As interest rates increase, the cap rates of properties also increase. Cap rates indicate the rate of return that an investor expects to receive on their investment in a property. This increase in cap rates results in a decrease in the value of the property itself. This is a significant concern for both property owners and banks, as it could mean that the property's value is less than its outstanding debt. This could make it difficult for owners to refinance or sell the property. The commercial mortgage debt maturity is a major threat to the real estate industry due to rising interest rates, making it challenging for owners to maintain their properties and for banks to refinance or sell their loans. When considering potential deals, it's essential to exercise caution as many deals may be risky and could potentially result in significant losses. Thank you for your insight.
Do you believe it’s true that a property is still a good investment even if the loan is greater then the property value? as long as it has strong cash flow, if you buy and hold long term Equity isn’t always your main focus in the present right?
What investor is going to borrow money at 6.5%-7% interest (current rates) and accept a 5% cap rate? Sellers need to wake up. Going to take some time for them to digest the "new normal"
It just occurred to me. Because the interest rates have been so low these past 20 years, it's probably kept a lot of people out of the commercial space who would have purchased the commercial property outright. Since high interest rates lead to higher caps, and higher caps mean lower price, there may have been a lot of people that may have wanted to enter the space but didn't due to the high cost of property. I could see people trading in 3-5 sfh to upgrade to own a strip mall outright at 1M, but it's a lot harder when that same strip mall costs 5M because the interest rates are 2%.
@@lyleburlingame2276 Investers need a reward commiserate with the risk of the investment. If a treasury goes from paying 1% to 5%, then the amount of money that an investor is willing to risk for a lower cap goes down. If a 2 cap property was giving them a 4% return, then they were beating the treasury by 3%, but after the Fed rate was raised, they'd be out 1% by taking the same deal over a treasury. The cap would need to be raised an amount that is enough to outweigh the treasury plus the added risk of investing in the property. Granted, most professional property investors would balk at anything paying 4%, but in the era of ZIRP, there's been a lot of institutional investors that have purchased properties using a similar formula. There are a lot fewer low cap deals that work for those investors now as compared to a year ago.
@@jbrandonporter is 8% cap rate good then ? I always thought cap rate higher the better. But he’s saying you need a higher cap rate to make it worth it to invest is that right ?
@@lyleburlingame2276 Yes, a higher cap is usually better. Cap is nothing more than the % return based on property value, so your actual return is based on the amount you're investing in as well. For instance if you're putting $100K down on a $1M property with a 3 cap, your ROI is actually 30%. ($1M * 3% = $30K, $30K/$100K = 30%) If you invested $200K into that same property, the ROI is 15% ($30K/$200K = 15%) If you bought that same property with the $200K at a 6 cap, your return goes back up to 30% though. ($1M * 6% = $60K, $60K/$200K = 30%) (cont)
(cont) ugh. For some reason RUclips didn't post my second comment. Now to retype. Now let's say you're in more of Ken's space and look at a $50M property. You put in the same $100K, only this time there are a lot of other investors. The bank still wants that 10% equity, or $5M. Your $100K is now 2% of the overall funding ($100K/$5M = 2%), so you will get 2% of the payout. We'll set the cap at 3 like the first property, so the payout on the property $1.5M ($50M * 3% = $1.5M), but your 2% stake gives you $30K ($1.5M * 2% = $30K) so you're still getting that 30% ROI. Pretty good. The other numbers match. If the required equity doubles, your payout gets cut in half, and if the cap doubles so does your payout. The advantage (or disadvantage depending on perspective) is that this syndicated deal is a passive investment. You are a small player in the pool, whereas on the $1M property, you are in complete control so the success or failure depends on you alone. So to circle back to my original post, with institutional investors willing to push the cap rates lower and lower because they're just looking for something that beats buying treasuries, prices keep going higher and higher because of the reverse correlation between cap and price. I'm betting there are a ton of more conservative investors like Danille, who don't like the idea of having almost a million in debt, but do have a few homes that they own free and clear. These investors might be willing to trade up to a million dollar property by selling their homes, but if the market cap is low because of these institutional investors, then what would have been a $1M property in a high interest rate environment is being valued at $5M, which prices these investors out of the market.
Hi Ken ! I know you are busy and if you happen to see this message! I need your expert opinion on the following: My coworker mentioned he wants to sell his home & I'd like to make him an offer. He has a 3% mortgage and has about 100k in equity since we last spoke March 2023. I would like to take over his 3% mortgage since as you know mortgage rates are double that right now. I have no money to put in this deal. I plan to buy and hold long term as rental property. I am looking for cashflow. He has not listed the property and his wife is a realtor. How would you structure this deal so it works for both parties? . I keep the 3% debt & property and he gets 100k so he can use to build on a lot his family owns.
How are they losing money foreclosing on the property. The LP equity is stripped by the high caps. The bank will get the cashlow from NOI. They will take over earn cash flow and shop the property to new investors.
@@piRatCaptain It depends on the LTV generated with the new market value Based on the higher interest rate and cap rate. If The property is upside down (loan greater than current market value) it would be better for the.banks balance sheet to keep the loan as a "special asset" and reestructure the debt so they can avoid a write off/loss. If the new ltv is at 100% or lil less they might foreclose and find a new investor. It all depends on the Banks policy.
I would like your thoughts on Cap Rate if there is no mortgage in place? Meaning the property was paid in full. Only then can you realize true cap rate. Otherwise with a mortgage in place you would need a 7+ cap rate with commercial loans at the same rate to break even.
The cap rate before or after debt service will still be indicating the value going down. But yes, most real estate people quote a cap rate before debt service.
I think it’s possible but I think the sellers note or note instrument would have to be issued in the name of the qualified intermediary on behalf of the buyer. A licensed attorney dealing with real estate would know this.
As interest rates increase, the cap rates of properties also increase. Cap rates indicate the rate of return that an investor expects to receive on their investment in a property. This increase in cap rates results in a decrease in the value of the property itself. This is a significant concern for both property owners and banks, as it could mean that the property's value is less than its outstanding debt. This could make it difficult for owners to refinance or sell the property. The commercial mortgage debt maturity is a major threat to the real estate industry due to rising interest rates, making it challenging for owners to maintain their properties and for banks to refinance or sell their loans. When considering potential deals, it's essential to exercise caution as many deals may be risky and could potentially result in significant losses. Thank you for your insight.
Clear math helping. Many thanks for sharing such an important refresher
Excellent summary and explanation. Thank you
Do you believe it’s true that a property is still a good investment even if the loan is greater then the property value? as long as it has strong cash flow, if you buy and hold long term Equity isn’t always your main focus in the present right?
Ken really knows his stuff
What investor is going to borrow money at 6.5%-7% interest (current rates) and accept a 5% cap rate? Sellers need to wake up. Going to take some time for them to digest the "new normal"
It just occurred to me. Because the interest rates have been so low these past 20 years, it's probably kept a lot of people out of the commercial space who would have purchased the commercial property outright. Since high interest rates lead to higher caps, and higher caps mean lower price, there may have been a lot of people that may have wanted to enter the space but didn't due to the high cost of property. I could see people trading in 3-5 sfh to upgrade to own a strip mall outright at 1M, but it's a lot harder when that same strip mall costs 5M because the interest rates are 2%.
High interest leads to higher cap rates ?
@@lyleburlingame2276 Investers need a reward commiserate with the risk of the investment. If a treasury goes from paying 1% to 5%, then the amount of money that an investor is willing to risk for a lower cap goes down. If a 2 cap property was giving them a 4% return, then they were beating the treasury by 3%, but after the Fed rate was raised, they'd be out 1% by taking the same deal over a treasury. The cap would need to be raised an amount that is enough to outweigh the treasury plus the added risk of investing in the property.
Granted, most professional property investors would balk at anything paying 4%, but in the era of ZIRP, there's been a lot of institutional investors that have purchased properties using a similar formula. There are a lot fewer low cap deals that work for those investors now as compared to a year ago.
@@jbrandonporter is 8% cap rate good then ? I always thought cap rate higher the better. But he’s saying you need a higher cap rate to make it worth it to invest is that right ?
@@lyleburlingame2276 Yes, a higher cap is usually better. Cap is nothing more than the % return based on property value, so your actual return is based on the amount you're investing in as well.
For instance if you're putting $100K down on a $1M property with a 3 cap, your ROI is actually 30%. ($1M * 3% = $30K, $30K/$100K = 30%) If you invested $200K into that same property, the ROI is 15% ($30K/$200K = 15%)
If you bought that same property with the $200K at a 6 cap, your return goes back up to 30% though. ($1M * 6% = $60K, $60K/$200K = 30%)
(cont)
(cont) ugh. For some reason RUclips didn't post my second comment. Now to retype.
Now let's say you're in more of Ken's space and look at a $50M property. You put in the same $100K, only this time there are a lot of other investors. The bank still wants that 10% equity, or $5M. Your $100K is now 2% of the overall funding ($100K/$5M = 2%), so you will get 2% of the payout. We'll set the cap at 3 like the first property, so the payout on the property $1.5M ($50M * 3% = $1.5M), but your 2% stake gives you $30K ($1.5M * 2% = $30K) so you're still getting that 30% ROI. Pretty good. The other numbers match. If the required equity doubles, your payout gets cut in half, and if the cap doubles so does your payout.
The advantage (or disadvantage depending on perspective) is that this syndicated deal is a passive investment. You are a small player in the pool, whereas on the $1M property, you are in complete control so the success or failure depends on you alone.
So to circle back to my original post, with institutional investors willing to push the cap rates lower and lower because they're just looking for something that beats buying treasuries, prices keep going higher and higher because of the reverse correlation between cap and price.
I'm betting there are a ton of more conservative investors like Danille, who don't like the idea of having almost a million in debt, but do have a few homes that they own free and clear. These investors might be willing to trade up to a million dollar property by selling their homes, but if the market cap is low because of these institutional investors, then what would have been a $1M property in a high interest rate environment is being valued at $5M, which prices these investors out of the market.
Hi Ken ! I know you are busy and if you happen to see this message! I need your expert opinion on the following: My coworker mentioned he wants to sell his home & I'd like to make him an offer. He has a 3% mortgage and has about 100k in equity since we last spoke March 2023. I would like to take over his 3% mortgage since as you know mortgage rates are double that right now. I have no money to put in this deal. I plan to buy and hold long term as rental property. I am looking for cashflow. He has not listed the property and his wife is a realtor. How would you structure this deal so it works for both parties? . I keep the 3% debt & property and he gets 100k so he can use to build on a lot his family owns.
Thumbnails are getting a little goofy. lol
The banks will restructure the debt with a lower interest rate just to make the dscr work. They will lose more money by foreclosing..
How are they losing money foreclosing on the property. The LP equity is stripped by the high caps. The bank will get the cashlow from NOI. They will take over earn cash flow and shop the property to new investors.
@@piRatCaptain It depends on the LTV generated with the new market value
Based on the higher interest rate and cap rate. If The property is upside down (loan greater than current market value) it would be better for the.banks balance sheet to keep the loan as a "special asset" and reestructure the debt so they can avoid a write off/loss.
If the new ltv is at 100% or lil less they might foreclose and find a new investor.
It all depends on the Banks policy.
Interesting times. What should have happened in 2020 but the problem was papered over and pushed down the road. I wonder how much worse this will get.
I would like your thoughts on Cap Rate if there is no mortgage in place? Meaning the property was paid in full. Only then can you realize true cap rate. Otherwise with a mortgage in place you would need a 7+ cap rate with commercial loans at the same rate to break even.
The cap rate before or after debt service will still be indicating the value going down. But yes, most real estate people quote a cap rate before debt service.
The debt structure has always been the reason I've stayed in the single family market. But this may make opportunities in the multi family market
Ken, is it possible to 1031 exchange out of a house into a 5+ unit with seller financing? Thank you sir!
I think it’s possible but I think the sellers note or note instrument would have to be issued in the name of the qualified intermediary on behalf of the buyer. A licensed attorney dealing with real estate would know this.
Would a sale leaseback help those with Ballon payments?