Multi-Family Cap Rates

for NYC properties, that CAP rate is about right

... and one of the key pieces of evidence that the bubble mentality remains strong. A cap rate at that level offers no return unless you anticipate rapid rent rises or even lower cap rates in the future (i.e., bubble growth).

Pre-2000 (and for larger properties today) a cap rate this low would have been unprecedented.

How does financeguy explain that a bubble has existed for over a decade (since pre-2000) and "remains strong?" Shouldn't the "laws" of finance or economics kick in at some point to take away the bubble money?

meant Manhattan, not NYC

I assume Brooks2 means "right" in the sense of "that's market pricing now," not "that's pricing at which one can expect to make a profit." Absent expectations of rapid future price increases, no one would be willing to hold the equity interest at a lower expected return than the safer mortgage.

Bubbles depend on buyers and sellers believing that prices will continue to rise faster than underlying costs or income. Eventually, those expectations change and prices drop.

No economic theory, so far as I know, has much to say about how fast bubble expectations change (except for ECMH/rational expectations theories that falsely assume no one ever has bubble expectations in the first place).

Historical experience is mixed.

Sometimes bubbles end quickly. On the demand side, sometimes prices get so high that the pool of eligible buyers disappears and lenders get spooked. That didn't happen in NYC -- our buyers are rich and our lenders are brave.

On the supply side, sometimes inventory suddenly soars, as bubble speculators conclude the end is nigh and race for the exits, as happened in the dot.com bubble. And sometimes supply rises rapidly, as in tulips or Nevada suburbs, when suppliers discover that they can make huge profits giving the speculators what they want.

But all RE markets move slowly, and NYC slower than most. Supply can rise only as fast as conversion, building, renovation, and gentrification, and those take time. And inventory can remain tight even as supply increases if potential secondary market sellers continue to expect bubble price increases.

It is not uncommon for RE bubbles to take as long or longer going down as going up. In Japan prices have been dropping for longer than they rose.

Still, we know this. A market in which investors expect to lose money on investments unless they are rescued by an investor thinking the-same-way-but-more-so, is not a stable market.

Long term buyers should be planning on significant (real) price drops: supply will slowly increase so long as builders can profit by building and landlords can profit by converting rentals to sales. Eventually, cap rates will return to levels that allow investors to make money from the investment and not just other "investors."

Short term -- anything is possible. American buyers and sellers might decide that Euro/Chinese investors are going to decide that losing 20% in NYC is better than their alternatives, and rush to buy first. They might imagine that NYC is suddenly going to add gazillions of high paying jobs, driving rents up as employment increases faster than construction. Or not. Expectations about other people's expectations are hard to predict, especially about the future.

Cap rate is definitely 4-5% right now for large luxury-ish multifamily buildings in Manhattan. More like 5-6% in Brooklyn. It seems to me that cap rates for multifamily townhouses, walkups and tenements are often quite a bit higher, but I don't pay close attention to those.