspr1", "text": "What the heck. My brain can't even understand what a 30cap is...you're paying basically 3 years NOI? Or like 2x gross revenue? How does that even work and what type of asset is it?", "replies": [{"id": "ggwh9ap", "text": "Nobody is buying anything at a 30 cap.  This is just bad math.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "ggul2qp", "text": "I was told by an old brokerage vet that during one of the runs in California, appreciation was expected to be so good that people were buying them stabilized a negative caps. Hold it, take the loss on taxes, and re-develop when everything could get ironed out.", "replies": [{"id": "ggwgyv2", "text": "Cap rates are not a return and there is no such thing as a negative cap rate.", "replies": [{"id": "ggx8tt1", "text": "A Cap Rate is a ratio. Ratios using integers (which are of course both positive and negative) can be positive or negative. If you buy a property with negative cash flow, you will technically get a negative cap rate as a result (property is losing $25k, bought for $500k, -5% Cap; -25/500 = -.05). Granted I should have said \"fully occupied\" rather than stabilized.", "replies": [{"id": "ggxbxrq", "text": "You are confusing what cap rates measure.  They tell you what investors are paying for NOI.  The calculation starts with PGI, potential gross income.  A vacant building has a positive PGI.  A property can have negative cash flow but still sell at a positive cap rate.  A 1% cap rate means investors are paying $100 for each possible dollar of NOI.  A .1% cap rate means that same dollar of NOI is selling for $1,000!  In your example there is no dollar of NOI so there is no cap rate.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "ggun12j", "text": "Debt is 2% so you\u2019re getting 150-200 bps spread. Vacant spec office buildings in Paris and Munich sell for 2-3% (proforma)... because there\u2019s still a \u201cdecent\u201d spread over negative government bonds.\n\nThere\u2019s a fuckton of money looking for yield.", "replies": [], "depth": 1}, {"id": "gguon43", "text": "Rates are low, that means margins on old rent is high compared to where it should be. Someone gets jacked.", "replies": [], "depth": 1}, {"id": "ggusraq", "text": "Often it's pension fund money, so 70year time horizon. Or insurance companies. \n\nGetting out of cash in an inflationary period (now, given the flood of printed money) is the objective.", "replies": [{"id": "ggvl2yd", "text": "This is the prevailing reason in my understanding. Institutional investors are the whales and the ones buying these low yield deals. They have so much capital and they simply have to deploy it. They can\u2019t put the money under their mattress (or overweight into \u201cgrowth\u201d stocks). So there\u2019s just so much capital chasing every deal, pushing prices up. Meanwhile in such a low yield environment, a 2-3% in-place ROI on class A real estate sounds pretty good for their long investment horizons.", "replies": [], "depth": 2}], "depth": 1}, {"id": "ggv8y44", "text": "Socialist countries like Canada restrict commercial activity which causes shortages and thus increased prices.  \n\nIt's grade 4 math, but most Canadians are either comfortable or gullible, and they vote in politicians who promise them that Daddy guvmint will give them everything they need including UBI spending money.\n\nTake a look at the taxes and government fees on a  new 1-bd condo unit, it's well over $100,000. That doesn't include if your building has to provide 20% of the units at a significant loss to \"below market\" residents, in which case add another $60,000.  \n\nIn general Canadians prefer to pay higher taxes than let fellow Canadians provide the resources they need.  It's weird but great for real estate investors.", "replies": [], "depth": 1}, {"id": "ggwi5uc", "text": "Crazy that someone writing about real estate doesn't have a grasp of basic terms.  He stated \" Cap rates, as they are commonly known, are the rate of return owners expect to earn on a property,  \"  What an idiot.  Cap rates come from an income approach to value called direct capitalization.  Cap rates are not a \"return\" metric.  You can buy at a 3 cap and have better returns than a property bought at a 9 cap in another market.", "replies": [], "depth": 1}, {"id": "ghb0z0s", "text": "I see, it is Canada. You guys are having the same issue as us in Miami. It is foreign capital. People in the \"third world\" or in places where the rule of law can be \"very flexible\" and the economy can change drastically prefer big city markets in countries with strong economies and property rights. Many people do not trust reits because they literally need something that they can touch and feel in control.\n\nTL;DR foreign people do not trust their gov/currency and they do what we perceive as shitty real estate deals. Do not buy, rent.", "replies": [], "depth": 1}]