When Cap Rates Are Lower Than Interest Rates

Is it possible to make money investing in commercial real estate when cap rates are lower than interest rates or should you just wait until interest rates go down (or find properties with cap rates higher than interest rates)? Discover the answers to these questions, plus a case study that demonstrates a simple but effective strategy for investing in today's commercial real estate market of high interest rates and low cap rates.

0:00 Intro
0:32 Cap Rates and Interest Rates
4:30 Case Study - Multi-Family, Big City U.S.A.
11:50 Beat High Interest Rates with Creative Financing

[RandalColling]

Thanks Peter... The only trouble is *DEBT SERVICE*. Most lenders want the income to cover 1.25X the debt service. Getting a loan on a negative cash flow deal based on speculative rental increases is almost impossible, most lenders would require additional collateral or a much larger down payment. A hard money lender will hurt you bad.

[charleskaufman]

DEAL MUST CASH FLOW, DON'T BASE ON JUST EQUITY INCREASE.
Using your example, over 5 years the NOI increased to $127, 500 which increased the price to $2.55M at 5% THE BIG Over the 5 year period if the Cap rate increases to Cap = 6.375% NOW the Price is back to $2M.
You just lost the 5 year equity Increase, But if you have CF then you are still good, THEREFORE the property must CF, To many investors are buying properties that are Not cash flowing and when time comes to get new commercial loan they are going to loss their property.
If I am wrong please make to video explaining, I have been following you for years and thanks for the great education but always more to learn.

[blessedfold]

The advice given here about forced appreciation through raising rents 5% a year works for multi family if rents do not soften but it would not work for another asset class like STNL or MTNL unless they were way below market rents. It should be noted that this advice is very specific to multifamily.

However, it should be mentioned as others here have pointed out that interest rates are likely to keep rising which makes the investment worth less and less due to the risk free rate of return being a better and more attractive option for investors with capital to invest.

[rex]

I'm not sure it would be fair to assume 5% rent hikes over the next 5 years, especially in light of the tremendous rent hikes we experienced in the last few years. While I don't expect rent to decrease meaningfully, I would personally prefer to err on the side of conservatism when underwriting in the current uncertain environment. Moreover, if the fed stays at a higher interest rate level (more like a normal level when compared historically), it's very possible cap rates could rise in the next few years. However, I agree that being pencils down is not a good strategy, and my personal approach is to lead with creative financing (eg seller financing). Never stretch your assumptions during underwriting, and build in more conservatism and larger margins of safety in your pro forma models during market uncertainty.

[SudeshMehru]

Great presentation. As lenders ask more down payment COC return goes lower than current CD rates which is keeping people ate fence.

[jasonmalabute]

estimating 5% rent growth for next 5 years in any market without considering that market's historical rent growth from 2000-2020 and that rent has been dropping since 2022 in some markets is not conservative

[deltadigger]

I'm here in CA and I see some job losses already taken place. Rent increases tuff in an economy where food has to come first.

[theadrianfajardo]

When he talks about NOI/Price, he is referring to the Yield on Cost. No one can influence the cap rate. This is what confuses people in the topic of cap rate.

He mentioned it correctly that the MARKET cap rate is a measure of what investors are willing to pay for an income producing asset.

So you can say, the bigger the spread between the Yield on Cost and the market cap rate, the more money you will make ☺

[mikedulrich]

I'm not confident in some of the assumptions made in this video but a bigger issue the video didn't mention is cashflow. Using some rough numbers based on the assumptions in this video, a property would probably have negative cashflow for several years. This depends on the exact terms of financing but almost any traditional financing will result in negative net income. Even with the optimistic assumptions in this video, it's likely 7+ years of negative income.
If the assumptions pan out, it may be worth taking annual losses if those losses can be offset when selling the property but not many people can afford to lose money on a deal for several years. And if the assumptions don't pan out, say you can't raise rent 5% annually or cap rates go up (both of which happen in down economies) an investor may need to hold a property for over a decade to break even when selling (all while losing money each year on expenses).
This changes a bit if you can secure very favorable non-traditional financing but you'd still be relying on strong market appreciation.

[josephtagliente]

Peter, I like your videos very much but I have to make a point here. For an investor who is focused on capital appreciation and IRR your scenario works, but for the investor who is looking for cash-on-cash returns and positive cash flow it does not. A mortgage of $1.6M in your scenario would create a monthly debt service of ~$10, 113 or $121, 356 annually resulting in an annual negative cash flow of $21, 356. How can an investor make this work?

[hj]

Welcome to developing markets. cap rate 9%, interest rate (floating) 11%. Capital gains and inflation will hopefully get you to positive cash flow in a few years, but geared capital growth is where the gains are made.

[glennstarin]

Hey Peter...
My name is Glenn Starin...I'm going to be one of your students some day...just not now...
But some day...
Thank you for your videos...
Glenn

[joser]

How do you value a apt bldg if the whole building is vacant? There no income coming in, so no

[tettsubushi]

Unfortunately, in NYC, for rent-stabilized properties, the HSTPA of 2019 stopped rents dead in the water...

[vosk]

This holds mostly true for value-add transactions with low leverage. Low leverage = lower IRR, Coc and EM

[AlonsoHernandez-zg]

How did you calculate loan pay down? Thank you

[DerekLau]

How was the loan pay down of $101, 000 derived? Thank you.

[davidferro]

One of the things Peter teaches, is to look at the exit, how far below market are the rents? Even if market rents don't increase, or tick down a bit, you could still have upside
Every deal is unique, and there out there!

[oumichael]

Great video. I’ve been investing in single-family homes. looking at moving into multifamily.

[denisdemidovitch]

What if the assumption of raising rents is not viable? Than another option would be to ask for the reduction in the property sales price to maintain adequate cap rate