What’s a Cap Rate? Cap Rates with Mark Illsey

David Moore: Well, David Moore, Equity Advantage. Mark Illsley, CBRE. And we’re back for one last segment.

Mark Illsley: All right.

David Moore: So, first, I got to give you a hard time about that big old CCIM thing on your lapel there.

Mark Illsley: It’s almost like a shield.

David Moore: That’s a new pin. Is that bulletproof or something? I mean, it could save you.

Mark Illsley: They used to be smaller. It’s the new design that they have now. And I think it’s for our generation. We don’t see as well. So, they had to make the pin bigger so we could tell what it said.

David Moore: Got it. Got it. So, what is CCIM?

Mark Illsley: CCIM is a… It started 55 years ago or so as an education association, teaching people about how to invest in real estate. And it was primarily for real estate professionals. And they weren’t getting the education in school, in colleges, because they really weren’t teaching. And I was part of that generation. At my university when you were getting something in real estate, it was appraisal finance. That was a… And there’s a lot more to it than that. And so, that’s what started. And certified commercial investment member, and it’s an association, like a CPA. They liken it to a graduate degree in real estate.

David Moore: So, a few years ago, you were the grand-poobah, the president of our local chapter. And that was a good year. You actually had to tolerate me on the board, that…

Mark Illsley: It was two years.

David Moore: In a row. Yeah, that’s right. It was… Since two years. It seemed like one. It was so much fun.

Mark Illsley: Well, I didn’t get it right the first year, so they told me I had to do it the second year. But it was two years. And then I was regional vice president for CCIM and on the CCIM board, and then they got tired of me. And so, I retired from CCIM board.

David Moore: So, what’s interesting, and for those of you out there that watch our videos, I jokingly tell them a lot of times, if somebody’s having a hard time to fall asleep some night, they can turn the video on, it’ll put them right to bed. But you’ve probably heard me say before. I came to Oregon in 1990, and the guy that dragged me here was a early CCIM pin holder. And we’d just go into an area and pick up the book and see who was CCIM in that community. And we figured they had that level of professionalism. And that’s how I met Mr. Nelson years ago. And a lot of my great friends are all part of that CCIM community. And for people that call up, a lot of times, they’ll ask us, “Well, how do I find a good CPA or lawyer or someone like that in a community?” And I often say, “Well, look up the CCIM site, call somebody and see who’s there.” Who’s active in that community, who goes to the chapter meetings. And we’ve got good tax and legal people there too.

But, the reason I brought the pin up is we’re talking about cap rates a little bit. And I’d sort of like your opinion, first off, tell the audience, what it is, but sort of what you’re seeing with cap rates today and how they can be manipulated too. How come they may or may not tell you what you think they’re telling you?

Mark Illsley: Cap rates are just a value determiner. It can be a simple formula, or in the Harvard Business Review, 10 years ago, I read a 19-page article on cap rate, and the formula they used for that, it was way beyond what I could understand. And I had been in the industry 30 years by that point. But, it’s just a value determinator. And cap rates can be manipulated by the change in income. They can be manipulated by 100 different things, but I just kind of take a look at seven or eight of them. Vacancy factor can be one. Cost of debt is another, if you’re going to be borrowing. That affects cap rates.

The internal rate of return that you want to get on the property or return on investment is part of it. There’s just different aspects that can manipulate a cap rate so that it can be changed by half a point to… Just within certain parameters or even greater than that. So, when interest rates went up so fast a year ago, cap rates moved up, value dropped because you couldn’t maintain value if you didn’t have the same amount of change, proportional change, to your revenue stream to increase your net income. So, your value had to drop based on cap rates.

David Moore: Yeah. It’s one of those things where you just hear, everyone throws it around. But, I really sort of feel as though if you look at the professional real estate community, there’s such a difference between somebody that sells houses and somebody that sells commercial property. One is all driven by numbers. Everything is about maximizing. The other one is the color, location. I mean, location, location, location’s always there. But, the emotional stuff, like you’re saying. And I think it’s really important that when you’re… If you’re going to go into some area of investment, get the best people you possibly can. Don’t just ring a broker that happens to sell a house if you’re buying a mobile home park. It’s really important that you’re working with people that understand the product that you’re working with and how to analyze it.

And as I said earlier, it’s not just the analysis of it. You’re going to make your money when you buy it, right? You’ve got to have that idea, what you’re going to do with it, how you’re going to do it. And it was interesting, a couple weeks ago, we had a company approach us wanting us to send investors their way. And so, I’ve got one of my closers in here, only does institutional investments at Delaware Statutory Trust or institutional ticks. That’s all he closes. And this guy that this company had approached us, and the CEO was the guy that had made his money selling a food service. And he’s a young guy. And then I said, well, okay, so, let’s find out, one, how long this company’s been here? Two, who’s at the helm? Three, who’s in charge of acquisitions? What’s their background? And four, like you said, the management. It’s okay, who’s managing these assets?

David Moore: And then you look at top to bottom on this company. It was really pretty entertaining to me because the company’s only a couple years old. The guy, the CEO was a tech guy that had gotten into real estate. Now he’s got this fund he’s putting together. The director of acquisitions had 10 years in real estate, but primarily in residential. And the management was run by a guy that had just graduated from college last year. So, I guess the long and short of it is what do you think the odds of success are? I think we’re in a market where the people you’re working with in this business, if you’re looking at real estate today, I think there’s a lot of people since the last crash.

We were talking about… If you could, fog a mirror in the last decade, you’re probably making money on the real estate. But now we’re at a point where you better know what you’re doing. And my general rule is when I’m talking to investors, they’re looking for different things, is you better be working with somebody that’s been through a bad time. Because if they haven’t been through a bad time, they’re probably not prepared to.

Mark Illsley: Well, I have an anecdote to that. We were in a meeting at CBRE, there were 60 brokers in the room and our manager here in Portland said, “Okay, I want to take a survey. How many of you were in the industry before 2010?” And I think out of the 60, there were 15 people that raised their hand. So, a lot of those had not been in there during that first crash. Then he asked, “Well, how many people were in this in the 1980s?” And only two of us raised our hand. And he was going to move on, and I said, “Well, can I ask one question?” I said, “How many of you were in the industry in the 1970s?” And I raised my hand and there were several young people there that go, “Whoa!” Like I was ancient. But there are people who’ve been in the industry since the ’70s who’ve been through a lot of the different recessions, seen a lot of different changes, and sometimes that experience has value. I hope.

David Moore: I always like to say, I am always happy to learn, I’m tired of being taught. You know, got kicked in the head so many times.

Mark Illsley: Yes.

David Moore: So, with that said, and we’re about done today, we got to get you out of here. But with that said, we talked briefly, you talked that scope from the ’70s on, that’s a broad scope of work there.

Mark Illsley: Yes.

David Moore: And you’ve experienced a lot of different things. And my feeling is, once again, work with people who have been through it because you don’t want to have to be taught these things on your own, right? So, if we look at the interest rates today and I think we both saw a big reaction when those rates went from… By the way, what do you think money should cost?

I think since the last crash we had free money and I think people got used to it and they thought that’s the way it is. But if you just look at how a bank works, a bank historically has worked, you deposit X and they pay you Y, and they loan at Z, right? That’s the whole economy of the thing. So, I think that if we look at the rates today, what are your feelings about the rates today? And are they pretty close to what they maybe should be? Are they high/low? And we hear talks of dropping and some of the conversation with them dropping, I think is stifling some of the movement today, Because people are just sort of hanging onto that hope it’s going to go back to free money again.

Mark Illsley: Well, I guess you have to ask, why do interest rates drop? And interest rates drop because there’s a lot of capital that’s been brought into, whether it’s created by just computers creating money and putting it into the banking system or other international communities bringing money in. Or you’re trading out of one asset type, and putting it into the banks to hold for a while you make a decision on another asset type. So, that can cause interest rates to drop. And we saw, traditionally in my career, interest rates were somewhere in the 5 to 7.5 or 8%. And I was in the industry when interest rates were in the 15-16%. But people were still making acquisitions because they felt like the value of the property was going to go up because of inflation and because of long term holds.

So, they knew that that interest rate that they were borrowing at you were going to get a greater appreciation if you held it for a long time and you could refinance out. That was the hope back in the early ’80s, whether it was residential or commercial. And we’ve had a whole different change in the commercial market. At the time, in the early ’80s, most people who owned real estate, it wasn’t investment real estate, it was companies who built real estate to run a business. And so, the investment market has changed since the early ’80s. There are more people who are now interested in real estate. My dad was just, I guess lucky that there were some people who were making money in real estate and he just kind of held on to their coattails until he and some of his friends left and did their own thing. They learned from other people. But the market’s changed.

David Moore: A good mentor.

Mark Illsley: Yeah. They had good mentors.

David Moore: So, you made a comment earlier about different investments, like stock market, for example. And if we go back to… And we are going to retitle it, but take a look at Ask the Geezers. Nelson had sort of a gem in there and he made a comment. He says, “Real estate’s not a get rich quick scheme. It’s a get rich slowly but surely scheme. With one golden rule. Don’t get yourself in a situation where you’ve got to sell in a recession.” And I think you made a comment earlier that if you’ve got an unencumbered piece of property, it may fluctuate up or down in value. Even a bad investment will write itself over time.

Mark Illsley: Yes.

David Moore: But it won’t go away with it. On you. The only way it’s going to go away is if you don’t pay the property taxes, state, FED, somebody takes it from you at some point. But Wall Street, it could just be gone.

Mark Illsley: Well, what I don’t think people understand is when you’re investing in stocks and whether it’s… Let’s just take stocks. The broker’s company is buying the stock for you, but it’s in their name. And if that stock, company, that fiduciary goes away or goes bankrupt, they take that asset. And so, you don’t own the asset. That’s interesting because when you own real estate, today, you own real estate. And yes, you may have some debt on it, but today, you couldn’t borrow more than 60-65% on that asset. So hopefully you purchased the asset, so that it doesn’t go into foreclosure, but you own that asset. If I were to take the same amount of money and invest it in and give it to a stockbroker, the stockbroker’s going to buy $1 million worth of stock for me but it’s in their name. Well, that’s… I feel as riskier, riskier than buying real estate.

David Moore: Yeah, it’s interesting. Well, thank you so much for your time today. As always, it’s great to have you here.

Mark Illsley: Thank you.

David Moore: You want to let people know how they can reach you if they’ve got questions for you?

Mark Illsley: Sure. Mark Illsley with CBRE and my phone number’s 541-941-2341 or [email protected].

David Moore: Thank you so much. Really enjoyed it.

Mark Illsley: I did, too. Thank you.

David Moore: And I look forward to getting out there and playing with you again. We got to get out there and ski on some water or ski on some snow. It’s been too long.

Mark Illsley: Yeah, well, it has been too long. And since you were a swimmer, I got to get you back in the pool.

David Moore: Never.

Mark Illsley: Since… Yeah, never?

David Moore: Never, never.

Mark Illsley: Bad memories?

David Moore: Yeah. Yeah. Not good memories but a lot of chlorine.

Mark Illsley: Yeah. Thank you.

David Moore: Thank you very much for joining us, and don’t hesitate to reach out if you’ve got questions on something we talked about, or you’d like a video on something else. Give us jingles, shoot us a message, we’re happy to provide content to help you understand things and take advantage of opportunities that might be out there.