Importance of buying below market value for buy and hold investor?

Question

Obviously for flipping poperties buying below market value is a must, but is it as important for a buy and hold investor? I have found a property that is at market value but cash flows well. List price is $79,000, no major repairs in the foreseeable future and a new rent lease has just been signed for $1100/month. With 20% down and 30 yr financing this easily meets the 50% rule, but I'm dragging my feet because of the market value aspect. Any thoughts or suggestions?

Brian Burke · Answer

At some point you will want to sell this property, whether to just cash out and retire from the business, or to trade up to a multifamily or commercial property.  When you sell, you'll have costs to exit...I count on 10%. Five to six for commission, one for closing costs, a couple of percent for pest repairs or whatever.  If you buy at an 11% discount, one dollar of appreciation is one dollar of profit.  If you pay market value, the market has to go up 11.1% just to break even.  That doesn't mean that there is never a good reason to pay market value, but I avoid it as much as possible.

Steve Babiak · Answer

In the event you have to sell in a hurry, chances are you will take a loss if you bought at full market value; you try to sell to some investor, and that investor will definitely want a discount so there's room to profit!

Bryan L. · Answer

This question came up recently on another thread.  And my reply is the same.  I'll sell you every rental that I have at market value.

Serge S. · Answer

This is the same question I am debating in my market right now. Buying below market value will give you another exit strategy. I've bought many properties that looked great on paper only to find out that the home attracted the wrong type of tenant amongst a host of other unforeseen issues. Since I was able to buy at the right price I simply sold, made some cash and moved on to the next. Lesson learned. If I had paid retail then I would have either been stuck or had to take a loss.

In today's market I find it very tempting to jump on a cash flowing property even at retail or close to it. When starting out I do think its imperative to always buy well below market value. If that is just not possible or cash flow unavailable then it may be a sign that its not the right time to buy in that market. The best investors are disciplined enough to sit out portions of a market cycle.

Brie Schmidt · Answer

I am in Chicago which is pretty competitive and I have no problem paying market value for a good cash flowing building.

Darren Flater · Answer

I agree with most people. I have bought two properties close to market value that I didn't put any cash down. Bill is right you need to consider all the factors. Some times it's good some times it's not. The reason I would buy is that someone else is paying for my house and building my equity.

Bill Gulley · Answer

Marc, you need to consider a bit more than MV. What is the state or the expected cycle of the are and the subject neighborhood. Is the property in a mature area, is it a sought after area or just a run of the mill area? Is the property functional, or will it be outdated needing a rehab later on to sell? How is the appreciation in the area, what is expected? As mentioned, you may need 10/12% to flip it out, if properties  are increasing at 3%, that will be met in 3 to 4 years, if you hold it for 7, when tax benefits begin to fall off,  things should be fine selling at a profit.

When assessing any deal, don't start the valuation at the property, begin in the area, economic conditions, functionality, demand and utility of the subject property in light of the area. If these aspects are good, there is no issue with paying market if it cash flows over the term to be held. Try to view the property 7 or 10 years into the future, not just how it sits today.

If a property has been on the market for awhile, it's unlikely you'll ever buy under the market value, it's a false concept, what you pay is the market value. Now, what you really mean is buying at a  "distressed value" when for some reason a buyer is willing to take less than what a property may sell at on an open market. Depending on who you talk to in this business, you need to convey valuations accurately so that you can demonstrate your level of understandings of the business.

Profits are made on the buy side, not the sale, buying at a true market value through good negotiation will allow a profit, buying at a distressed value provides more profit after you cure the distressed aspect, as it may apply. (A seller could just bail out for personal reasons, so the distressed value is not something to be cured.) :)

Marc Steinert · Answer

Thanks for the breakdown @Brian Burke and I totally agree with you. The immediate cash flow is enticing but my gut is telling me to wait for a better deal.

Marc Steinert · Answer

@Aaron Montague According to my calculations, I should cash flow ~$250/m with a cash on cash of 16%. This is if I paid asking, and I will be managing the property myself.

@Ryan Steele Properties on the higher end have been appreciating quite well, but on the lower end(where I'm looking mostly) have been pretty stagnant. I'm not banking on appreciation in the near term, but if I could get it I could potentially use the equity to purchase more properties down the road.

Importance of buying below market value for buy and hold investor?

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