Is there a such thing as too low of a cap rate ?
Title. I have been reading basic technicals and I thought that a lower cap rate meant an higher property value. So could cap rate become too low that it becomes a probelm, and what is a good cap rate for sectors like multifamily and data centers
Prospect in RE - Other, have you checked out these or run a search:
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I hope those threads give you a bit more insight.
The cap rate is essentially a risk free rate + risk premium associated with the asset. If the cap rate is too low and doesn't justify the additional risk (and work) to invest in RE relative to a "risk free" asset, then yes, its too low. As an extreme example, why buy a stabilized asset at a 2% cap rate if you can earn 2% on a money market fund? You have to get additional yield to justify going through the process of finding and purchasing deals, managing them, dealing with tenants, risks of occupancy/rent declines or cap rate expansion upon exit, unforeseen capex needs, illiquidity, etc... whereas buying a money market fund takes a few mouse clicks to buy/sell and is a completely passive investment.
Another thing to consider is where the debt markets are, why buy for such a low cap rate that your debt will reduce levered yields (or make then go negative) or provide insufficient coverage ratios even at conservative LTVs?
Good to think about cap rates from multiple perspectives, when considering something like "good" or "bad" cap rates.
Low cap rates should theoretically correspond to low risk assets. A brand new amazon leased NNN warehouse might trade at a 3% cap, since there is very little risk associated with it.
High cap rates mean you're probably busing something risky. Maybe a 50% leased retail center in tulsa, OK, at a 11% cap, or a vacant office building in Houston at a 14% cap. That is, if something is very risky, and less likely to blow it out of the park in terms of financial results, you're going to want to pay less for it.
There are many ways to think about cap rates, but it's also helpful to consider yields. Even an amazon warehouse, mentioned above, should never trade beneath the 30-year treasury rate, unless people suddenly think the U.S. will default. Until that happens, we don't associate risk with US bonds. Therefore, the difference between Amazon's 3% cap/yield and a US bond (call it 1.5%) means that you're taking an implied 1.5% extra risk to buy the warehouse instead of just putting cash in a bond.
Lastly, a low cap rate is never bad if you're on the selling end. However, if prices are too high, cap rates are too low, and you over pay for something, then that could be "bad"
A developer would say that you cannot have too low of a cap rate ;)
We love a 4.
Not if you’re Eastdil.
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