Investors often ask about in-place cap rates on BAM Capital’s acquisitions relative to current interest rates. This relationship tells investors if BAM Capital is creating positive or negative leverage on these investments. While this question is fair, it doesn’t tell the whole story.
CASH FLOW IN REAL ESTATE
Real estate is a cash-flow business. The trick is to underwrite a property not on in-place cash flow but on stabilized cash flow. This calculation gives us a stabilized cap/yield, the most important metric for evaluating real estate. Not only is this metric important relative to current interest rates, but it also gives us the intrinsic value of the property.
IN-PLACE CAP RATE & STABILIZED CAP/YIELD
Below are two scenarios that display the difference between an in-place cap rate and a stabilized cap/yield with the corresponding cash-on-cash yield. Let’s look at the in-place proforma. BAM Capital purchases a property for a 5% cap rate and borrows money from a lender for 5.5%. This relationship represents negative leverage (in-place cap rate < interest rate) as it yields an initial levered cash-on-cash return of 4.25%. Does this initial below-average return make the deal bad? The answer is unequivocally no.
Now, let’s fast forward to the stabilized proforma, which shows the stabilized cap/yield relative to the interest rate. BAM Capital acquires property at a 5% cap rate, underperforming the market (rents below market, occupancy struggles, above-market operating expenses, etc.). All other assumptions being equal, BAM Capital executes its business plan and takes net operating income from $5 million to $7.5 million. This equates to a stabilized cap/yield of 7.5% compared to the interest rate of 5.5%. This relationship is called positive leverage (stabilized yield > interest rate), which now yields a levered cash-on-cash return of 10.50%. Not a bad deal after all.
HOW BAM CAPITAL CREATES INVESTMENT OPPORTUNITIES FOR REAL ESTATE INVESTORS
This example clearly illustrates why the stabilized yield is critical to current interest rates. More importantly, the stabilized yield is paramount to the market cap rate, which creates real value for our investors. In the above example, the stabilized yield is 7.5%, and the market cap rate is 5.5%. This 200-basis-point spread is all profit. Said another way, BAM Capital acquires a property for $100 million with $5 million in net operating income (5.0% cap rate). BAM Capital increases the net operating income to $7.5 million (7.5% stabilized yield). BAM Capital sells for a 5.5% cap rate on $7.5 million of net operating income ($136 million), which produces a levered equity multiple close to 2.0x. So, while the initial cash-on-cash yield wasn’t appealing, the overall investment delivered healthy returns to the investor. That’s the BAM Capital advantage. Learn why BAM Capital is an award-winning multifamily syndication investment company.
Author: Tony Landa, Chief Investment Officer, The BAM Companies
CONNECT WITH AN INSTITUTIONAL REAL ESTATE OWNER/OPERATOR
BAM Capital has been focusing on buying the most profitable assets and staying disciplined in its investment thesis. BAM Capital’s investment strategy aims to create forced appreciation while mitigating investor risk. To date, the brand has successfully managed over $1.7 billion in assets across ~9,000 apartment units. [5]
Remember that no investment is without risk. Before making financial decisions, consult your investment advisor and schedule a call with a BAM Capital investment team member.
Disclaimer: All investments carry risk, including potential loss of capital. This content is for informational purposes only and is not financial, legal, or investment advice, nor an offer or solicitation to buy or sell any security. Consult an independent advisor for personalized guidance and contact BAM Capital for details on current offerings. BAM Capital and its representatives are not fiduciaries or investment advisors. The information provided is general and may not reflect individual financial goals. Any financial terms, projections, or forward-looking statements contained herein are hypothetical in nature and should not be interpreted as guarantees of future performance or safety. Such statements reflect BAM Capital’s opinion and are subject to market fluctuations, economic conditions, and investment risks. Past performance does not predict future results. BAM Capital and its affiliates do not guarantee the accuracy or completeness of this information. BAM Capital offers investment opportunities under Rule 506(c) of Regulation D exclusively for accredited investors as defined by the SEC. Verification of accredited investor status is required prior to participating in any investment.
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