Understanding Cap Rates | Questions with Ken #4

everybody it's Ken here and appreciate you guys sending all your questions in on Instagram and Facebook and tick-tock and all the different social medias and LinkedIn so we take a look at those questions every every single week and and kind of decide which ones would be great for podcasts which ones would be great for videos and so I picked four questions today that I thought we're really really good that all of you might really really enjoy and so the first question is why are cap rates given so much attention if I practice a buy-and-hold strategy so I'm not in the market to sell and assuming you are able to cover your debt and cash flow which makes sense why do they even matter or do they not even matter so this is a very good question so what I'm gonna do is I'm gonna just talk to you a little bit about how we approach cap rates and so first of all I think cap rates for a lot of you people don't know what they are they're called capitalization rates and essentially it's just the price that you pay divided by the Noy or the net operating income which of course is income minus expenses and so what you're trying to do is you're trying to buy properties at a higher cap rate or a higher capitalization rate which means that your price that you're paying is lower than something that has a lower cap rate so you're always looking at you know kind of where cap rates are for those of you don't completely understand them I suggest you underst take a look and try to understand them so cap rates for us are just more or less anything less than a barometer of what's happening in the marketplace so let me give you an example so on the outside of a particular town we'll just pick Dallas for example you're gonna find in the rural areas kind of a little further away from the core of the downtown Dallas area cap rates are gonna be a little bit more in other words they're gonna be a little bit higher so you're gonna pay a little bit less on the outside of town and this isn't always the case but it's generally the case and what you're gonna find is it cap rates are generally lower in downtown core areas so a lot of times cap rates have a lot to do with kind of what the markets doing at the moment so if you have a city core where it's completely vacant and there's you know a lot of the office buildings are vacant and nobody wants to live down there like the City of Phoenix is actually going through right now it's not in my opinion a great downtown core your cap rates are gonna be a little bit higher than they are gonna be let's say in a downtown Seattle area where there's a lot happening right now obviously the big push up there is you know with Amazon and Amazon put a lot of pressure on the office buildings and a lot of pressure on the apartment buildings and you know the retail and all that stuff so so cap rates are interesting just from a macro standpoint just to take a look at and really really drill down on and but this particular person asked a great question because it does you don't really need cap rates unless you're about ready to position to sell and and or refinance and so so it's nice to know when you're sitting down with a bank and you're about ready to refinance kind of what cap rates are because then now you can have a healthy conversation with that particular lender about you know where prices are trending and and what's kind of going on in that market so they're just an indicator of kind of how vibrant that market is at the time and so we really like to take take take a look at cap rates now what that being said I can tell you that I bought properties before that had no cashflow in other words they're what I would call value ads and I think we talked a lot about those and those properties don't have very good cap rates if you think about because they're not stabilized so generally cap rates are something that's on a stabilized property so it's something you want to look at you know in a long term basis after some kind of a remodel or a renovation or something like that and you've kind of stabilized and then you can kind of you know use that as your own individual barometer but when we decided to sell ten properties this year you know we had bought all these properties in the six seven even eight percent cap rate and then we went down to one of the nation's largest brokerage companies and we're packaging them all up and they were in all different cities in all different states we said where do we think these properties will trade from a cap rate basis and they said they think that they're gonna trade under five percent cap and after one year and we had sold all these we ended up settling in at a four point two cap rate and so it does mean something if you're selling it does mean something if you're refinancing it doesn't mean a lot if you're holding but it's nice to know because if an investor or let's say one of your investors or some of your equity partners want to kind of know what the property's worth you have to use cap rates for that to be able to kind of calculate it now I've talked about this a little bit but one of the biggest things that you actually need to be concerned about with cap rates is well what I call the exit cap rate so there's a cap rate that you buy on and there's there's a cap rate that you exit on so let's say you're buying something for two three five years and it's not necessarily buy and hold strategy if cap rates go let's say from four to five percent let's say you buy it for and you're trying to sell it five that means that that's a 20% loss in the net operating income as it relates it's just math and so you would have to actually grow your net operating income if you're gonna sell at a five at exit five because that's just to break even so the exit cap rates are really really important in cap rates are really really important depending on the equity so if you're gonna go to Wall Street and borrow from big groups like Blackstone or Goldman Sachs they understand what cap rates are they understand what exit cap rates are and so if you can't deliver that if you can't show them that you're gonna grow the NYC and aggressively they may not might not invest with you because they're looking at the exit cap rate so the exit cap rate is very very very important great question I really appreciate it cap rates are something to watch but if you're in a buy and hold strategy sometimes it's just fun to see you know how much your property's worth and whether you can harvest some equity out of it on a refinance so great question I really appreciate you guys listening to my show and to learn more I have an entire website dedicated to real estate education at Ken macro comm and the price is just $14.99 a month and you'll have access to hundreds of videos in the video library so please visit Ken McElroy comm if you're interested in more education the second question that was brought up was you know I talked a lot about this is that I say don't focus on finding the investors but focus on finding a good deal and then investors will follow and this is a common question so this question came in a lot and so I'm just gonna walk you down my own personal journey because what happens is the emotion side of anybody wants to say hey I need the money like when you're gonna go buy a car you know you know that you generally need some kind of a down payment you know you're gonna have to write a check for that I get that and same thing with you go to Costco or Target and you're buying a TV or something you know you're constantly using your own money so I want you to wrap your head around this a little bit better you don't necessarily need money in order to buy real estate so that's the big difference and so this particular question is around investors so think you know in most cases people are focused on their own money what they have in the bank and whether they can afford it in this particular case you're trying to find somebody else to put that down payment down and so on my own story when I first started my adventure to say 20 years ago I went to friends and family so I went to my rich uncle who had done very well as a home builder and he had started businesses and I sat down with him and I said hey would you be interested in investing and some of my stuff now he was by far the most gracious I can tell you that everybody else I asked would basically say of course you know we'd be happy to take a look at whatever you have and so it's a it's just it's something I understand that you guys need in place and it's good for you to potentially go find people that may but I can assure you if you ask 20 people if they're going to invest the chances of all 20 pulling through are super low in fact I would say that's probably just a handful of people most people aren't going to tell you know most people are gonna say oh I'll look at that I'll look at everything and then then there's a massive amount of work that has to be done and so what I learned after meeting with my uncle was he said listen you're not gonna raise money this way because there's nothing to talk about it's just that basically you're saying would you invest in me because there is nothing else it's just me you know so the question would be do you have a team well no okay do you have a property no okay what's my return McGee I don't know because I don't have anything to look at and so what I when I try to teach people is that you need to go out and get yourself educated you need to go out and find a deal and once you find the deal then least you have a talking point because when investors invest they invest in things so if you're investing in a t-bill let's say a government t-bill you know the rate if you're investing in a bond you're doing it you know the rate if you're investing in some kind of debt product you know the rate so the investors are investing in things that they actually can see the return on if you just go to somebody and say hey you know would you be interested in investing with me most the time they're gonna say yes you know generally and so most people aren't gonna say sorry I'm busted right now how many money most people are always gonna say yes and so but then the Robert when the rubber hits the road is when you actually bring them some kind of a business plan or some kind of a ye'll so and I'll give you an example so I bought a two acre piece of land with a billboard on it and it was listed and had been listed for six months and so I said because I'm in the billboard business I was interested in the billboard more than the land so I called my partner and I said hey we can buy this property move the billboard and sell the property for exactly what we bought it for he said done okay that is an infinite return on a property that I actually did that is a plan it doesn't have to be all in writing etc etc etc but who doesn't want a billboard for free so that's some kind of plan and so when I just call my partner and we eats just through fifty percent of the cash in and bought it completely with no debt we ended up buying this land and we got the Billboard for free and now the billboards producing about $4,000 a month net so for about $50,000 a year in in cash flow we've got a billboard for free okay who's not gonna want to do that deal everyone's gonna want to do that deal that is a deal that's somebody something that somebody can get their head around that's something they say okay I can how much how long is my money gonna be invested in the deal when am I gonna get it back what's my return gonna be those are all the things that people ask and if you don't have that information then it's it's almost a waste of a conversation so my suggestion is that you go out look for deals and try to find the best deal you can then go and pitch them to people and that's actually well you'll get the most your education will go up a lot your experience will go up a lot because people they'll be asking you questions back about the deal some of it you'll know and some of it you won't know and so the next deal you're gonna get a little better the next deal you get a little bit better and each deal you get a little bit better but you actually have to have something physical it can be anything it can be a duplex that you live in one side and run out the other it doesn't really matter it can be a condo that you have an Airbnb strategy with and then you know it's gonna cash flow over time but people need to be able to wrap their head around things before you actually ask them for the money even if you're not completely spot on if you've done all the legwork and done all the research and you have all the information for them to make it appear like it's a good deal and hopefully it is and you've done a lot of that work beforehand the chances of you raising money and getting investors is a lot higher you know if if I'm gonna buy a vacant building just on a corner with an investor there's no upside for the investor but if I find that vacant building on the corner and I find a tenant while I'm in escrow now I'm going and saying listen we're gonna buy the building for a million we're gonna put a tenant in it and that's gonna increase the value to two because its cash flows they can wrap their head around that so you just put them put yourselves in their shoes if you're being asked to invest what are the things that you look at you look at the return what I'm going to get my money back how secure it is it is the management team sound does it have good property management you know is everything that they're saying that it's going to be done is it actually going to happen you know what weighs the market going etcetera etcetera etcetera etcetera so those are all the things that a good investor asks you and so when you start with a deal and you bring a deal to somebody especially sophisticated investors like my uncle you're gonna learn a lot because they're gonna ask you questions and it's gonna make you better and better and better and that's how you raise money and that's how you find investors and that's how you find great deals to make yourself rich over a long period of time so great question

Channel: Ken McElroy

Views: 29,138

Rating: 4.9007092 out of 5

Keywords: Rich Dad, Entrepreneurship, Investing, Personal Development, Get Wealthy, Earn Wealth, Ken McElroy, Entrepreneur, Rich Dad Advisor, Success, Business, Self-Help, Coaching, Real Estate, Real Estate Entrepreneur, Real Estate Investing, Freedom, Lifestyle Business, Hustle

Id: 7BPmcpU1I34

Length: 15min 7sec (907 seconds)

Published: Mon Dec 16 2019