Whats YOUR Metrics for Buy and Hold investments?

Question

Hi BP,

In California (my local market), I'm having trouble deciding which metric to use for buy and hold investments and what I consider a "good" percentage for metrics like IRR or Cash on Cash return. I'd like your input on what metrics you use and what % or number you look for in your investments.

In summary:

• What are your key metric criteria’s you set for yourself (what’s the number on CoC, IRR, etc.)I've been looking at IRR as my metric given that Bay Area does not cash flow well. IRR seems to be the better metric since it accounts for the appreciation/value-add you get in the event of a sale
• I've been looking at IRR as my metric given that Bay Area does not cash flow well. IRR seems to be the better metric since it accounts for the appreciation/value-add you get in the event of a sale
• How did you determine for yourself the right number? Do you lower your expectations or switch markets if your market doesn’t meet this number?
• Is buying at a discount a must for building instant equity on the buy? In the Bay Area, MLS properties usually go 5-10% more than listing price.

• I've been looking at IRR as my metric given that Bay Area does not cash flow well. IRR seems to be the better metric since it accounts for the appreciation/value-add you get in the event of a sale

Jonathan Pflueger · Answer

@Robin Ji

To be honest I am still trying to figure out "the right metric" for real estate in the Bay Area myself. Our part of the world is very unique and vastly different than 95% of the rest of the country. BP is great, but a lot of the information/metrics (ie. 1% rule, 2%rule, etc..) are just not valid for where we live. In fact, most people would recommend that small time people or new investors go out of state and seek "easier" / "safer" investments. To be honest, whatever metric you decide to go with depends 100% on your situation. I will try and explain my "metric" for what I am doing below and maybe that will help you.

Currently I am playing the owner occupant strategy. When my wife and I were looking for a house in the Bay Area we were told time and time again that we would not be able to find a cash flowing property to owner occupy, much less something we could get at a discount. This was largely true and while I still believe such deals are possible we adjusted our goal (metric) slightly.

Before we bought we were paying $3,750 in rent every month for a 4 bedroom house (way bigger than what we needed but that was all that was available in our area at the time). I looked at our finances and realized that our single biggest expense, by far, was our house and I decided that wherever we moved I wanted our next place to pay 75-100% of our mortgage (PITI). In other words, my metric (and this is very basic) was that I wanted to eliminate 75-100% of my housing costs.

After extensive research and hard work we ended up buying a single family residence with an attached in-law unit, and an additional detached, legal, 2 bedroom guest house. We were even able to get the property at a significant discount. When all was said and done the rents from the in-law and guest house cover nearly 100% of our PITI. Since we are owner occupants we were able to take advantage of amazing financing, best of both worlds.

My point in all this is, in our area, your metric completely depends on what your strategy is. I realize that you are looking for some sort of IIR or COC but I am not as sophisticated as that yet and honestly I'm not too sure that completely applies to our situation all the time.

Omar Khan · Answer

@Robin Ji There are no right and wrong answers because it depends on your needs. Since you are young and have enough investment capital for a down payment (both assumptions), looking at one metric in isolation will not be the best way.

In your market, cash-on-cash numbers might be low but appreciation is unreal. Most other parts of the country can only dream of the appreciation that the San Fran market witnesses. Hence, relying on cash -on-cash might not be the best metric for your market. I do agree with your assessment that the fundamentals, even at today's elevated prices, point towards a rosy future (maybe not as high growth but very healthy growth). Hence, utilizing a combo of cash-on-cash, IRR, liquidity measures (vary from investor to investor) and DSCR (debt service coverage ratios) should help in formulating your strategy.

Parts of the country where cash-on-cash is high have traditionally not experienced strong capital appreciation. Hence, in those markets investors are focusing on how much juice they can extract from a property. Cash-on-cash and related measures would be the best way to value properties.

I agree with your analysis. The real estate mantra of location, location, location holds true around the world. IMO, if you manage your liquidity and invest in quality locations (great schools, high wage earners/companies and safe neighborhoods), you have a better chance, long-term, of beating most investors.

Bill F. · Answer

@Robin Ji I like to use IRR  (well really MIRR) or Capital Accumulation Comparison since they are the only calculations that allows you to capture all four of the wealth generators in RE. The downside is that to accurately calculate them you need to model a number of different variables and as a famous statistician said "All models are wrong, some are useful" If you don't have confidence in your modeling ability or you are too optimistic with your assumptions, the math will lead you astray.

No one can give you an exact rate since everyone's risk profiles and goals are different.

John Warren · Answer

@Robin Ji it is definitely possible, historically speaking, to buy and hold in your market, but it is going to be pretty tough currently to make sense of anything. I would not personally use IRR as a stand alone metric as it will not give you a picture of your monthly cash flow.

I like to see a 15% COC return on my investments. I won't personally invest in a rental property unless I feel that I can hit this metric. Believe it or not, there are a decent number of properties that have sold in my market (Berwyn/Riverside/Brookfield area) that hit these returns.

As for selecting a market, this is a tough question. I personally would continue to look in the market you are in, and maybe select one additional market that you enjoy visiting due to family/friends/etc.

Jonathan Pflueger · Answer

@Marcy Moyer

I couldn't agree more. I am now looking to have my wealth accumulation needs met just like you! I love our market, it makes me a little apprehensive at times but overall I wouldn't choose to invest anywhere else at the moment.

Marcy Moyer · Answer

@Jonathan Pflueger You are so right that where we live is not like most places where people invest. But Ca. real estate has been very very good to us. You have your cash flow needs met and I had my wealth accumulation needs met, and now after paying off mortgages great cash flow. The key is figure out what your goals and needs are and then find the investment that best fits those.

Marcy Moyer · Answer

Robin when I had mortgages on my properties my goal was to have a neutral cash flow. Now that the mortgages are paid off I am happy with a 3% CAP rate and solid appreciation for buy and hold. I have 3/4 of my investments in Santa Cruz due to a historically low vacancy rate, now at 1.67% and good rents compared to cost to purchase. There is very little new building and a never ending supply of student renters. Other University towns offer similar benefits. Over time I want to try and beat 5% appreciation per year. So far I have.

Max T. · Answer

1. I'm looking for that 1% rent to price ratio.... or close to it. It is getting harder to find.

2. Neighborhood - has to be showing strong signs of appreciation and also be decent already. I often invest where I live.

3. Cash on cash return I'm less concerned with, but it has to be over 10% and should be closer to 20%.

4. If I'm not clearing at least a few hundred per month after all expenses, it's not worth it.

Robin J. · Answer

@Marcy Moyer love the strategy and wish you continued success. I feel like for California investors, we don't quite see the same cash on cash returns in these premium locations. My beliefs are that if I invest in a strong location (great schools, high wage earners and companies, safe neighborhood) with limited supply (especially in the Bay Area), expecting some appreciation over the long run is not TOO speculative. Obviously I won't rely on appreciation to bail me out in the short-term and I'm okay with a longer term horizon buy and hold strategy with these investments. The returns will be driven by debt pay-down and longer-term appreciation.

@Jonathan Pflueger

My endgame is to build wealth over the long run and I agree with you on the Bay Area being suited for this type of play. My belief in the Bay Area is driven by continued growth in population driven by tech company growth, large demographic/population of high wage earners, and that the Bay Area will remain the primary tech hub and attract out of state people.

I don't plan to sell in the next 5 to 10 years, and I am willing to hold for the long-term. That's why I'm also attracted to owner occupant strategies, where I have the option to send my kids to a good school if I don't move out (since these premium locations have great school ratings).

I’d still like to hear your thoughts on the right metric to track here? It seems too unsophisticated to just look for breakeven cash flow given that this doesn't allow you to compare investments across different properties or even other investment classes (e.g. stocks, notes, etc.)

Whats YOUR Metrics for Buy and Hold investments?

Most Popular Reply