I get this question all the time so wanted to clear the air a little…
8% cap rates aren’t out of the ordinary for certain areas of any state and country. Yet, as an example 8% caps in the actual city of Seattle should be impossible to find while they should be the norm in areas in the distant suburbs (Renton/Tukwilla/Auburn for example). This isn’t any different than the stock market really, there are lots of stocks that aren’t exciting for a lot of people due to the risks or perceived risks and thus those stocks are cheaper. The things you need to balance are…
- If the return is so good, what additional risk am I taking on? You are being paid the extra cash for extra overhead/maintenance/instability?
- Why haven’t the most experienced investors already purchased this property? As Mark Suster says, why are you so lucky?
- Is that risk real? Does the price accurately reflect the extra overhead/maintenance/instability?
- Are you willing to take on the extra overhead/maintenance/instability in exchange for the extra cash being offered?
- Do you have an edge in how you operate the property (Lease stabilization, lower cost for maintenance, lower cost for capital improvements, financial engineering)?
This basic principle holds for all investments, if you see an opportunity where the reward seems to be outsized from the norm of the market there is a reason. You’re job as an investor is to figure out that reason and determine if it is one that you can deal with. It is true that beating the market return requires work…. hard work… but that doesn’t mean it isn’t impossible – most people try to avoid doing any real work when it comes to investing. The thought that you can create wealth for yourself by simply investing vs. working for an employer seems to get most people into the mindset that the money is free. This is why real estate and all investing sucks… no you’re not working for an employer… but you are WORKING. It’s a lot of work, if you don’t love the actual work then you’re probably better being a passive market participant and just take the market return (use publicly traded liquid real estate funds if you want exposure to real estate).