Does this make sense?

[Brett Cook]

I'm trying to develop my search criteria for a small multi-family unit, say a 4-plex. I wanted to get some opinions on whether I understand the 10,000 foot view or not. I have selected a couple of nice neighborhoods in my area, Tucson, AZ that I think may be able to cash flow. The problem is, that my numbers aren't working, or else I haven't figured out how to make them work. I'm using some rules of thumb to down-select to a few properties that I could then dig into more closely.

My assumptions based on rules of thumb:

Vacancies are 25% (avg in Tucson in 2013 was from 11%-21%)

Expenses run 50%.

Avg cost of 4-plex is ~ $300,000 (mortgage = $13,750 at 4%, 30yr with 20% down)

There are two basic methods I've seen to come up with a value for the property, cap rate and cash flow.

To get a 7% cap rate (3% above par value on borrowing money for fixed, 30yr), I calculate the property would have to bring in 56,000 gross, or $1167/mo/unit. The average is more like $710 for this area. To get 7% cap rate, I'd have to get this property for $182571 (

[710*4*12*.75*.5]/.07). That seems unlikely.

Method 2 is to look at cashflow, and that's what I'm most interested in. The zero cashflow point is where the property just pays for the mortgage. This would give me an offering price of 267,691 (Yields a 30yr mortgage at 4% with 20% down of 12,780, which is the earnings using the rules of thumb). This might be possible. Any improvement in vacancy rate or expenses would give me cashflow, but I know I'd be able to at least pay the note.

Am I expecting too much? I suppose another way to look at this would be to figure out how I might be able to increase the rents (more money for updates), or reduce the asking price (so I could afford to do updates and increase rents), but I haven't seen any properties that even come close to the price point.

Any advice would be appreciated!

Brett

[Nathan Emmert]

Vacancy generally falls into the 50% rule of expenses... that said, if your vacancies really are 25% why would you even consider buying in that market to rent?  If there's that big of a glut of inventory that 1 in 4 units in the city isn't rented, find some place else to invest.

For rent to price ratios (seriously, get rid of CAP rates and all that crap, you're just giving yourself a headache)... 1% is about break even at today's interest rates (6% CoC w/ 4.5% for 30 years & 25% down)... 1.5% is about a 18% CoC return given a 25% down... 2% would be a 30% CoC.

These are rough rules of thumb based on the 50% rule for expenses. The 50% rule assumes you do not pay utilities beyond water/sewer/trash... have about 5 - 8% for taxes... about 5% for insurance... vacancies in the 5 - 10% range... repairs and CAPEX in the 10 - 20% range and 8 - 12% for Property Management.

At 25% vacancy your expenses are probably closer to 70% knocking a 2% deal down to a 10.6% CoC return. I'd exit that market in a hurry if you're a cash flow investor.