CAP rates in different locations?


#1

How do you all figure out what the going CAP rate in a particular location is? If I am looking in Indianapolis vs Chicago, should I be looking for an 11-cap no matter what?

I know outfits like Costar list CAP rates per area but for those of us without Costar accounts, how do you figure out how to capitalize NOI when making an offer?


#2

In response to your first paragraph’s questions:

I am of the opinion that what you should be focused on is how much value you can bring to a park through increased NOI, and what your return will be after you do so if you wish to keep it.

How do you increase NOI? Lower expenses is one way - but that is kind of weak in all but extreme cases. And it is just as likely that the seller has lower expenses than you will if he has not been taking good care of the property.

So what is better then lower expenses? Raising rents and filling vacant lots. That is where the big money is and what you should be looking for. Read SDGuy’s first post in the “Live Like A Multi Millionare” thread. Most likely when he bought his CA park it had a low cap rate. He used the figure 6% in his post but did not say that is what it was at purchase, but at any rate, CA cap rates are kind of low. But he did a $200 rent increase. Run the numbers on that and your calculator will display “Wow!”

If your plan is to improve a property’s NOI, sell it and then move on, actually a lower cap rate market is better. That seems kind of counter intuitive until you realize that every dollar of added NOI you bring to the property, is worth more in a low cap rate market then in a high cap rate market.

Example: a $10,000 boost of NOI is worth $166,666 in a 6% cap rate market, but only $100,000 in a 10% market.


#3

Hi Mike, that’s a great question. Randy’s comment is absolutely a consideration with cap rates. I would pay a lower cap rate for a deal with upside than a stabilized deal. For example, I’m negotiating a price right now where the going-in cap rate in Wisconsin may end up being in the 6% - 7% range, however right-sizing rents and improving delinquency should bring the unlevered yield to 12/13%, if not higher.

I think it’s unrealistic to expect to buy deals at 11 caps in this marketplace, too many investors are chasing deals, unless you’re using proforma NOI. My personal benchmark for Wisconsin is high-quality, stabilized, non-institutional quality/sized deals are going to trade for 7.5%/8% cap rates, and I make adjustments for the market, deferred maintenance, quality of the park on top of what I mentioned earlier, upside. This could partly be because I’m finding expense ratios to be higher than the quoted 30%-40% you’ll hear all over this forum, especially after factoring in reassessment of real estate taxes (e.g. the park I mentioned earlier is assessed at ~$40,000 and the park will sell, and likely be reassessed for at least 8x that). Over the next 12 months, my cap rate benchmark will likely increase though as interest rates push higher. Jerome Powell announced he expects to increase the fed funds rate 4x this year.

Hope this helps, let me know if I can answer anything else!


#4

Low expenses means deferred maintenance.

Today I was investigating a park I valued at $X. It is expected by the listing broker to trade at 240% of X. The trade value is based on $20k per POH plus 6% cap rate on pro forma 35% expense ratio on lot rent only. These are not numbers that I can make work even if they are true (and they are no doubt wildly optimistic).

I estimate the eventual buyer will be lucky to make any money at all over the first 5 years, after which it may be a home run who knows. But for the risk involved, I am not going to mess around with it.


#5

I also find this true.

The cap rate is a guess at the expected return based on the size of the investment. But it is not all about return, it is also about risk. If the park is stabilized, it will trade at a lower cap as there is less risk and aggro involved. Or, to put it another way, parks with bigger warts trade at higher and higher cap rates because investors, smart investors, demand higher returns for dealing with bigger warts, all else being equal…


#7

Thanks all for the insightful replies.

Randy, you make a great point that if the plan is a turnaround as opposed to a buy-and-hold then a low cap rate might help more than hurt. That’s not something I had considered previously. Although it’s attractive to keep “hold” as an option when going in, that perspective certainly helps more markets make sense to me.

It’s also interesting to hear that the expected 30-40% expense ratio isn’t holding for everyone here. Brandon, 2.4x above where you thought you could make money? Sounds like California real estate to me… :slight_smile:

Wisconsin, indeed I think it’s wise to be concerned about the collision of cap rate compression and rising fed rates. Thanks for sharing the kinds of rates you’re working with out there.

Tony, thanks for all the great content you put out. I believe I watched your cap rate video a while back and IIRC, my takeaway was there are no easy answers.

I appreciate all the insights and would love to hear more about what people are seeing and negotiating out there.

Best,
Mike


#8

Cap rates aren’t all that important, in my opinion. Total return on investment over 5 and 10 years is more important, whether expressed as IRR or simple ROI. But to me, cash on cash return is most important, as I don’t plan on selling any parks. I’m looking for a 15-20% CoC in year 2 going forward.

  • Note that you should use a higher “selling” cap rate than the buying cap rate you pay. This protects you against values decreasing.
  • Frank and Dave say the cap rate you need to get a 20% cash on cash return is 3 percentage points over the interest rate on 80% LTV financing. Another rule of thumb is that lot rents should be about 50% of the average 2BR apt. in the area.
  • I am finding expenses to be 45-50% when you supply the water and trash.

#9

Curious as to allocation of your expenses as a % of revenue.

For any parks of meaningful size (75+?) with rents above $300, your margins should be significantly higher, barring operating in a property tax prohibitive state.


#10

If there are no obvious(or hidden) huge CAP-X charges looming, and, lot rents are average, or below average, you will win the CAP rate game at the end. As long as you manage the park in a top flight manner, even a 6 cap will turn higher (assuming city water, city sewer, strong MSA) and become a 12 cap. I would rather buy a super clean 6 cap than questionable/hopeful 9-10 cap as I know in 5 years that I will be sitting on a sweet asset.


#11

It depends on your buying criteria. We only buy 12+ caps (based on actual income (true verified NOI at closing) often with upside).

We have a lot of off-market deals on the go . We’re actually closing on another +15% cap in the midwest next week; 57 lots with tremendous upside. So the deals are definitely out there. This is not our first and will definitely not be our last. :slight_smile:

Our cash on cash return for this specific park (before increasing rents/adding homes/increasing occupancy/fine tuning management) is 42%. We like our coc to be above 30%.

If interested, email us. We often have too many deals; we can’t close them all ourselves and stabilize them efficiently. Open to assign contracts for fast closures.

Janie
wemindji.properties@gmail.com


#12

What market and type of deals do you work? I’m assuming this must be midwest for the most part. I’m in central Illinois and I’d be happy to see some of the deals you’ve managed as case studies.

I’ve got two parks I’m highly considering and am in the due diligence phase at this point. I’ve found that in both cases with the ma and pas the bookkeeping is done in house and not very well. One of these parks I presuming recently filled with tenants because the income reported is not anywhere close to where it can be reflected in its current status. So, what steps are you taking to get accurate numbers?


#13

Hi Steven,

We love these types of deals. We make offers on parks without looking at them in person; we base our P&S agreement based on the income the seller reports.

That being said, our purchase and sale agreement protects us very well. We could opt out of it anytime without consequence. Once we’re under contract, we scrutinize the reported income. In most cases, like you have noticed, the income disclosed by the seller can often be way off.

What we ask for is 3 years of tax returns, 3 years of P&L’s, and all copies of leases. If they can’t produce 3 years of verifiable income, 2 is usually acceptable.

Of course, our due diligence checklist is a lot longer than this but this is a good start. Once these have been verified, we usually have 2 choices.
1- Go ahead with the purchase because the income matches what the seller had originally disclosed (rare)
2- Renegotiate. That’s where it get’s really fun! We renegociate the pruchase price based on the actual NOI. At the end of the day… that’s what we are buying - income.

Also, as you have noticed, non professional park managers have a hard time, amongst other things, making clear P&L reports. Therefore, during dd, make sure to call at least 3 professional management companies to see if they’d be willing to take on your park’s management after closing. We always bring in professional management that assists the on-site manager. Professionals make your life a lot easier. Especially as you grow. :wink: Ask me how I know. Haha

Hope this helps. Best of luck with your future endeavors.

Regards,
Janie


#14

This is all so helpful. I hadn’t considered having a company manage it in such a way. I guess I will make some calls around town and see if any have even done that. I figured the management was all in house set up by the investor.

I’m in DD with two parks and the lack of separation of land business vs POH is incredibly hard to discern. Dave and Frank’s formulas look good on the surface but when I dig it the numbers are drastically different - no where near to these rule of thumb that give a first clue. And the reported income definitely doesn’t match what they say they can make.

If you have time I’d love to have a chat about what you do find expenses to be ballparking when separating the land and homes. I would definitely appreciate some experienced insight.

Thank you for response above!


#15

Ballpark, more or less, you will lose money in the homes. Unless you get into it in a big way and price it as middle class housing.


#16

Reported income will almost never be what is actually recorded… that’s when we renegotiate price. :wink:

I haven’t taken Dave’s and Frank’s boot-camp yet so I am unfamiliar with their formula. I would appreciate if you could elaborate on that so I can understand exactly what you are referring to.

What we do is we scrutinize 2-3 years of P&L’s/bank statements. We calculate the NOI and the CAP rate based on those numbers.

Once we receive the leases, we separate the lot lease income from the MH income and calculate the income.This gives us a better idea of what kind of return we will be getting moving forward.

We are in the land business and do not want to keep MH’s on our books. When we purchase a new park, we try to lease option the homes to the tenants as quickly as possible.

Therefore, with that in mind, we need to know what we are actually buying (calculating lot leases only) + all expenses. We recalculate the ROI to give us a better idea of the park’s future income and make a decision from there.

With no homes on our books, expenses usually go way down + all our parks have the tenants pay for their own personal utilities.

In the end, everything balances itself out quite nicely.

Hope this helps.


#17

Thanks wemindji - That is much my approach as well. With the ‘detailed’ bookkeeping I’m seeing from these owners its difficult to differentiate what was home rental expense, land business expense, and what expenses were one time write offs such as service upgrades and home set ups.

The rough formulas that give you an idea of whether to move forward are:
Number of Currently Rented Lots X Lot Rent X 12 Months X Multipier = ball park purchase price. Multiplier is 60 for smaller more rural parks and 70 for more attractive parks.

Number of Currently Rented Lots X Lot Rent X 12 Months X Exp. Ratio X Desired Cap Rate = ball park purchase price. Exp. Ratio is .5 for less attractive and .6 for more attractive.

Now if the park owned homes carry any value at all you can add that to the prices you’ve determined from above but you won’t count the rental income from it necessarily. As you say, you’re looking to acquire financing for the land business not rentals.


#18

Indeed, bookkeeping analysis could be tricky.

Start with the leases.
From there, you could ask the seller to tell you how much of the monthly payment is allocated to lot lease and to the trailer lease.

Are the leases month to month? Yearly but have expired?

In that case, once the park purchased, you could come in and make all your tenants sign new leases where you could mention the portion that is land vs home.

As for the expenses, once we have gone through the P&L’s and notice that there has been non-recurrent purchases, we’ll simply ask the seller to disclose what was done to the park. Ideally, we’d like the seller to provide invoices for the expenses. It gives us a general idea of what are recurring and non-recurring expenses.

Regards,
Janie