Multi family price craziness

Buying & Selling Real Estate
9yFollow

Multi family price craziness

Mark A.
Attorney · Hoboken, NJ · Member since 2016 · 24 posts · 17 votes

I am current resident of Hoboken, NJ, and a yet-to-be property investor.  I am currently looking for a great place to invest my money.  I have spent a decent amount of time understanding the basics of equity investing, and other than placing my money in index funds, i do not think it is for me.  At least not at this point in my life.  

My Journey has led me to real estate investing.  At this point, i have devoted a substantial amount of time to real estate investing and feel that i have a fairly decent understanding of the basics.  Obviously without doing a deal, and actually collecting rent i have yet to fully understand any of the practical aspects of it.  However, i do believe i have enough of an understanding to know when something is a "good" deal, at least on paper.  

It befuddles me understand the current marketplace surrounding me, and i am hoping some of the more experienced investors can chime in and help me understand it.  I am, of course, talking about the NYC Metro area.  I have yet to see a multi family property, whether that be in Hoboken, Astoria, Brooklyn, Jersey City, or even any parts in Queens, that come any where close to providing 10% Cash on cash return, after taking into account all necessary expenses.  In fact, many properties are listed at prices where the collected rents will not even cover the mortgage payment.  This to me, seems ludacris, and i do not understand what "investor" would possibly put their money into such a thing.  

Please do not respond back to me "you need to look outside your local area", as you will be missing my point.  I am interested in understanding the price dynamic for these "investor" properties, which are supposedly based upon their income.  Is it based upon pure speculation regarding market appreciation? Is it a bubble market? Is it too many investors (like Mr. David Greene's recent great article speaks to)? Or have i completely overlooked something? 

Your feedback is greatly appreciated!

Mark

3Reply
60 views

Most Popular Reply

Llewelyn A.
Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
9y

@Mark A.

The Answer is actually quite easy.

The Valuation of an Investment is underwritten using an Internal Rate of Return (IRR), not just a simple Cash on Cash Return (CoCR).

So, what does an IRR take into account? EVERYTHING. So why would you use just CoCR? Beats me. But as others have mentioned, if the Cashflow isn't a necessity upfront (but typically an IRR Investment Property will give you large cashflow in later years), then it is difficult for someone who needs the Cashflow NOW to invest in IRR Investments. This debate has been going on an on on this forum.

I invested with Partners and we own approx. $15 Million of Brooklyn Properties that we bought in the span of 20 years. We have been making Millions in profits and a very healthy Cashflow over time. We are expanding our portfolio of MF properties in Brooklyn. The last Property we bought was last November for $1.71 Million. We are now targeting MF properties around $2 Million plus.

Our IRR target is around 15% IRR given a 10 year holding period. That's quite doable. You just have to know how to do the calculations and work out the details with the properties and future economic developments.

IRR can evaluate everything, including hot Markets like Brooklyn and Cashflowing Markets like the ones mentioned by others on BP.

CoCR can only evaluate Cashflow Markets.

Here is a really good Article everyone should read by Ben Leybovich of BP:

Cash Flow vs. Appreciation: What Experienced Investors Know About the Debate That You Don’t

Here's one of the quotes: "I've written about the IRR a lot; please look up the other articles. Having said this, have you ever wondered why big time investors never give a hoot about things like cash on cash (CCR) and capitalization rate (Cap Rate), and all they want to know is the IRR? Why is this?"

I recommend reading the Article. However, it will take some time to understand IRR.

Once you get an understanding of it, then you can make your decision on whether or not you want to own in Markets where the CoCR doesn't make sense to own the Investment but the IRR tells you it's a Fantastic deal!

Personally, those that only use CoCR keeps my competition away from the best deals. That's the way I like it.

Investor Llew

12Reply
See this reply in the discussion

39 Replies

Jump to latestLatest
  • Darwin Crawford
    Rental Property Investor · Scottsdale, AZ · Member since 2016 · 296 posts · 243 votes
    9y

    @Llewelyn A. - amazing! thank you! Where would you suggest is the best place to start learning, and/or continue to improve on learning IRR?

    1Reply
  • Llewelyn A.
    Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
    9y

    @Darwin Crawford

    When I taught Real Estate Investing from 2005 to 2015 in my own CHARITABLE Education program, I based it on a book called What Every Real Estate Investor Needs to Know About Cashflow by Frank Gallinelli.

    It will be an extremely difficult read for those not used to the Time Value of Money which will lead into more sophisticated Financial concepts like Discounted Cashflows, etc.

    The other issue is that putting together these calculations should be in a Spreadsheet. Building up your understanding Excel should be a requirement. The Financial Functions like PV, FV, Rate, etc. will be needed.

    I didn't show any of the formulas, but, for instance, in the above, the Mortgage Payment in Cell B15 uses a Formula, PMT.

    Similarly, the Mortgage Balance when I calculated the Sale of the Property in Cell B20 uses a Future Value (FV) Formula.

    Anyway, I'm not teaching anymore. I'm just trying to point out that there is a difference between those that understand these sophisticated calculations which are needed to make sense of the ALL Markets, including the Markets that CoC would tell you that it's a bad Investment.

    What I find curious is that there is a sophisticated Calculator here on BP called BRRRR Calculator. It generates a Report based on a lot of the above Calculations, but I would have done it slightly differently.

    I would say 90% of the BP community will just not understand a report like that but yet it's really the kind of Report that helps you understand EVERY MARKET.

    I don't have time to teach again, so I use BP's forum try to explain to both beginners and experienced Investors that you shouldn't pass up on probably the best knowledge you can gain in your Investment Life.

    Investor Llew

    0Reply
  • Naveen Kumar
    Ashburn, VA · Member since 2017 · 85 posts · 28 votes
    9y

    Shouldn't you add the mortgage payment as an expense, or am I missing something?

    1Reply
  • Llewelyn A.
    Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
    9y

    @Naveen Kumar

    Ah! Thanks for actually looking at the spreadsheet! That's exactly right and an Excellent Catch!

    However, Debt Service is NOT an Expense. It is subtracted from the NOI to get Cashflow!

    I also adjusted some of the expenses. Here is the new Spreadsheet.

    When I'm doing these spreadsheets, generally, all my Investing Partners are creating their own as a check against my own. That way, we make sure that we catch mistakes like leaving out the Mortgage Payment from the NOI like I did in the snapshot of the previous posting.

    It also means that the CoC will be $2,836 / $25k invested = or around 11%.

    Note that in this example, the IRR is 14%, which is higher than the 11% CoC. That's because the Mortgage Balance dropped from $80k original to $64k at Sale.

    Thanks for the correction Naveen!

    Investor Llew

    0Reply
  • Alex CraigBusiness Member
    Real Estate Professional · Memphis, TN · Member since 2009 · 1k+ posts · 1k+ votes
    9y

    @Charles Worth for appreciation, it depends on where you are. I have properties in Collierville, Lakeland, Bartlett, East Memphis and Midtown that I have and will continue to get appreciation. Then I have my lower income rentals that provide cash flow but zero appreciation, but had a far less point of entry expense. My real estate strategy when I started at age 32 is going to be much different as I get older. At some point when I have drained all the depreciation from the lower end homes and looking to simplify my life by more cash flow with less properties, I will sell, put in a 1031 exchange and look at either higher priced homes in the suburbs or MF in Midtown. Of course, that could change too, depending on the market opportunity. When that time comes, I really do not know as "older" is subject to change.

    Large appreciation would be great if I lived in a market where I could buy, hold and sell it 5 to 7 years for a big payoff, but I don't, so I invest in Memphis and Little Rock. Both great cash flow markets and will give me the desired amount of passive income I am looking for when I am "older." Also, maybe appreciation would be more important if RE was my only investment, but I am nicely diversified.  

    901-848-9028
    1Reply
  • Kenneth Mooney
    Rental Property Investor · Augusta, GA · Member since 2016 · 348 posts · 171 votes
    9y
    My guess would be that a "rental" is not the right strategic play for your market. It sounds like you're in a market where the play is the appreciation (which I personally wouldn't suggest trying to conquer). In certain markets if you can read the market indicators properly (inventory, absorption rate, building permits, etc) you can see where your area is at in the cycle. If your are still in a market of appreciation you can buy, rent (for less than mortgage) for 1-4 years ish, and then sell. Your property has hopefully appreciated astronomically when you sell, you've brought in decent rent, you'll have depreciation, and you'll have tax benefits. Sounds like that's the play for your market. Or maybe you're just looking for the wrong "deals". I'm from Augusta, GA
    0Reply
  • Mark A.
    OP
    Attorney · Hoboken, NJ · Member since 2016 · 24 posts · 17 votes
    9y
    @ Llewelyn A. @ Ben leybovich I appreciate all of your responses, as well as everyone else that has chimed into to this discussion. Although I cannot claim to understand all the intracacies of IRR at this point, I do understand that COC is just one of the metrics used to calculate IRR. As far as I understand it, if you aren't getting COC return, you need to get some form of appreciation in order to make your IRR positive. Please, correct me if I'm wrong. Assuming that my assumption is correct, I guess my question has evolved into being a bit less defined - when do YOU consider Prices to be inflated and appreciation to be overly speculative? Are you looking at all at the COC returns in determining that? I'm assuming you are looking at the trends of property values in some respect and interest rates. But can't COC returns speak to something about the fact that prices may be too high? This is probably a much more complex question than I am making it out to be, but nevertheless I ask away! Again, thanks for all your time and effort being put into this thread. As you can see, I am trying to absorb as much as possible!
    1Reply
  • Jeff G.
    Real Estate Investor · Sacramento, CA · Member since 2016 · 32 posts · 36 votes
    9y
    Originally posted by @Mark A.:

    As far as I understand it, if you aren't getting COC return, you need to get some form of appreciation in order to make your IRR positive. Please, correct me if I'm wrong.

    It is possible to have 0 appreciation, negative CCR, and positive IRR if the loan's principal was reduced by an amount greater than the cash on cash loss.

    1Reply
  • Leland Barrow
    Investor · San Marcos, TX · Member since 2015 · 272 posts · 360 votes
    9y

    At the core of any real estate investment is three very basic functions appreciation, debt paydown, and cash flows. Any one of those or all three combined can make a property worth acquiring. If you have zero cash in a deal and someone is paying down the 100% LTV you can end up having a higher IRR than a property that cash flows $500 per month, but loses its value and requires a very large outlay of your cash.

    There is more money than there are good deals and there are more passive investors than active investors. Holding large amounts of cash is like holding a hot potato. The game is played by getting cash into deals. Foreign investors will park large amounts of capital into American real estate, because it is far more secure for their cash than other alternatives. In America we are not competing against just ourselves. Instead we compete with Chinese, Russian, Australian, and European investors on a daily basis. We even compete with hedge funds and REITS. Baby boomers may even want to park large amounts of cash into real estate for estate planning purposes. 

    People without money need cashflow because it helps their debt to income (borrower types). People with money do not need cash flow because they could care less about debt to income (lender types). At the minimum wealthy individuals want to beat inflation which is why they are holding a hot potato. Every second cash is held it is worth less than the second before. 

    The vast majority of people on BP are ok with CCR because they have no real wealth. At least not significant enough wealth that they can disregard cash flow. If you do not watch your debt to income then you can figuratively paint yourself into a corner. That is why CCR is so popular and also why it is not that bad to use as a primary evaluation for an investment. In other words income building is a higher priority than wealth building. Income comes before wealth, attempting to build wealth without income is putting the cart before the horse. For those that are actually wealthy they play a completely different game.

    4Reply
  • Llewelyn A.
    Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
    9y

    @Mark A.

    @Jeff G.

    Those are good thoughts and questions.

    I'd like to answer the question: "It is possible to have 0 appreciation, negative CCR, and positive IRR if the loan's principal was reduced by an amount greater than the cash on cash loss."

    Look at the same IRR analysis that was in my previous Post but I changed the Mortgage from a 30 year fixed to a 15 year fixed, and lowered the rent to zero out the Cashflow. The property was bought for $100k in 2017 (cell B3) and sold for exactly the same in cell B19.

    This is what the Analysis tells me:

    Because the 15 year fixed rate mortgage reduced a lot faster than the 30 fixed in the example in my previous post, the Mortgage Balance in Cell B20 is at $32,827 instead of $64k.

    When you sell the property 10 years later, you receive $57,173 from your investment of $25k.

    That gives you a decent return of 9% IRR (which is sort of the equivalent of 9% per year for 10 straight years).

    So the answer is YES, you can have Zero Appreciation, Zero Cashflow and still have a decent 9% IRR !!!!!

    This is the power of understanding more sophisticated Financial calculations.

    It's exactly why I tell Investors that you cannot just use CoC.

    If you learned IRR really well and can put together the kind of analysis that I just did, you can invest in any market and compare all kinds of Investments, not only Real Estate, but every kind of investment because they will all have an IRR analysis.

    I am hoping this thread will get some attention, but I'm afraid it won't.

    Here is the one with NEGATIVE Cashflow but still returns a 6% IRR.

    It's amazing what Investments can open up once you have a FULL understanding of all the Calculations.

    It's also only Math. It's not an opinion. It's just Calculations.

    BTW, Leland is abolutely correct. The vast majority of BP members are not wealthy and are dependent on CoC. However, that doesn't mean they should stop learning more sophisticated calculations. You need to have your education BEFORE you have the money to invest so that you know exactly where to put it. Not AFTER you invest.

    Investor Llew

    5Reply
  • Jason Rohr
    Developer · Flagstaff, AZ · Member since 2015 · 10 posts · 11 votes
    9y

    The gulf between the total return (IRR) people and COC people is wide. I just rehabbed and leased up a duplex in a very tight market. Sold to someone who was only looking for total return. I couldn't wrap my brain around his math (I thought my price was stratosphere), but its finally starting to make sense. Depreciation is a big factor that matters to high earners.

    "However, I come from a 15+ year background in construction and management, with a nerd-like focus on efficiency and building technologies. That is my edge. Others have theirs in underwriting, or maybe deeper pockets than the rest of us, or a nose for deals, or maybe the advantage of having grown up in a certain area, and knowing everyone."  _ Darwin Crawford.     

      just nailed it.  When the market was awash in forclosures you didn't need and edge, just a pulse and some working capital.  This is a radically different world and you need and edge..   If your a networker, network like mad.  If you can fix stuff, find one that scares others off.  The most impressive edge to me is that of the people who can assemble and maintain a team of people who each have their edge.

    0Reply
  • Jason V.
    Investor · Rochester, NY · Member since 2016 · 477 posts · 426 votes
    9y
    Originally posted by @Thomas S.:

    It just seems contrary to the basic principals

    It is beyond logical comprehension that anyone would invest and not have a expectation to generate income from day one. Most investors use the profits to further invest or put food on the table. The only logical explanation is that they already have more money than they need and are simply playing at investing. I guess some get lucky but likely most that do not have very deep pockets hit a bump in the road and lose it all.

     It's been a while since I really, strongly disagreed with something you've posted Greg, but I have to chime in on this one :-) Unless you meant to write: "...not have an expectation to generate value from day one..." I think you're way off base. 

    A lot of value-add investing involves not having a positive cashflow from day one, month one, or sometimes even year one. I'd certainly call doing large scale development or new construction 'investing' and the wait for 'income' from these activities might be substantial. The BRRRR strategy that's ever so popular here on BP doesn't generate income from day one either. And I'm sure if you look past your frustration at the current market, you can see quite a few instances (high-income earners in states with income tax, etc.) where it makes sense to invest in real estate with 'income' as a secondary or tertiary goal - the long term benefits (delaying income) and short term tax benefits could easily outweigh the short-term yield sacrifices.

    There are as many different reasons and ways to invest as there are investors. (And yes, sometimes the reason is 'because I was stupid' and the way was 'poorly') but that's not necessarily the case here. 

    2Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free