Do you use any financial criteria to filter out properties?

Question

Newbie here. To investors of buy-and-hold multi-family and small apartments: Do you use any financial criteria, or rule of thumb, to filter out properties for more thorough consideration? In the Ultimate Beginner’s Guide they mention the 2%, 50% and 70% rules, for example.

Mark H. Porter · Answer

@Aegis Fang Aegis, I use either $500 or $750 per year per door for maintenance budget.

If the property has a roof, heating source, and hot water heaters under 5 years old you can also reel in the caped.  Just be conscious before you spend down reserves that you keep a couple thousand per door set aside for any of the above.

In 23 years I have never bought anything with a negative cash flow, never.  There are people that play the appreciation game, only, but this type of speculation sunk a bunch of investors from 2008-2010.

T. Davidson · Answer

It is a good idea to have criteria to filter out properties but at the same time, that criteria might make you miss a deal.  Everyone might be passing a deal with a bad cap rate, but if you dig into the deal more you might find that the rents are way under what they are supposed to be or the property is so mismanaged that you can find easy ways to reduce expenses.  Many times you don't "find" a deal, you make a deal.  So as you are looking it is good to look at caprate but especially if you are looking in one area and you know an area well, you might know what a 2/1 apartment should rent for and if you see the rent is much less then you know there might be something there to look into.  Just a thought.

Mark H. Porter · Answer

@Aegis Fang Aegis, we're all very different but for me ...

I'll take a first look at a 7% plus cap rate to determine what the cash flow may be.  At 8% I'm doing a more thorough analysis.  At 9%+ I raise a flag as to why would something have that high a cap rate.

For those that raise a flag, I look to see if the cap has been manipulated.  Because the NOI is the numerator, and that comes from Income minus Expense, it can be higher by either lying about income or deferring maintenance to lower expenses (more common than the former).  It is a measure of risk, the cap rate can be higher because that is the only way to sell properties either because they are a class C or the neighborhood is a class C.  I prefer, as I know many do, to buy under-rented class B's and fix them up only enough to raise the rent to market rents.  I can find prospects quite easily in the 8%+ cap rate.

Mark H. Porter · Answer

Aegis, a google search is going to give you the same answers as asking your question here.  Many of us get interested in a property based on cap rate and decide to buy based on cash flow.

Aegis Fang · Answer

Thanks for the advice @Mark H. Porter! How do you calculate vacancy rates?

Aegis Fang · Answer

@T. Davidson, thanks for your comment. Unfortunately I lack experience, but I plan on becoming more knowledgeable about my area over the next few months, and hopefully be in good position to buy when things start to cool off. I just started using the Bigger Pockets Rental calculator and the first property I analyzed from the multiple listings had a cap rate of 5.8%. It turned out to have a -150/month calculated cash flow, and a -500/month 50% rule cash flow. But I'm sure you're right about needing to dig deeper than the cap rate to be sure. I was using 5% vacancy, 5% capital expenditure and 5% repairs which were complete guesses. I've got some research to do.

Aegis Fang · Answer

@Mark H. Porter

Thanks very much for your detailed response. This helps a lot! You showed me that I need to do more analyses to get a handle on this. Do you use a rental property calculator or your own spreadsheets?

Aegis Fang · Answer

@Mark H. Porter Following you advice (I think), I searched the forum and found 2 related topics. This one was pretty helpful. What are your cut-off lines for cap rate and cash flow?

Do you use any financial criteria to filter out properties?

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