Curious as to what everyone is doing for cap rate spread between going in and exit cap.
I am at a large brokerage shop (CBRE/JLL/CW) and we are being (in my opinion) very conservative on our spread between going in and exit cap. Currently 50bps on a 5 year hold and 75bps on a 10.
i understand why we are doing this but almost feel like we’re shooting ourselves in the foot given the current environment. Would I be crazy to suggest underwriting flat same going in/exit.
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Nah brah. UW at LEAST 75 bp compression on 3-5 yr hold. How tf you think we get this shit to pencil dawg? We’ve closed a handful of deals already this year. At a GVA/Tides type shop btw.
Suck it bro. We compress our cap rates 25 bps every month. Our underwritten exit caps are -7%. Heck yea, we win every deal!!! Suck it all. Im the greatest!!!
Regards,
CEO of Nitya Capital
btw be sure to check out my video on how great I am, you can find it on my youtube link below
Do people seriously thinking before making videos like that. I mean seriously this guy must have told the producers of his little biography to make him look like a douchebag.
This guy quotes MLK, accepts some fake award, while putting on a suit all within 30 seconds.
I'd simply ask you what your thesis is for underwriting in place caps today at exit? If it's because you're anticipating rate cuts, then underwriting in place or even cap rate compression would in my opinion be making a proxy macro bet on rates through an illiquid investment and there are better ways to achieve that thesis than investing in hard assets. This statement is more reflective of someone underwriting cap rate compression, but I believe holds in some capacity for underwriting flat cap rates.
Why expand cap rates? One could argue you'll be selling an older property in X years, albeit, for a 5 year deal this shouldn't be significant and isn't the primary driver in my opinion.
What I think the real driver behind expanding capes rates is that underwriting is an art and not a science. I expand cap rates because it helps reduce the asymmetric risk profile of the deal relating to the health of the capital markets, which is out of my control. It allows me to purchase assets where the business plan is a meaningful enough contributor of value versus macro components related to interest rates and the flow of funds into CRE which are out of my control and are ultimately what drives cap rates at a macro level. I want to invest in deals where an executable business plan can drive enough value to meaningfully mitigate the macro forces that are outside of my control.
You'll never be able eliminate macro factors entirely, but I've always viewed it as if you have an executable business plan that is grounded in sound fundamentals and reality, you can weather the uncontrollable elements better.
I think the simple answer is that even with a great business plan, it's near impossible to buy any deal right now if you're underwriting cap rate expansion for an institutional size deal, and if pricing came into check where you could start winning deals underwriting that way, the basis you'd be picking up these deals at would be insane compared to replacement cost. I think the argument about there being better proxy macro bets than real estate might hold true as an individual investor, but at the end of the day institutional capital already has capital set aside for those types of bets and they also want to be in real estate. Same goes for private capital where a lot of people just simply like to have their money in real estate. So that basically just boils down to that there is always capital that needs to go into real estate, and in today's environment you can't place that money underwriting cap rate expansion. Where cap rates go is anyone's guess, but there's actually good reason to believe that buying real estate today comes at a good basis and that cap rates might compress at least a little in the coming years. It would be a different story if we were talking about underwriting cap rate compression when buying 3% - 4% cap rate deals back in 2021. I personally try to make sure that my deals this year work by assuming the base case is a range where cap rates either stay flat compared to today or they compress slightly (like 25 bps). Significant compression is the upside, cap rate expansion is the downside.
Don’t worry if you’re at a brokerage I’m sure your going in cap is far too low. 50-75 bps evens it out somewhat.
Depends on the deal, but if value add or core plus purchased opportunistically we're underwriting either flat or with some compression. Silly to underwrite expansion on that deal profile today if you're actually making meaningful improvements to the property through your business plan because you should be able to force compression through those means without relying on rate cuts and other macro factors.
If it's core product then your expansion parameters are probably logical.
Cap rates only go down, nerds.
This chad gets it
Hahaha
Do you want to win the deal? Any deal? Do you want to be working in 12 months? Find a rationale to compress cap rate. The only people who have the luxury of expanding cap rates are the academic types who have the luxury of not making deals.
Bears always sound smarter. Bulls always make more money.
This chad also gets it - expanding cap rates at this point of the cycle is an absolute loser mentality when they're already at 6%, especially for Type I / Class A. Scared money don't make money
10 bps per year of expansion is normal UW even at a brokerage, you'll find other ways to fluff the numbers anyway like $6k/unit renos with $200 premiums.
Haha, jokes aside I've heard 10 bps a year as a standard as well (so 1% for 10 years).
Yeah that is pretty standard. Its not a direct assumption that cap rates will rise 1% over 10 years, just a general catch-all for downside protection including rate movement and simply the building losing value from aging.
Nobody knows what future cap rates will be. Keeping cap rates the same allows you to isolate how much value was created by improving operations.
convinced shops closing on deals at numbers that don’t make sense are betting on cap rate compression.
Maybe it’s more gambling than investing but tbh they may hit it big.
To answer your question I usually get through first UW flat to understand value creation and then add 75-100 bps expansion on anything brought to partners/IC/etc
Can always do an exit cap sensitivity.
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