What are Cap Rates and why do they matter to syndication investors?

You might wonder what kinds of metrics should guide your decision-making process as you consider one investment opportunity as compared to another. At Syndirater.com, we emphasize the track record of the syndicator / sponsor / operator (people tend to use these terms more or less interchangeably) you are working with. Those that share transparently about their track record, are honest about the things they've learned along the way, get you the information and tax documents you need in a timely fashion--those are the kinds of syndicators we like to work with.

But is that enough?

A good syndicator can cover for a multitude of sins. If the deal's not a great one but the syndicator has a lot of skill and experience, they may still pull off a good return for you. A lousy syndicator can mess up even the best of deals through ignorance, neglect, not having a good team around them, and so forth.

What makes for a good underlying deal, though, you might ask?

One of the many metrics that you will no doubt pay attention to is the Cap Rate, or Capitalization Rate. This simple metric tells you something basic about the relative cost of a deal compared to other, similar deals, now or in the past. Investopedia offers this definition:

The capitalization rate (also known as cap rate) is used in the world of commercial real estate to indicate the rate of return that is expected to be generated on a real estate investment property. This measure is computed based on the net income which the property is expected to generate and is calculated by dividing net operating income by property asset value and is expressed as a percentage. It is used to estimate the investor's potential return on their investment in the real estate market.

We think that's a pretty good, straightforward definition. For us as Limited Partners (LPs), we use a glimpse at the Cap Rate is a way to gauge whether the deal is priced reasonably or not. When you are a buyer, the lower the Cap Rate, the more expensive the deal. The higher the Cap Rate, the more reasonably the deal is priced.

These days--2022--the word on the street is all about "Cap Rate compression." What that means is that Cap Rate are getting lower in many markets. That means also that the amount that people are paying for various forms of commercial real estate, such as multifamily real estate, is rising compared to the rents that are being extracted from the properties (calculated by the Net Operating Incoming, or NOI). While rents are rising across the country--which in turn should drive a higher NOI for many properties in many markets--the cost the syndicator has to pay to acquire the property is rising even faster right now.

What is a range of Cap Rates, you might ask? Well, twice a year, the firm CBRE releases a report answering just this question. Their most recent report is out now and accessible online. If you want to go deep on this topic, you need look no further than this report. If you'd like one investor's take on this recent report, Neil Bawa has a good short video interpreting the data on his website for the firm Grocapitus Investments.

There's no one perfect Cap Rate that makes a deal a good one. If you get a Cap Rate these days of, say, 4.5 in a very hot market in the United States Sun Belt--in Austin, TX or Fort Myers, FL--you might jump at the chance. In a slower growing area such as the Midwest, you might be more excited about a much higher Cap Rate, say, a 6.5 Cap Rate--and not even consider a deal with a Cap Rate under 5. So the context matters enormously--and it pays to know your market, your operator, and the many other factors that go into deal analysis.

What we do know is that these days, Cap Rates are generally getting lower--or compressing--across the appealing markets in the United States, especially for multi-family syndication deals. That doesn't mean you can't find a good deal, but it does mean you have to be choosy, take your time, and consider a range of factors as you decide where to invest in private syndications.