If I'm cash-flowing why does Bigger Pockets make me feel like I failed?
Investor · Decatur, GA · Member since 2014 · 56 posts · 16 votes
I just joined Bigger Pockets. I'm a buy and hold landlord with 6 properties in a middle class area of Atlanta. All are rented and rents are all $500 above PITI. So, though there's been some repairs, for the most part they all do okay in my book. Yet, only one met the 1% rule.
I like renting out Middle Class housing where their close to my house, most of the renters are easy to deal with and take good care of the homes. But it's soooo hard finding properties that fit in most of the calculations that I have found on Bigger Pockets.
I don't want to buy bad deals. I don't want to have to go too far out for a deal. And I still want to grow my portfolio, so I'm not sure what to do.
David
Hey David
It's funny reading this post. I am actually sitting in Atlanta in the West End.
I am going to tell you this. If it makes financial sense and the properties support themselves then I don't actually see the issue. It may not fit their criteria, but if a property is putting a cushion in your pocket every month then keep doing what you are doing. Your niche makes sense to you. It definately makes sense to me.
Keep going!
Best of Luck to you!
Gerald
No problem. I can't get this kind of discussion anywhere else. It is something to think about. In my type of buy and hold investing, I cannot figure out why CAP rate would ever be useful to me which is why I focus on cash on cash return. The 50% rule is a great guideline to price in future cap ex. I actually have a worksheet from a book that I got in the 90's that helps you break out and amortize expenses like a roof or an AC unit over a ten year period. I think that is just a long form of the 50% rule.
In my type of buy and hold investing, I cannot figure out why CAP rate would ever be useful to me which is why I focus on cash on cash return.
Absolutely, 100% agree...
And that's what I was (trying to) say earlier -- when I did the hand-waving cap rate analysis, it was simply to indicate what an expected cash-on-cash return would be given an unleveraged purchase. It was a bad choice to even mention cap rate -- I should have just left it as a cash-on-cash analysis to highlight my point, as that would have been cleaner (and wouldn't have opened the door to the ridiculous debate that was had).
I personally don't use cap rate for anything, unless I'm evaluating large multi-unit deals. And even then, it's more for curiosity than for any real analysis benefit. I know some big investors who really like cap rate metrics, but I haven't figured out a useful way to use cap rate in my business.
@J Scott You have a lot of patience. You must be a great father :-)
I understand how CAP rate, NOI and all of that works, but honestly, all I look in a deal is how much money I will make on the amount of money I am investing and if it meets my threshold, I move forward. May be I over simplify things, but that is what I do.
In my type of buy and hold investing, I cannot figure out why CAP rate would ever be useful to me which is why I focus on cash on cash return.
Absolutely, 100% agree...
1. It was a bad choice to even mention cap rate -- I should have just left it as a cash-on-cash analysis to highlight my point, as that would have been cleaner (and wouldn't have opened the door to the ridiculous debate that was had).
2. I personally don't use cap rate for anything, unless I'm evaluating large multi-unit deals. And even then, it's more for curiosity than for any real analysis benefit.
Aaaaaaagh! Exactly! Yet you hurt my feelings by calling me a liar and a troll! :-(
Anyway I'm all over it and emailed you a makeup picture of my junk ;-) BFF's ?
As Paul said, I can't get this discussion elsewhere. People email me and say they get it. Good. I'm not trying to be a jerk and I could just send anyone to an Appraisal Institute link and be done with it but I like to see the psychology behind peoples adherence to bad information and I think most people really "get" it when they see different sides progress through a discussion. I do wish more people would join in and ask questions and not just sit on the sidelines. I hope I'm not intimidating people because I know what I'm talking about. I'll honestly answer any question. It was a process for me in my learning and there were times I argued on the wrong side of the facts.
Generally cap rates are used to determine the worth of a NOI. It is not needed for most people here because there are more accurate means to determine value for most properties. It is best used in commercial properties where the NOI is made up of market rents, above market rents and below market rents. Two identical building side by side managed by the same company can have NOI's of say $100,000 for one and $200,000 for the other because of the timing of their leasing. The market is not going to pay $1,000,000 for each NOI even though they are buying the exact same building. They will determine a market cap rate, lets say 8% for this example and will generally pay $1,250,000 for one and $2,500,000 for the other. Identical buildings, different values. Now if all leases are long term at the time of sale both properties should have similar profitability. That's how the cap rate equalizes income streams.
People that are trying to sell you Grandma's doublewide in Kokomo IN based on a 12% cap are trying to TRICK you. Don't be that investor.
@J Scott did you get my email? Sometimes bigger is better! LOL
First that huge gap in vacancy rate would be totally irrelevant to the NOI IF the total of vacancy, credit loses and expenses all shake out to be 50% of the gross rent.
For your other comment you are 100% correct that 12% in one market can't be compared to the 6% in a totally different market to say one is a better deal. If in the IN property if they bought at a 12 Cap and things are typically trading at a 10 Cap then they bought below market, good job! If they bought the SF place at 6% and things are trading at 8% (Yes I know that 6% is probably a good deal in SF, not the point) then this guy overpaid. If you switch the market caps to 14 and 4 you will also flip who the "savvy" investor was as well.
Yes, I walked right into that one. It's just that all this cap rate computations on the subject property is completely backwards to how it is done in real life that I am trying to explain from that point instead of from the correct way.
So yes 50% off gross rents to get NOI is mathematically the same. But, a property will not have 10% less expenses JUST because it has 10% more vacancy. The fixed cost will remain the same and variable will probably be the slightly less.
But as you stated in your last paragraph where you agreed with me a cap rate comes from market COMPS. @J Scott stated he would buy only based on the cap rate he computed on the subject and would ignore market cap rate comps. We both seem to agree that that is not a correct way to determine profitability.
But hey, made you guys do math!
Seems like you are arguing a different point here.
If you want to say that many people on here take a back asswards view of Cap Rates I am actually totally with you on that.
First off the premise of having Cap Rates for single family homes is meaningless as that is not how SFH (or 2-4 unit places) are valued. Cap Rates are used to value commercial real estate.
Next "calculating" a Cap Rate is total BS too. You don't calculate a Cap Rate, there IS a Cap Rate for the market the property is located.
If you assume that Value = Purchase Price (Terrible assumption) then mathematically
Value = NOI / Cap Rate
is the same as
Cap Rate = NOI / Purchase Price
However the 2nd equation is just some BS that someone calculates to market some investment to get people excited. The 1st is how commercial properties are valued as in that is what someone should reasonably be willing to pay for it, and more importantly that is what a commercial lender will use to determine the value it will lend on.
So for example you have a small apartment complex that has an NOI of $45,000 and the market Cap Rate is 8% that you just paid $490,000 for.
"Your" Cap Rate isn't $45,000/$490,000 = 9.18%
However your VALUE is
$45,000 / 0.08 = $562,500
Congratulations you bought really well and have $72,500 of instant equity!
So for example you have a small apartment complex that has an NOI of $45,000 and the market Cap Rate is 8% that you just paid $490,000 for.
"Your" Cap Rate isn't $45,000/$490,000 = 9.18%
However your VALUE is
$45,000 / 0.08 = $562,500
Congratulations you bought really well and have $72,500 of instant equity!
Like there's a prize for saying it better. Oh wait, there is. Big vote for you. But to carry it further, did you get a deal or are you buying on the way down. Now that YOU made a cap rate comp of 9.18% every new buyer is going to be analyzing your purchase and arguing that their sellers should sell to them at a 9.18% cap . Then if the next sale is at a 8 cap...you did get a deal!
The 2% rule is a goal, you set your sights on it and sometimes you might take less if the property is what you are looking for.
In my market the 2% rule only really works on houses under $70k for the most part, if I buy a SF home for $100k in Pittsburgh I will be lucky to get 1.25% but I will have less vacancies and get a better tenant then the houses that I can be in for less then $30k and have 2% all day.
Pick and choose your battles but as long as your cash flow is good then more power to you.
@David Cohen It's hard to evaluate whether you "failed" with out seeing your numbers. I definitely agree with sacrificing a substantial amount of cash flow to get into the better neighborhoods but you have to draw the line at some point, I'm not sure where your line is.
Everybody calculates cash flow a little differently. I would be interested to see how you get $500/mo cash flow out of a property which does not meet the 1% rule. If you own them outright with no mortgage to pay that makes sense. In which case the cash on cash return would be very low.
On your median rental, what is - rent, insurance, property tax, any utilities you pay, principal and interest (and did you leverage 80% of purchase/rehab), what % do you use for vacancy, what % do you use for maintenance?
I use 10% for maintenance when calculating cash flow. As mentioned by others, this is probably too high as you get into homes that are very high rent but not necessarily any larger than lower rent areas. I also use 10% for vacancy which is likely an over estimate, part of the reason for investing in better neighborhoods and school districts is to get more stable tenants. I also pay a property manager, but it does not sound like you have that expense.
@David Cohen You are doing fine, a hundred or so per door seems to be working for you. In the end if they all pay for themselves you will have a great portfolio. The reason they look for 2-3% is more cushion for turnover times and repairs. I'm getting close to 2% only because I make lots of low offers, but have only purchased a few houses too. I buy at half of market peak and stick to pre-forclosures, foreclosures, or estates mostly. My avg purchase is around $62k and worth $125k. It's been a lot of hard work, but my plan is to have 5 tenant paid for houses in 7 years and am well on track at the 4 year point... Find what works and repeat as often as possible!
No problem. I can't get this kind of discussion anywhere else. It is something to think about. In my type of buy and hold investing, I cannot figure out why CAP rate would ever be useful to me which is why I focus on cash on cash return. The 50% rule is a great guideline to price in future cap ex. I actually have a worksheet from a book that I got in the 90's that helps you break out and amortize expenses like a roof or an AC unit over a ten year period. I think that is just a long form of the 50% rule.
I recently discussed this with a person who runs a REI firm with over 20 large apt complexes in it. When he asked what kind of CAP rate I was looking for in my SFRs I said I don't really care about that. I look at long term ROI. He gave me a perplexed look. It was pretty clear he didn't understand why I wouldn't be focusing on CAP rates.
Youre in the black. There is no failure. Set those kinds of self destructive emotional thoughts aside. This site is intended to make you wiser about how you invest moving forward. If you find ideas that work for you, use them. If something doesnt fit your situation, toss it. Make friends, make money, move forward. Dont let your mind confuse the issues, bro.
Everyone has their own strategy's and whats works best for them.
Obviously you've heard the expression, "Never listen to the naysayers"
I commend you on writing this post, because my strategy that I am about to implement after this tax season will go against the grain of traditional strictly cash flow investors.
Keep doing what your doing as long as it makes financial sense for you.
Lots of properties work as long as things go well. But as soon as you have a major problem you're suddenly out of pocket thousands of dollars. Big repairs do eventually need to be made - roofs, furnaces, sewer lines ($6200 last summer). Tenants do occasionally require evictions and cause extensive damage. Some months your only expenses are taxes and insurance. Some they're not.
I concur with OP and Jon. 1.5 years of smooth sailing, +++$$$ above PITI every month, and then BOOM: 1 property with non payment of rent, destruction, eviction. another property with early lease termination, pet urine soaked carpets, and bed bugs, and another with likely bed bugs. So $3k of expense for repairs and clean, $4k for cap ex on tiling one property, no rent coming in for a month on both of these, and bed bugs still dealing with.
Pretty much a rough quarter. On the bright side, 2 of the 3 properties had rents increased 10 - 20 % and quickly found what so far are good tenants. The one with tile should not have carpet cleaning costs again.
It did force me to look at financing and cash flow management. The $4k for tile is a capital improvement in an asset that is designed from my retirement. So I decided to create an LLC whose 'job' it is to do maintenance on these properties, manage contractors, etc. Then I created a Solo 401(k) (through equity trust company) and rolled my self directed IRA into the new 401(k). Now I can borrow against the 401(k).
I understand that borrowing against the 401(k) is generally a bad idea, however, in this case it is 'like for like.' As long as I am using the loan for capital improvement (eg. tiling a house), I am borrowing from my future self to capitally improve assets that are held for my future self. Then I am paying my future self interest (with a slight hit for double taxation on the interest, but at least that interest is going to future self rather than another bank).
The 'trick' is obviously to keep a 'firewall' of the loan money and not let it seep into consumer spending, or not let it cover non capital expenses. Nothing 'disqualifying' about that, but it is bad money management.
But yes, having essentially a $10k hit was rough this quarter, and put stress on me and my family. Having a way to handle that if/when it happens is important
In the SFR market, if I calculated CAP rate, isn't that the same as saying, "if I paid cash for the house this is what my return would be?"
If what I am saying is correct wouldn't that be helpful in analyzing a property?
In the SFR market, if I calculated CAP rate, isn't that the same as saying, "if I paid cash for the house this is what my return would be?"
If what I am saying is correct wouldn't that be helpful in analyzing a property?
Yes that is valuable but it isn't a Cap Rate.
What you are really doing there is calculating your ROI for the initial investment.
ROI is basically your gain/total investment
For properties we typically just figure out the expected ROI for the first year (and 99% of the time just the NOI, not messing around trying to figure out appreciation or calculating tax benefits or the value of mortgage amortization if financed...).
Seems like the much preferred metric for SFR investors is CoC so if you finance a place you can see how much money you are actually banking vs. what you put out for the investment to start with.
Hey J,
The houses I've bought have tile roofs and are newer, so they haven't needed to be replaced and likely won't for a long time. I plan on selling before a roof needs to be replaced on anything I have that would need a roof replacement, as that kills years of cash flow no doubt. I get an inspection on any property that checks the roof. As far as HVAC and water heaters, I buy home warranties when I purchase to cover those, so I haven't had any big expenses like that.
The houses I've bought have tile roofs and are newer, so they haven't needed to be replaced and likely won't for a long time. I plan on selling before a roof needs to be replaced on anything I have that would need a roof replacement, as that kills years of cash flow no doubt.
Yes, but remember, if there's a 50 year roof on the place, the guy who sold it to you factored that into the price, and you've already paid a premium for it. Also, if the roof is anywhere near end-of-life, the new buyer is going to get bids for replacing it, and his offer will reflect the cost of a very expensive roof replacement.
In other words, there are no loopholes and no free lunch here -- if it's saving you costs or enhancing future revenue, you've probably paid for it in some other way and if it's costing you in terms of expense or future revenue, you're probably getting a discount somewhere else in the transaction.
You're not saving or losing money...just moving it to other parts of the transaction/investment...
Of course, it's also possible that I'm completely wrong...this is just my common sense viewpoint (and we all know common sense isn't always common-sensical :)...
Yes I completely agree that a roof is a significant expense and cannot be ignored. I'm just not sure you can automatically say it's going to help eat up %50 of rents. If one of my houses needs a new roof in 15-20 years, the principal on the loan I've paid off from those same rents is more than going to cover the cost of the roof. I don't hear people talking about that much.
As we all know real estate can make you money (or lose you money) in many different ways. In my experience, with the types of properties I've bought, my expenses haven't been very close to 50%. The lone exception is a 4 plex I bought that is older and often needs repairs. 4 units of oldness means constant replacement/repairs/maintenance. But that just goes towards my point that the 50% rule is more applicable to older properties or properties with less rent.
I think that the original poster on this thread sounds like he has made some good investments. I also think it is better that he made them then if he had done nothing or not made them. For him, it sounds like these were good decisions. And I'd hate for him to feel like a failure because the people on this site tend to evaluate every deal through a rigid set of metrics that don't always apply to each situation. I'm assuming he has some nice appreciation, some equity paid off on his loans, as well as years of positive cash flow. The real failure would have been if he'd done nothing because he couldn't find anything that met the 2% rule.
David,
Back on page 2 of this thread I wrote the following:
"If the properties are cash flowing, and you're happy with your yield/return, that's all that matters. You don't need to adhere to any rules in terms of what yield you're receiving -- that's completely personal to your financial situation and decisions."
At the same time, the OP clearly wanted our opinions as well...he can always do what my wife does and just ignore everything I say... :-)
Touche!
Hey David, I've realized that there are many very experienced investors on BP, and they tend to be more vocal. Its easy to get your back up and defend yourself, but I've learned its better to genuinely try to see if what they are saying is true whether they are kind about it or not. I would pick and choose what you listen to, but maybe what they are saying could make you a better investor! Good luck and keep investing.
It's probably harder now to make the numbers work than a year ago when you started this thread. It's good that you just took action and got into several rental properties. The journey is faster for those who take action. If you made a little money in the process, all the better. But even losing ventures are great learning experiences.
Remember how the saying goes about not being able to see the forest for the trees. That is a HUGE issue in the REI community. On one hand, everyone has stretched further than the ordinary employee type and is seeking a better life. They think that REI is the answer before they have looked at many alternatives. REI is easy to get sucked into because it has so many benefits. There are so many sections of the REI spectrum to work, and they all have different profiles. Some are simply another job, some pretend to be passive but really aren't, some are really speculative, etc.
If your houses are cash flowing NOW, that's fine, but the profit figures can be manipulated by deferring maintenance and cap ex. If you are doing 2% deals, you should have enough margin to always make a profit if they are not class D properties. But if you enter the REI space with yield targets and a 10-20 yr plan, you could be disappointed, especially if you develop bigger goals for yield.
I'm of the belief that tunnel vision does not serve the entrepreneur. If that were the case, you would have never gotten into REI. Your step out of the familiar should be a lifelong principle. If you are still getting the same yield today that you did 2-3 years ago, you are not learning. At some point, you are likely to become dissatisfied with the meager returns of rental property but you will have some equity and hopefully some accumulated savings from the income so that you can step into the next asset class, at least with some of your portfolio. Diversify and in time cut the underperforming assets loose and overweight in the higher performing assets.
The rules are guidelines from the experiences of many investors.Circumstances do differ, with changes in market conditions etc.With six properties already, thats great especially to your preference