Love High Cap Rates? Me Too — Ever Ask Yourself WHY They’re High?
Posted @ 5:16 pm - Filed under Real Estate Investing, Cash Flow, Buying Income Property, Investment Lessons, Capital Growth
I read a bunch of real estate related blogs, many of them regularly. Equity Scout, written by real estate investor Chris Smith is among my regular reads. We disagree from time to time, but usually in degree, not principle. He’s one of the smartest guys I’ve met. (by phone) Warning: Don’t read his ‘about’ page if your ego is in a delicate state — it may shatter. 
Chris wrote a post last Friday, Five Approaches To Today’s Soft Real Estate Market. In it he asks the question — What do I do now? What do you do when you’re on the coolest iceberg around, and it’s time to jump off? Which way to jump? Decisions, decisions.
He listed five approaches, three of which I said would be a solid combo. Doing nothing when not geographically bound is usually not necessary. Anchoring yourself to your local market makes no sense given today’s real estate reality. And what’s that?
Simple — America is now local to you.
Chris wrote in part about improving his position, which would include acquiring properties with the ‘right’ cap rate. I know what he means. But it brought to mind the never ending drumbeat of cap rate cap rate cap rate, so often preached in real estate investment circles. Chris didn’t mean anything like that, but it isn’t hard to find that attitude. It permeates real estate investment ‘wisdom’.
Hogwash.
Cap rate is not the be all end all telltale factor, screaming to us, “This is the perfect property! Buy it now moron!”
For the record, if you’re about to retire, and possess boatloads of hundred dollar bills, a high cap rate is your best friend. I’ll help you find a killer location housing a fine building with a AAAAAAAAA rated tenant, and you’ll find yourself coming home to rest and change before leaving on your next cool trip. (I may have exaggerated a tiny bit when describing the tenant’s quality.)
Back to hogwash.
Allow me to reprint here, at least partially, a comment I left at his place. I’ve added emphasis or italics.
Chasing cap rates has retarded growth in more portfolios than has bad economic times. I realize that may come off as a bold statement, but I make it inside a very narrowly defined context — and stand by it. In fact I’ve followed my own advice on this since Carter was in office.
If growth is your primary goal, acquiring double digit cap rate properties will almost always have the following two consequences:
1. Your cash flow will increase, relative to your last property.
2. Your capital growth rate will simultaneously decrease, as most smallish residential income properties sporting high cap rates are in lower demand areas. 
THAT’S WHY THEIR CAP RATES ARE SO DARN HIGH.
I’m openin’ up a new can of Duh for that one.
Let’s look at it differently for a second.
You find a duplex allowing 10% down, fixed rate amortized financing, and it’s brand new. It’s well located, attracting quality tenants, and best of all? It breaks even or better with real life operating expenses, not the usual fantasy crapola expenses you’ve no doubt often seen.
Gonna tell me yer walkin’ away cuz the cap rate isn’t even 8%? Really? Seriously? Of course yer not.
In fact, you’re gonna buy four if you can afford it, because over time, and while your tenants are comfortably paying for your holding period, the property is more
likely than not, going up in value over the long haul.
Before all investment goals, the preservation of your capital is paramount. That never changes. After that you have goals established.
Falling in love with high cap rates is a distraction from the #1 goal — capital appreciation. Forget that principle at your own risk.
This entry was posted on Wednesday, January 23rd, 2008 at 5:16 pm and is filed under Real Estate Investing, Cash Flow, Buying Income Property, Investment Lessons, Capital Growth. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.