Cap rates are the top topic for multifamily investors—especially for Southern California players, where cap rates are at all-time lows. Cap rates, however, can be subjective, according to Mark Ventre, VP at Stepp Commercial. Ventre focuses on the client’s needs rather than on a cap rate. In this exclusive interview, Ventre explains why cap rates can be subjective and how he is advising clients looking for multifamily opportunities.
GlobeSt.com: Can you describe the evolution you have experienced with how apartment investors measure an asset’s value?
Mark Ventre: Some of my favorite conversations are with clients that have owned apartment buildings for a generation or more. They tell stories of days when Westside Los Angeles buildings fetched five or six times gross and they thought that was pricey! They also didn’t care about cap rates, in fact some didn’t know what they were. It was the gross rent multiplier (GRM) that mattered. Investors wanted to know how many years it would take to earn back what was paid for the property in gross dollars.
Then over the past couple decades investors started getting more detailed and analytical, considering metrics like cap rates, IRRs and cash-on-cash returns. The price per foot suddenly became important. But of all these indicators, it seemed the cap rate was king.
GlobeSt.com: How important are cap rates for investors today and are there different ways to report them?
Ventre: Cap rates are very important to investors and are typically the first thing a prospective buyer wants to know about any given asset. That question doesn’t always have an easy answer, however, because of their subjective nature. Cap rates vary based on different investor perspectives. Below are a few different methodologies buyers have when looking at the cap rate: Using in-place rents and a broker’s projected expenses; using pro-forma rents and a lender’s projected expenses; end of year-one cap rate after renovations and new management; the stabilized cap rate after repositioning. These days, other expense factors are sometimes considered when determining a cap rate, such as the budget to seismically retrofit the building (which is the case with a number of older Los Angeles properties). That not only means the direct construction cost, but other expenses such as temporarily relocating tenants while the work is being done.
GlobeSt.com: What kind of impact do cap rates really have?
Ventre: Nowadays most buyers have long-term horizons or aggressive repositioning plays. Either way, the going-in cap rate doesn’t really seem to have as much of an impact. Unless it’s an institutional asset where – depending on the market – one basis point could mean the difference of tens or even hundreds of thousands of dollars, I just don’t see it.
GlobeSt.com: Given your stance on cap rates, how do you advise your clients when they ask you that all-important cap rate question?
Ventre: My response is to ask what is most important to them. If it is immediate cash flow, then I point them in the direction of a stabilized asset that has been repositioned and is achieving market rents. Those assets offer the highest cap rates since most of the upside has already been captured. If they want to roll up their sleeves and renovate a building, then I suggest they move away from the cap rate and consider the return on cost.