Industry Basics and Core’s Use of Cap Rates

Wally Smith:
Okay. Here’s some basics, basics in the industry. Describe what is a cap rate?

Jeff Montgomery:
Oh, no. So, cap rate NOI, net operating income, divided by your purchase price. So easiest metrics, or one of the easier metrics in the industry. A lot more detailed metrics go into our analysis, but cap rate’s a good initial barometer of where deals are. And it’s also a way that we’re valuing properties. So it works both ways. So when we’re looking at a property, we’re looking at, “What’s the current income, in-place income? What are expenses? What changes can we make to that? When taxes reassess, what’s the impact of that?” Ultimately, down to a net income before debt, and dividing that by the purchase price gives us a good point of reference from other assets.

Wally Smith:
Where are they now in multifamily properties? Is there a band you’re looking for? Is it regional?

Jeff Montgomery:
Who are you asking? No. There’s a chasm right now between buyer and seller. So the buyers are coming from a… or the sellers are coming from a market where they were selling a deal six months ago that’s a 3.5 cap market.

Wally Smith:
Mm-hmm. It’s crazy.

Jeff Montgomery:
Yeah.

Wally Smith:
Yeah.

Jeff Montgomery:
But interest rates were in the 2s. You now have a market where interest rates are pushing 4, 5, 6, and you have a seller who’s gone from that 3.5 to now, “Hey, I’m giving you a hundred basis points increase. I’m at 4.5.” The problem is, and what’s creating the divide right now is, the buyer is looking at a 6% interest rate, high 5s interest rate and saying, “Well, that’s too much negative leverage. I really need to be pushing closer to a 5.” So that’s why you’ve seen a lot of the transaction activity of late really just take a pause. So a lot of our competitors, especially institutions right now, are sitting on the sidelines. They have buckets of money. They need to deploy it. But there’s this chasm between buyer and seller of where they view the cap rate value of their property.

Wally Smith:
Can you make up for it with the core plus?

Jeff Montgomery:
We can. That’s one of that aspects of looking at a core plus deal, is we’ll start out with potentially a little bit of negative leverage, but throughout the first year, through executing the business plan and not relying on rent growth, relying on just natural growth through the business plan, we’re able to make up for that negative leverage.