60k Prop or 100k Prop? Cash flow vs. Value
Marlton, NJ · Member since 2017 · 129 posts · 16 votes
@James Wise I cant find a deal for my life. Most properties I walked are not livable, requiring specifics that a conventional mortgage wont allow. Properties I am seeking through zillow are mainly listing at retail. I am getting to the point to just give up. I have see lots of properties in a specific affordable housing area.
Sellers sell houses for what they are worth. Nothing less. Unless you have some major competitive advantage that puts you in front of extremely distressed sellers before everyone else time and time again you are going to have to pay the same price everyone else is going to pay. Nothing wrong with that. I imagine you pay retail for gas, groceries, cable & everything else. What about real estate should be My different?
Hey @David Faulkner - I wanted to learn a little more from you and had a couple questions. I started to message you since it's slightly off topic, but as I started to write it out I thought that it might useful knowledge for others as well. And it's close to on topic.
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So, I think I understand your stance and there is a lot of validity to them. I have a couple questions I was hoping you could answer them so I could better understand and learn some more.
1) If properties are regularly selling turnkey on the open market for well below replacement cost (~$150 SF), then right off the bat you know you are dealing with a neighborhood with negative appreciation.
- Even if there's a new kitchen, bathrooms, flooring, light fixtures, HVAC, & roof... How does your statement account for the difference in buying a 50-100 year old foundation, insulation, wiring, plumbing, etc instead of buying brand new everything? There's also a big preference for the new layouts & design of a new build vs the old one (trust me in dealing with tiny closets, small bathrooms, & an OK at best entertainment layout in a ~110 yr old personal dwelling!)
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2) When you say: "In markets... cash flow may start out very high but go down over time as prices and rents don't keep up with inflation so that eventually CapEx eats it all ..."
- How does this account for areas & markets that would fall into this category in your eyes, but are still being rented out today for profit? I'm thinking there would be markets/neighborhoods/areas that would fall under this category in your analysis but have had profitable rental units in them for decades and decades. How long does that take to happen? It seems as though this statement would mean eventually you couldn't make any money renting anything in these markets, but there have been rentals for decades in them.
1)If it has 50-100 year old everything that has not been touched behind the walls, then it is not turnkey ... I'm not talking about lipstick on a pig type of stuff that many "turnkey" providers in fact peddle, I mean real turnkey where this stuff has been addressed. Having said that, I doubt there would be much truly in that category in those type of neighborhoods simply because it is not usually economically viable to put the kind of money into the property to do all those repairs ... you would never get your money back out. However, short of having all those things done already at purchase, if you had a property that is in decent condition other than not having these things done, and you bought it at retail price and proceeded to do all those things, and the purchase plus those repairs would put you way over retail ARV for the property, then those repairs are not economically feasible and this is the kind of market I'm talking about. So, unfortunately, what ends up happening is that many (not necessarily all, but many) landlords get pushed by the market dynamics, pricing, etc. holding a long time, or they go there freely day one, into "slum lording" ... that is, not updating these systems properly when they break, dragging out the usable life with bubble gum and duct tape, and renting out basically dilapidated and unsafe properties because the economics don't lend themselves to fixing them properly.
2)Not to say you can't still make money in these markets, but it is a different strategy. Don't mean to sound insulting with this analogy, but it is really closer to the business model of a rent-a-car lot ... you start with a asset in good condition but goes down in value (or maybe stays the same price, which is down in inflation adjusted dollars), you rent it out, then when most of the usable life of the asset is gone before there are high dollar repairs that eat your cash flow, you slap on some lipstick and sell it off and buy another to rent out. So, IMO, the best way would either be flipping these properties (like turnkey operators) or buy, fix, and rent them but sell to rotate your inventory every 7-10 years before the major CapEx items hit. This is all assuming you can buy them at sufficient discount (often pennies on the dollar, which you can in these type of neighborhoods, usually from those distressed remote landlords that don't know how to run this model) to make it economically feasible to fix them up just enough to get you to your exit. Hold them too long, and your cashflow would in fact likely get eaten up. So, not a very passive model long term IMO, especially compared to appreciating assets where the best model is generally buy and hold forever (or 1031 those gains on up) because you are rewarded and it is more economically feasible in the long term to take on the CapEx, though it is tougher in the beginning in these markets because prices are higher and cash flow is lower (but increasing with time).
I'm not saying every market is like this, and I'm not saying that if the market is this way that you can't make any money ... I'm saying in very low ARV value markets, investors need to be aware of these dynamics and the impacts they have long term on their business model. Another reason IMO the whole "I'm not going to factor in appreciation rates because that is speculating" business is nonsensical to me ... because they can be negative too and ignoring it in these types of markets can get you into trouble ... whether the appreciation rates are negative, zero, or positive, they will have a profoundly important impact on your business model and exit strategies over the long term, whether you like it or not and whether you admit it or not. You may not see these dynamics play out for many years, and think that you are killing it the first year or two or five ... just like the folks here that have not invested through a downturn don't necessarily know anything other than blue skies and green pastures in the market may leverage way up and think they are killing it, and they have been for many years ... heck, even in some of these low ARV markets you might even have seen some appreciation coming off of historical lows, but things tend to have a way of reverting to the mean and evening out to their long term averages over the long haul, be it appreciation rates, CapEx, etc. ... being around the business for a decade or more, and these are the type of things you begin to notice after awhile ... best to know how to screen for them, spot them early, and know how to adjust your business model accordingly.
Hey @David Faulkner - I wanted to learn a little more from you and had a couple questions. I started to message you since it's slightly off topic, but as I started to write it out I thought that it might useful knowledge for others as well. And it's close to on topic.
...
So, I think I understand your stance and there is a lot of validity to them. I have a couple questions I was hoping you could answer them so I could better understand and learn some more.
1) If properties are regularly selling turnkey on the open market for well below replacement cost (~$150 SF), then right off the bat you know you are dealing with a neighborhood with negative appreciation.
- Even if there's a new kitchen, bathrooms, flooring, light fixtures, HVAC, & roof... How does your statement account for the difference in buying a 50-100 year old foundation, insulation, wiring, plumbing, etc instead of buying brand new everything? There's also a big preference for the new layouts & design of a new build vs the old one (trust me in dealing with tiny closets, small bathrooms, & an OK at best entertainment layout in a ~110 yr old personal dwelling!)
...
2) When you say: "In markets... cash flow may start out very high but go down over time as prices and rents don't keep up with inflation so that eventually CapEx eats it all ..."
- How does this account for areas & markets that would fall into this category in your eyes, but are still being rented out today for profit? I'm thinking there would be markets/neighborhoods/areas that would fall under this category in your analysis but have had profitable rental units in them for decades and decades. How long does that take to happen? It seems as though this statement would mean eventually you couldn't make any money renting anything in these markets, but there have been rentals for decades in them.
1)If it has 50-100 year old everything that has not been touched behind the walls, then it is not turnkey ... I'm not talking about lipstick on a pig type of stuff that many "turnkey" providers in fact peddle, I mean real turnkey where this stuff has been addressed. Having said that, I doubt there would be much truly in that category in those type of neighborhoods simply because it is not usually economically viable to put the kind of money into the property to do all those repairs ... you would never get your money back out. However, short of having all those things done already at purchase, if you had a property that is in decent condition other than not having these things done, and you bought it at retail price and proceeded to do all those things, and the purchase plus those repairs would put you way over retail ARV for the property, then those repairs are not economically feasible and this is the kind of market I'm talking about. So, unfortunately, what ends up happening is that many (not necessarily all, but many) landlords get pushed by the market dynamics, pricing, etc. holding a long time, or they go there freely day one, into "slum lording" ... that is, not updating these systems properly when they break, dragging out the usable life with bubble gum and duct tape, and renting out basically dilapidated and unsafe properties because the economics don't lend themselves to fixing them properly.
2)Not to say you can't still make money in these markets, but it is a different strategy. Don't mean to sound insulting with this analogy, but it is really closer to the business model of a rent-a-car lot ... you start with a asset in good condition but goes down in value (or maybe stays the same price, which is down in inflation adjusted dollars), you rent it out, then when most of the usable life of the asset is gone before there are high dollar repairs that eat your cash flow, you slap on some lipstick and sell it off and buy another to rent out. So, IMO, the best way would either be flipping these properties (like turnkey operators) or buy, fix, and rent them but sell to rotate your inventory every 7-10 years before the major CapEx items hit. This is all assuming you can buy them at sufficient discount (often pennies on the dollar, which you can in these type of neighborhoods, usually from those distressed remote landlords that don't know how to run this model) to make it economically feasible to fix them up just enough to get you to your exit. Hold them too long, and your cashflow would in fact likely get eaten up. So, not a very passive model long term IMO, especially compared to appreciating assets where the best model is generally buy and hold forever (or 1031 those gains on up) because you are rewarded and it is more economically feasible in the long term to take on the CapEx, though it is tougher in the beginning in these markets because prices are higher and cash flow is lower (but increasing with time).
I'm not saying every market is like this, and I'm not saying that if the market is this way that you can't make any money ... I'm saying in very low ARV value markets, investors need to be aware of these dynamics and the impacts they have long term on their business model. Another reason IMO the whole "I'm not going to factor in appreciation rates because that is speculating" business is nonsensical to me ... because they can be negative too and ignoring it in these types of markets can get you into trouble ... whether the appreciation rates are negative, zero, or positive, they will have a profoundly important impact on your business model and exit strategies over the long term, whether you like it or not and whether you admit it or not. You may not see these dynamics play out for many years, and think that you are killing it the first year or two or five ... just like the folks here that have not invested through a downturn don't necessarily know anything other than blue skies and green pastures in the market may leverage way up and think they are killing it, and they have been for many years ... heck, even in some of these low ARV markets you might even have seen some appreciation coming off of historical lows, but things tend to have a way of reverting to the mean and evening out to their long term averages over the long haul, be it appreciation rates, CapEx, etc. ... being around the business for a decade or more, and these are the type of things you begin to notice after awhile ... best to know how to screen for them, spot them early, and know how to adjust your business model accordingly.
Thanks for taking the time to answer David. Great info and insight and I agree with a lot of what you say. To expound a bit more for others readers (and correct/add to this if needed)...
The biggest point of caution investors need to look out for in the lower end markets for cash flow is the capital expenditure plan. If that's not properly accounted for, and you are buying something around the 1%-1.25% rent/purchase ratio, it's going to be near impossible to make money on the long haul with the lower markets. If you're buying something turnkey near the 1-1.25% ratio, you may want to consider having that 5-7 year exit strategy as David mentioned. Otherwise when the CapEx stuff hits again, you may end up with no cash flow. Yes, you could refinance at that time and pull out equity to pay for it, but you shouldn't have to do that with any property. If that's what it requires, then you have a pretty bad investment as compared to others.
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So, make sure to have a plan for that stuff. Make sure to run your numbers where you are accounting for ALL capex and still making money. If your rent/purchase ratio is in the 1.5-2% range you'll probably be ok. I have a portfolio that averages $715 per unit across 28 units (20 properties). I purchased that portfolio, $19,380 per month gross rents, at a 1.95% ratio. Last year we did 6 full HVAC systems (should replace 1-1.5 a year based on a 20+ year life cycle), and we did one complete gut remodel of a 3/2 last year. We did that all out of cash flow and we were still cash flowed positive for those 12 months decently.
For reference, here's what our cash flow would have looked like at different ratios and 20% down, 4.5% interest, 20 yr term.
1.95%, $24,300, 12.2% cash on cash return
1.75%, $17,400, 7.9% cash on cash return
1.5%, $6,200, 2.4% cash on cash return
1.25%, -$9,504
1%, -$33,044
You can see in that 1-1.25% range you stand to lose quite a bit when you have to take care of CapEx. Yes Capex was a little higher in that year, but not by some crazy amount. Yes, I had an extra 4.5 HVAC units more than a typical year will have. The gut remodel was more extensive and costly than the others would be, but I didn't have to do any roofs which will average to one every 1.5 years.
Know your numbers, make sure you're accounting for ALL capex, and have a plan.