Been having a tough time wrapping my mind around how to think about how an increase in interest rates (whenever that happens) will affect cap rates, more specifically, when I underwrite class b multifamily and how to exit on a practically fully turned property to deliver as a turnkey for an investor. Any help on how to think about this would be appreciated
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Are you asking about how much it will affect them or why?
The why is pretty easy. Investors need a spread between interest rates and the cap rate they buy at because otherwise the leverage they get is dilutive to the deal (if I'm getting 4% return on my investment, I can't/Won't pay a 5% interest rate).
If you're looking for how much. The last time I looked at this, cap rate historically (not now) have generally had around 100-150 basis point spread between interest rates. We have some cushion until interest rates start pushing up cap rates.
Would you say if fully turned Class B MF prices around 5-5.5% cap that it would be too conservative to assume an exit cap of 6.5% 5 years from now on a similar deal?
Most people I talk to are underwriting 5-10 bps of expansion per year (5.25%-6.0% in your example), so 6.5% would be on the high side given the fact pattern you presented.
yes - too conservative. they're priced the way multifam4life mentioned, seen as low as no expansion in hot markets. you aint gonna win any deals with that spread...
Many groups I have spoken with recently are underwriting exit caps between 4.75 and 5.25. Hard to be competitive if you don't.
Totally get that on being conservative...but 4.75-5.25% on a fully turned class b MF asset with little value-add left...isn't that very tight? Please correct me if I'm wrong..we also look at midmarket deals which I should have included....5-25mm
We're using 4.2% or lower on all deals that are 10 years or newer, and 4.3% or higher on deals that are older.
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