Could someone critique my yield forecast?

5 Replies

I'm looking to diversify my existing portfolio by adding Real Estate. I'm considering between actual property or investing into a REIT. I would be interested in both commercial OR residential but in the attached valuation I have only included residential. I've come up with the numbers (price, rent, etc) exclusively from Zillow and have gotten an average of about 3.5% return per year with a cash purchase and with leverage the number is even worse. 

The properties below are 1 bed 1 bath, condos, with HOA fees, in the southern CA area near a downtown zone.

I did a comparable comparison to one of the major REIT ETFs and the per year yield over the past 7 years has been 3.5%, roughly the same as actual property. Yield dropped to 2.5-3% from 09-11 but income never stopped and the principle has come fully back. 

Am I doing something wrong with my valuation below or is that just the nature of the condo game? Thank you.

As above, the price-to-rent ratio is very low in markets like CA and NYC.

The concept you are looking at is Cap rate, which basically describes what your potential yield would be on an investment if you paid all cash. Lower risk investments in stable markets tend to have lower cap rates, whereas higher risk areas have higher cap rates commensurate with the risk.

The other problem you are seeing is that many SFH are valued based on what people are willing to pay for them (comps model) as opposed to how much rent they can bring in (cap rate model). Commercial property is completely valued on cap rate.

How does one accurately value commercial property rental?

Obviously there is craigslist listings and searching for price per sq/ft in similar location, but it seems to me that that is too generic and would not be truly representative of the cap rate. Anybody have further color?

Is there a best way to play the california real estate story for an income stream in the current landscape?

Originally posted by @James Consworth :

How does one accurately value commercial property rental?

Obviously there is craigslist listings and searching for price per sq/ft in similar location, but it seems to me that that is too generic and would not be truly representative of the cap rate. Anybody have further color?

 James,

One could write a book (or at least a chapter) on this subject, but here's my quick-and-dirty summary.

Commercial is broad and can be used to describe multi-family housing, industrial, retail, office space, multi-use, etc. Price per square is useful when comparing apples to apples, such as industrial space for units not currently under long term lease.

For multi-family commercial (apartment buildings and others which currently are under long term leases), you need a pro-forma from the seller. This is a (usually grossly over-stated) estimate of the income from the property. The best numbers are of course conservative, including adequate maintenance estimates, vacancy allowance, and management fees. They use the actual incomes from the previous year, not "what could be" incomes.

Cap rate = NOI / Purchase price. If you can adequately estimate the NOI, find out the prevailing cap rate for your area, you can figure out the ideal offer price for the area. Alternatively, you can calculate the cap rate for the asking price of the property.

If you are considering commercial investing, Galinelli's book "What every real estate investor needs to know about cash flow" is a great place to start looking at the numbers.

@James Consworth  

Hi James! Check out this book: "The valuation of apartment properties" by Mills and Reynolds. It's a hard read as it's about as exciting as the inner workings of a rock but the information is very accurate. 

Good luck !

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