Today’s REI Classroom Lesson

Kathy Fettke explains why you shouldn’t be settling for low cap rates and how there should be a change in the commercial market starting later this year.

REI Classroom Summary

Kathy gives a real life example of why settling for too low of a cap rate can put you at risk to lose money. Listen in as she shares valuable information that you need to know.

Listen to this REI Classroom Lesson

Real Estate Investing Classroom Show Transcripts:

Mike: Welcome back to the flipnerd.com REI Classroom where experts from across the real estate investing industry teach you quick lessons to take your business to the next level. And now, let’s meet today’s expert host.
Kathy: Hi there. I’m Kathy Fettke, the co-CEO of Real Wealth Network and host of The Real Wealth Show, and I’m really happy to be here on FlipNerd’s REI Classroom. I want to talk a little bit about cap rates.
Mike: This REI Classroom real estate lesson is sponsored by the investormachine.com, FlipNerd’s private investor coaching program and your blueprint to investing success.
Kathy: Because I think a lot of people are confused about cap rates. What I mean by that is they’re settling for way too low a cap rate. I’m guilty of that myself. Our group, Real Wealth Network, syndicates which means that we raise money with investors and we buy big stuff together. We actually bought an apartment across from Google in Mountain View, California right there in the center of Silicon Valley, and we settled for a 1 cap. That’s a 1% return. That doesn’t leave you very much room if anything goes wrong, right? It’s probably going to be a negative.
Don’t think for a minute that we bought that apartment for the 1 cap. We didn’t. What we’re doing with it is re-entitling it with the city of Mountain View and taking it from about 200 units to about 800. We’re going to be building, bringing on more units and obviously that’s going to change the numbers quite a lot. It’s a development deal. That’s the only reason we would settle for such a low cap rate.
But, I’ll tell you what. There are people who are not thinking in that way. There’s obviously a lot of foreign money that’s just looking for any place. That’s probably not you or me. They’re just looking for a place where they’re not going to lose it, so even a negative cap rate would be okay for them because it would be better than maybe some of the negative bonds and things that investors, foreign investors, are doing.
As Americans and as people who are trying to build our retirement and trying to get to a place of living off of passive income, be careful about settling for too low of a cap rate. Let me give you an example.
We’re at this part in the market cycle where it’s hard to find good deals. There’s a lot of money chasing a few deals. The problem in the U.S. today is lack of inventory. When you’ve got that much demand and not enough supply, well, prices go up and cap rates go down. Every single time we get to this part of the cycle, and remember, cycles change. We’re at the peak. We’re going to see a trough. We’re going to see a slow down. It’s just the way it’s worked every decade forever, so it won’t be any different this time.
Unfortunately, most people forget that or they don’t know that, so they’ll settle for less thinking that if they don’t buy now they’ll never get it, cap rates will just keep getting worse and returns lower.
It’s just not the case. I mentioned in our last training that we’re going to see a slow down in commercial real estate just this summer in August because there are so many loans coming due and there’s not money for those investors to refinance. Don’t settle.
Again, back to the example, I’ve seen people buying storage units because they hear storage units are so great. They are great, if you get it for the right price and the right cap rate. Otherwise, you’re working for free. We’re seeing people buy storage units with a cap rate of 4% in Texas. That’s craziness.
Same thing with dollar stores. We had a bunch of dollar stores come across our desk. Dollar stores are a great investment, nothing wrong with them, but it’s got to be a great investment. You should be getting around an 8 or 9 cap, and this group was selling it for 6. Great for them. They were going to make millions on that deal while we were not stupid enough to settle for such a low cap rate on something like that. It’s a dollar store, so there’s more that can go wrong because it’s a business.
Same thing with apartments. People think there are no apartments out there. I can say this from first hand experience because we’re selling an apartment right now. We are taking advantage of the market cycle. We asked for way more than it’s worth. Guess what? We have eight offers that have come in from people who aren’t thinking about the numbers or really looking at the numbers. I hate to say. It’s just the way it is.
This is a good time to sell. Not a great time to buy. Be very cautious. Make sure you understand the numbers, because if you buy a 4 cap or a 6 cap and you try to improve that property, you’re going to have to find somebody crazy enough to buy it at a 3 cap. That’s going to be tough to do, especially if the market turns.
All right, I hope that was helpful. I’m Kathy Fettke, again, co-CEO of Real Wealth Network. Thanks for listening.
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Kathy Fettke is the CEO of Real Wealth Network, host of the Real Wealth Show in iTunes, and best selling author of Retire Rich with Rentals. With a passion for researching real estate market cycles, Kathy is a frequent guest expert on CNN, CNBC, Fox, Bloomberg, NPR, CBS MarketWatch and the Wall Street Journal. She was also named among the “Top 100 Most Intriguing Entrepreneurs” by Goldman Sachs two years in a row.

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