26.8% Cap Rate on His First Deal?? | Office Hours
In this episode of the Commercial Real Estate Investor Podcast, I came across a wild Reddit post about a first-time investor claiming a 26.8% cap rate on a commercial real estate deal. Sounds too good to be true, right? As I dug deeper, the red flags started piling up—sky-high rent, unreal financing terms, and questionable ownership.
This is a prime example of why due diligence is everything in real estate. From verifying ownership to getting an environmental assessment, you must check all the details before jumping into a deal. Don't let flashy numbers blind you!
Let’s break it all down and answer your questions on commercial real estate investing.
Get commercial real estate coaching, courses, and community to jumpstart your investment journey over at CRE Central: www.crecentral.com
Key Takeaways:
Be very cautious of deals with extremely high cap rates (over 10%), as there are likely underlying issues with the property or tenant.
Thoroughly vet the seller and ensure they are the actual owner of the property before proceeding. Verify ownership through title work.
Conduct thorough due diligence, including a Phase 1 environmental study, to uncover any potential problems or liabilities.
Have a commercial real estate attorney review all lease and purchase documents carefully before moving forward.
Work with reputable title and escrow companies, not directly with the seller, to protect yourself from potential scams.
Ensure the tenant's financials and business model make sense for the high rent being paid, as it may not be sustainable.
About Your Host:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors.
Episode Transcript:
Tyler Cauble 0:00
Tyler Cauble 0:00
This episode of the commercial real estate investor podcast is brought to you by my cre accelerator mastermind, where you'll get access to my step by step investment blueprint, essentially a library of resources on how to invest in commercial real estate. You'll get connected to a supportive community of other commercial real estate investors that are doing projects just like you. You'll get personalized coaching and feedback from me every step of the way. Go to www dot cre central.com to learn more. Welcome back to the commercial real estate investor podcast live from the Cabo group Studios here in Nashville, Tennessee. Back at you with another round of office hours. You've got questions on commercial real estate, whether it's investing, brokerage, property management, making money in the business, whatever it is, jump in and ask those questions. That is what we are here for. Today. We're going to be diving into a pretty interesting conversation over on Reddit. This guy found a deal that looks like it was a 26.8% cap rate. We're going to break down what he was looking at in the deal and what the Reddit community's thoughts were on that, because 26.8% cap rate is a hell of a deal, especially for your first one. Before we dive into that, I want to know Question of the day, do you prefer high or low cap rate deals, and why high or low cap rate deals and why? Let's have a conversation about that. Today will be an interesting one, for sure, because everybody has very different opinions on what makes a good cap rate and what doesn't. This past week, what have I been up to? I was out in Atlanta for a Siri accelerator event. It was actually put on by one of our pods. So we have accountability pods that are broken out for the whole group. So, you know, there's over 100 members now, we break them out into four to six person accountability pods that meet once a week or once every two weeks for an accountability session, right? They'll sometimes underwrite deals together. They'll go find deals together, work through problems, whatever it is, and this group decided to put together a two day workshop down in Atlanta, meeting with a private equity firm down there. I came down and we ran a workshop on underwriting. It was, it was a lot of fun, but a lot of travel, because I went from Nashville to Chattanooga on Tuesday night, Chattanooga to Atlanta on Wednesday morning, back to Nashville on Thursday morning, hopped on the plane for Phoenix. Thursday afternoon, had a an old buddy of mine. We've been friends since kindergarten. Is getting married in May, and so we flew out to Phoenix for his bachelor party. It was a lot of fun. Had a good time. Haven't spent much time out in Phoenix. I mean, you guys saw that I was out in Sedona hanging out with Ken McElroy, but haven't really spent any time in Phoenix proper. And I hear that this is the perfect time of the year to be doing that, like mid February, because it's not too hot. I mean, it was like 75 or 80 degrees every day. Got some great golfing in. Went on a pretty insane hike. I'm a big hiker. We went out to Glacier National Park a couple years ago. That was that was a lot of fun. I've never done a hike as technical as the one that we did in Phoenix. It was called Camelback Mountain, or something like that, or the Camelback trail. And there were parts where we were literally rock climbing, which was kind of wild. It was a hell of an incline. So we had a good time. Got back on Sunday night and back at it yesterday, recorded a couple of videos. So excited to be back here in the studio with you guys, diving into things. Vicin is saying good morning Tyler. Morning. Vicin, good to see you here. Jorge is saying good morning Tyler. And all participants welcome Jorge. He's also saying, Tyler, thanks again for all of your insights and encouragement. I'm doing preliminary work on a project. You have been an invaluable asset. I appreciate that, Jorge, thanks a lot. I'm glad to hear that I do everything that I can to provide as much information on commercial, real estate, investing and whatever else about the industry as we can on this channel. I genuinely enjoy it. It's a lot of fun. So glad to glad to be a resource. Charlie saying, morning, dude, great call last night. Morning. Charlie, what's going on? Man, yeah, we had a great accelerator call last night. So, so when I was in Atlanta last week, I pitched to that to that accountability pot. I said, Hey, what could I do to, you know, just continue to improve on our group coaching calls. Because typically the format is, we'll review two to three deals that students submit, and then we just kind of popcorn questions around whatever anybody is thinking of that day or what they're dealing with. And Allie, one of our one of our members, said, Well, you know, you ask a question of the day on the live stream, why don't you ask us a question of the day in the group coaching calls? And I was like, That's a brilliant idea. Why haven't I thought about that? Because it helps split. Mark the discussion. So I thought that we had a pretty good question of the day last night for the CRA accelerator, because it really ended up sparking a pretty great discussion. And it was, what is the one thing that if you mastered today, would help you grow the real estate portfolio of your dreams? And so we ended up talking. We had some some feedback that estimating construction costs was one of those items. So we actually spent, I don't know, 30 to 60 minutes talking about construction costs. How to estimate that. Everybody started jumping in and sharing certain things. You know what? One member was like, Hey, how much does a roof cost? And so everybody started jumping in saying, Well, I just got a quote for, you know, $12 a foot. I just got one for $16 a foot. I just got one for $10.37 a foot. I think I just got one for $9.81 a square foot. So having a group like that, and having all those resources, it's pretty nice, right? Because we actually decided last night, why don't we start keeping track, keeping a database, of all of the construction quotes that we get, so that we can very quickly and easily look at these numbers and put together some rough underwriting and so that's what I'm working on now, is compiling all of our construction estimates, everything that we've gotten from the property management company. Property management company, what I've done on the on the development side, we've got some students that have done their own projects that are that are contributing their numbers as well. And so we're going to build up a nice little database of our own construction costs so that we can just, you know, use that as a major resource moving forward. So glad you enjoyed it. Charlie, it was a great call. I thought last night was one of our better calls because of that. So it was really cool to see that kind of take place. Dan is saying, what areas of commercial real estate today excite you the most good question? Dean, sorry, Dean, that's a good question. So I, I like self storage. I think the right deals make a lot of sense. I like, I mean, I'm still a big proponent of smaller neighborhood mixed use, right? You know, projects like the wash, it's not necessarily mixed use, because it's all food and beverage. But you know, these smaller deals where you can really focus on cool, experience oriented, local businesses, that stuff really is exciting to me. One, because it's place making, right? You're creating something unique. Two, it actually positively contributes to the neighborhood. But three, there are a lot of small businesses out there that do not have space or can't afford what's going on the space so very important to be able to have that. All right, let's dive into this article over here from Reddit, and then we'll get back to you all's questions. So I thought this was pretty interesting. I saw this yesterday, and it's and it's titled, would love some feedback on my first ever commercial real estate deal. And I gotta tell you, when I was looking at this thought, man, if this is their first commercial real estate deal, good for them. And also, what a spoiled way to jump into the commercial real estate market, because you're gonna have a hard time finding another deal like this. They purchased a location with an existing dog grooming tenant. As a business, negotiated the purchase price to $210,000 down from 250k financials, they're putting down 50% and the seller is actually carrying a seller finance note at 50% it'll have a 10 year balloon at 5% interest. That is one of the reasons why I love negotiating seller financing so much, because you can get much better terms than you ever could with a bank, right? So 5% interest for 10 years, killer deal, and it's low risk for the seller too, right? Because they've got 50% down right. Rent year one is $5,000 a month, triple net. That's crazy to me that the dog grooming business is paying 60,000 a year, triple net, with 5% increases per year. They've got a personal guarantee a 12 month penalty, should they want to terminate early, and comes out to be what they think is a slam dunk. So super high cap rate, 26.8% when I was running the math, though, I actually came up with a different number. They're saying 26.8 when I run 60,000 a year divided by $210,000 I'm getting a 28.6% cap rate. So I'm not sure maybe they're basing that 60,000 off of the original ask of 250,000 nope, different number altogether. So who knows? Sometimes, sometimes math is hard in commercial real estate, they were saying debt service coverage ratio is 6.76 6.76
lenders were. Require you to have a 1.25 so to have a 6.76 is pretty insane. Typically, if I see a debt service coverage ratio that high, I want to put more debt on the property because that means that we're just not unlocking the full value of the cash that we possibly could be but it always depends, right? I mean, maybe this person just wants something that's super secure, that they never have to worry about. And, you know, 50% down tough to argue, right? Or 50% seller carry, they're saying they're getting a cash on cash return of 45.7% annual debt payments are only $8,315 that's pretty crazy. So, oh man, they are saying, in the future, if they don't have enough to leverage this to buy more, they could pay off the financing early, they could recoup the down payment and have a money printer. I mean, it's, it's definitely one of those deals. I probably wouldn't even touch the financing for a long time, because it's going to be a while before you start to see 5% interest from banks, in my opinion. So one of the first comments saying, I would say this deal is suspiciously good if the numbers are correct, especially for your first commercial transaction, I'm assuming you did not have a commercial broker representing you. Did the seller have anyone representing them? If it was Fizbo, then there was a chance you lucked into something, and a seller desperately needed cash, but most likely, you got scammed in some way, confirm the financial status of the tenants LLC and have a real estate attorney look over your purchase and paperwork has somebody else underneath them is saying too good to be true. Why would a $5,000 rent building sell for so little? I agree. I mean, there's, there's a lot of red flags with this, right off the bat, right? I mean, if, if somebody, if a seller, could make more off of selling a building, they would do that like there's no reason for them to just give a random stranger a discount. And if you're sophisticated enough to own a commercial building, chances are good you're not so unsophisticated that you'll sell it for a 26.8 or 28.6 28.6 whatever it is, percent, maybe they have dyslexia. They took the 26.8 when it was 28.6 you know, why would they sell it for that cap rate? I mean, even a 10% cap rate is still an incredible cap rate, and they would get twice the money. So seems like something's going on there. I wonder if it's really 5000 triple net. That's why it's so important to get in there and review the leases. That being said, These deals are out there, right? I mean, it's not entirely uncommon for a deal like this to happen. I have seen them before in my 12 years of commercial real estate. I wouldn't say that it's common by any means. It's certainly not, but every now and then you can find a deal this one person saying, I've never seen 5% annual increases, pretty insane. That's not necessarily true. I mean, three to 5% is pretty standard in terms of annual increases, generally, like here in Nashville, we see closer to 3% but it depends, right? If it's a smaller space, you know, we'll, we'll typically lean more towards like 5% annual increases. Because, if you think about it, I mean, let's just say that your rent is, you know, $1,000 a month. If you're increasing by 5% that's 50 bucks, right? It's not much. So you go from 1000 to 1050 a month. Not a big difference there for the tenant, but on a percentage basis, big increase for you as the landlord. Yeah. The only issue here is the cap rate. Usually anything over 10% means there is something wrong with the property. Exactly. That is why the question of the day is, what do you prefer high cap rate or low cap rate deals, and why? For me, I'm more middle of the road. I like to see something that's probably under a 10% cap rate if it's already existing, if there's already a tenant in place, because I know that anything above and beyond that, again, a seller is going to be asking a much lower cap rate if they could right. And so something is wrong with the property, either the tenant credit is poor, the building is in poor condition, something like that. Maybe there's environmental issues. Something is going on behind the scenes that is causing that to just not be a great deal. So let's see. It does seem too good to be true, which makes me wonder, if the seller knows something you don't. Is there possible environmental issues you'll be on the hook for? What were the previous tenants? That's a good point. What if there was a chemical spill on the property that the seller knows about? Are they are sellers supposed to disclose that absolutely do. They always, no, they don't, because they'll just play like, Oh, I didn't know that that was going on, and now you're fully responsible for it. So always important, when you're doing deals like this, do your due diligence. Go in there, make sure that you're getting the Phase One environmental you're doing the survey, you're doing the proper title work. You're vetting the tenant, you're reading through the lease, or having a even better the commercial real estate attorney read through the lease, because all it takes is one word and on one page in one massive document to completely change the outcome of that deal. So important to keep that in mind. Let's see. Something seems fishy. Oh, here we go. A lesson I learned very early on. It's another comment. You want to be very wary of any deal north of an 8% to 10% cap rate. Once these deals start trading at unbelievable returns, then something might be wrong. Remember, the seller knows this property better than you do, and nobody gives away real estate for free. A few things you should investigate, make sure the seller is actually the owner of the property, who I actually encountered that a couple years ago, we went under contract on a deal right up the street from my office because one of my brokers found it and it was off market, and it was a crazy good deal for the dirt. And it gets over to the title company. They start doing the title work, and they caught it, and they were immediately like, hey, this person is a known scammer. They don't actually own this property. They just tried doing this on another one to try, they wanted us to give, like a non refundable earnest money deposit that would be immediately released to the seller. Obviously, right? That's not uncommon, but if somebody doesn't own a piece of property, that's how they're trying to make money, right? So make sure the seller is actually the owner of the property. Don't ever give somebody money directly. Make sure that you are going through a title company, or at least your attorneys or some sort of escrow account. First, do a phase one environmental study to make sure the site is not at risk for contamination. Work with a major national title and escrow company. Have title, give you a prelim and make sure you understand everything recorded against title. Make sure you're getting a grant deed once you buy the property. Those are some pretty great tips. I mean, as you're going through this, definitely wanna make sure that that you're just doing that due diligence. It's always that. But, yeah, I mean, this was the question I had somebody saying a dog grooming business is paying 5k a month on a building worth 250,000 I mean, 5k a month is that's a lot of money for a dog groomer, right? I mean, it doesn't make a lot of I mean, look, it could be a crazy market where, you know, just everybody has a dog and they get them groomed all the time, but $5,000 net, right? That's just, that's just the rent, right? Typically, these businesses want to be at like a 10% to 20% maybe operating expense ratio for their rent. So if they're paying $5,000 a month, net, right, they want that to be 10% I mean, obviously you're gonna have utilities, Cam, tax, insurance, all that kind of stuff built into it too. So it's actually less than this, but they would need to be making $50,000 a month, maybe $40,000 a month, in order for this to really make sense for them. That's a lot of money for a dog groomer. And I just have a hard time believing that a building that's $250,000 is going to be in an area where people are spending a lot of money grooming their dogs. So I don't know, what do you guys think? Did this person find a deal, or is there something that they should really be looking into a little bit more? Let me know in the comments. I think it's really interesting. All right, let's see what we've got here. Coming back into the questions Jorge is saying, also, I have a great book for you, building small by Jim Hyde, discusses the value of small, incremental products, right up your projects, maybe right up your alley. I actually know Jim. I spoke at his event when he came to Nashville not too long ago. I've talked to him about getting involved in his group a little bit more. Jim's a great guy. Love what he's doing. Jonas saying, morning, Tyler, when you're pricing out land, do you usually do a residual sort of analysis or look at it price per acre? It's good question for me. It's, it's price per acre. I know that. You know, some underwriters, some some analysts, they'll look at it on a residual basis. To me, it's all about the price per acre. I want to see what the hard comps are going for, just because I can't, like, a residual basis is basically saying, you know, if, if I can come in here and do multifamily, I can afford to pay x, if I can come in here and do a single family home, I can only pay one half of x right? So to me, just because I can do a
lot more units doesn't mean that I should pay more. If the comps are saying on a price per acre basis, it's going for something lower, right? So that's kind of how I look at that. Now, on the underwriting side, if you're going to buy a property. Be that having the residual analysis in there will help you understand the maximum amount that you can pay, right? There's market rate, and then there's what you can afford to pay. And those are two two different things, right? Just because, I mean, just because you can afford to pay more doesn't mean you should. So that's how I feel Have you watched any Ben Mala YouTube episodes and thoughts? Jonah, no, I haven't. I know who Ben is, and I've seen a couple of his videos pop up on my YouTube page every now and then, but I haven't really watched any of his stuff. John, good morning. Tyler, I'm a new commercial real estate agent. What are your top recommendations for getting new leads. John, go cold call like a maniac, knock on doors and go meet people in person and go to as many networking events as you can. Right? The more people you know, the better opportunities you're going to have for putting a deal together. So highly recommend just getting out there, just putting yourself out there. Chris is saying, Good morning, Tyler, any tips on finding local commercial real estate mentors? Yeah, Chris. I mean, kind of like what I was just telling John over here. Go out network. Go out and meet him. Go to the local Uli events, CCIM events, real estate investor events, whatever it is, and go out there and meet them. That's the best way to do it, right? Just build a relationship. And don't immediately ask somebody to be your mentor. Go meet them a few times, ask them out for launch, buy the launch, provide them some sort of value in some way, and build a relationship, and it will happen. Vign is saying, Tyler, what process does a broker do after finding multiple commercial buildings, vivid Vic and in what sense, like, what what do they do to get them listed? Or what do they do to analyze them? Let me know in the comments, kind of just clarifying your question a little bit. Troy, my partners and I bought an old tire shop rental lobby area for commercial commissary 4000 square feet to food vendor rental space. But thinking of doing triple net for other 4000 square feet, thinking of splitting 2000 to two to 2000 square foot spaces. What do you think also, would it be wise to allow new tenants to freely do what they want with 4000 or 2000 square feet? Yeah, Troy, I mean, look, I'm a fan of splitting up spaces into smaller spaces, right? Like, it's far more affordable for you to be able to come out and do that. I think that, you know, if you can even get maybe three spaces in there that are, you know, 12, 1300 square feet. Instead, you'll be able to charge a higher price per square foot for the rent, and probably end up netting more. So that's what, that's what I would look at. You know, keep in mind, converting to a commissary is very expensive. You know, the wash was like $1,000 a square foot for the full renovation. Now, we had to pretty much redo everything on that, but when you're talking about a grease trap, three compartment sink, a walking cooler, a hood vent, all that stuff starts to really add up and can get very expensive. So as far as like letting them freely do whatever they want, yeah, absolutely not. I would never let a tenant just do whatever they wanted within a space. I would recommend, you know, having covenants and restrictions within the lease as to what the tenants are allowed to do. We always have a permitted use right, which is what the tenant is allowed to use the space for. So you know, if we're signing a lease with a dentist, their permitted use is going to be as a dental office. So if they ever come in there and try to open up a yoga studio, we can say you can't do that. That's not your permitted use for this space. It's good to have control over that, because you just never know. Sometimes people want to completely change up what they're doing there because something's not working, and that could either compete with another tenant or just be bad for the building overall. Carlos is saying, Hi Tyler. Hey Carlos. Hope all is well down in Jacksonville, Chris is saying, Thanks, brother, absolutely. Chris, happy to do it anytime. Appreciate you guys. It's been a great episode of office hours. I've got to run out to salt ranch and do a quick construction meeting before I head to another interview podcast that I'm doing today. So thank you all for joining me every morning Tuesdays 8:30am not every morning. Every Tuesday morning at 8:30am Central Standard Time. Don't forget to like and subscribe if you are enjoying office hours. And I will see you guys in the next one. This episode of the commercial real estate investor podcast is brought to you by my cre accelerator mastermind, where you'll get access to my step by step investment blueprint, essentially a library of resources on how to invest in commercial real estate. You'll get connected to a supportive community of other commercial real estate investors that are doing projects just like you. You'll get personalized coaching and feedback from me every. Step of the way, go to www dot cre central.com to learn more you.
In this episode of the Commercial Real Estate Investor Podcast, I came across a wild Reddit post about a first-time investor claiming a 26.8% cap rate on a commercial real estate deal. Sounds too good to be true, right? As I dug deeper, the red flags started piling up—sky-high rent, unreal financing terms, and questionable ownership.