Why are people buying at these prices?

Real Estate Agent · Tucson, AZ · Member since 2018 · 112 posts · 73 votes

@Josephine Wilson in my experience most of the small multifamily listed near the university ends up being a rehab/management play to raise rents or a house hack senerio. There are also a lot of new investors focusing on the downtown area who aren't accounting for a lot of expenses. I'd suggest looking off market as mentioned or taking a look at other areas of Tucson that offer better returns.

7 Reply

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Brian Ellwood Good points. I haven't looked at the macroeconomic data on Tucson. It's _my_ market and my skills (marketing, handyman, active management) are pointing me toward local investment. The plan was to make it work here. But agreed, that would be good info to have.

@Account Closed Thanks for this info. I like the idea of the tenants being students or university staff. I can market to that demographic. But as you note, there just may not be those opportunities on the MLS. My next closest area is midtown. Are there people who want to rent in a Level A in midtown?

I need to look into off-market, as you both note. Will do more research on that.

Real Estate Agent · Tucson, AZ · Member since 2018 · 112 posts · 73 votes

@Josephine Wilson there are some A class rentals in midtown. What's got you so focused on class A properties?

I'd be cognisant of the current inventory of college rentals in the student housing market. That submarket is boarding on over served and saw flat or slight rental rate drop offs prior to covid. Now with the student population reportedly down by 15% due to covid I've seen a lot of student rentals with signs out front that would have normally been rented over the summer or even prior to the end of the spring semester.

Daniel TrimblePro Member

Member since 2020 · 5 posts · 11 votes

I just purchased my first 4 plex (and first rental property) in Tucson. It was listed too high based on their current rents, which are below any market average. I used that during the negotiation and brought the price down $26k. Now, even with current rents it’ll cash flow.

Part of the problem I see here is people look on Zillow and it shows their property as being worth X but the valuation really shows it is worth Y. If you see a place you want, put in an offer that is reasonable to you. Know your top dollar and don’t go above it.

9 Reply

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Account Closed PM'ed you!

@Daniel Trimble That is awesome - congrats!! Are you concerned at all about keeping it occupied with Covid and a lot of people being out of work or moving back in with family?

Stephen E.

Rental Property Investor · Member since 2020 · 172 posts · 110 votes

It does sound like you should look at B class neighborhoods. A class often have the worst cashflow because people are speculating. But there must be a better area to invest in in Tuscon. Every city has neighborhoods that aren't good for investors.

Daniel TrimblePro Member

Member since 2020 · 5 posts · 11 votes

@Josephine Wilson. No not really because the rents are pretty low currently and I believe that’ll keep tenants there. I may ride those rents month to month after a couple of the contracts expire and until the end of the year when the eviction restriction hopefully goes away. Better to have some in there renting than nothing at all. Have one vacant and will be doing some renovations on it. We will see.

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Daniel Trimble That's cool. Good plan to renovate one by one and keep the others occupied. What neighborhood is it in? Were you looking for a while?

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Stephen E. Yup, you guys are opening my eyes to that. I don't want to be a slum lord, so that's why I was saying A. But A/B sounds good. Not sure I totally understand what a B would be, but pretty sure I don't want a C/D.

I'll take a look at some adjacent areas. It gets into meth addict territory pretty quick but there are some nicer enclaves.

Stephen E.

Rental Property Investor · Member since 2020 · 172 posts · 110 votes

@Josephine Wilson owning B/C/D properties doesn't make you a slum lord. Not taking care of people and **** over your tenants makes you a slum lord. Lots of nice people in B and C class neighborhoods who care about their homes.

There's no real agreement on what qualifies as a B or C property, by the way. But a D property is a worse.

14 Reply

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Stephen E. Good point. I lived in an apartment building in Washington Heights in NYC. 157th St. Sketchy but not too bad, maybe a C, I'm thinking. The tenants above me threw their dirty diapers out the window for the super to clean up. Some landed on my fire escape and I had to deal with them. It's that kind of tenant I want to avoid.

So does a tenant in a B have decent credit?

Stephen E.

Rental Property Investor · Member since 2020 · 172 posts · 110 votes

Decent credit like in the 700s? Probably not. Depending on the year I'm betting 157th St was a B, haha.

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

157th a B?? No way, really? It was 2009. It was a stunning pre-war building - high ceilings, crown molding, hardwood floors. It will be a beautiful place some day. After that one tenant moves out, that is.

Member since 2020 · 984 posts · 1k+ votes

There is a sucker (fool) born every minute!!!

I work with people every day and there are many geniuses who shame me. Sadly, there is an abundance of people who are blissfully ignorant and they are buying over-priced properties because they are either too ignorant to do simple math, too lazy and/or they are ignorant enough to invest based on advice from either people who are ignorant or based on advice from people who have their own agenda.

People are crazy! About 15 years ago, I met a retired CPA who gave a person he casually met his entire life's savings of $125,000 because the person he met said he had invented batteries that work with only water. All you need to do is fill batteries with water and you can power your entire house, vehicles, cell phones, boats, ATV's and on and on.

How many people lose thousands of dollars at race tracks because someone gives them a hunch.

People who can's answer the following questions are buying the properties with negative cash flow.

Do your own survey and ask everyone you meet the following questions. I think you will be surprised.

.1. How many ounces are in a pound?

2. What is 20% of $3200.

3. What is the capital of California is?

4. How many square feet are in a room 15 x 20?

You will find the most popular answers are?

1. 12, 24 and 28

2. This one gets really crazy answers like 14-1/4, 16, etc.

3. Believe it or not? This one gets Washing State and Washington D.C.

4. You will get answers all over the map.

4 Reply

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Account Closed LOL! You really think that's what it is? Just people who don't know better. Woah. I need to take that in.

Member since 2020 · 984 posts · 1k+ votes

I am not a pessimist. I am a realist!

Andrey Y.

Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes

Originally posted by @Josephine Wilson:

Newbie question here: I'm looking to buy a Class A triplex or quad within 10 minutes of my house and doing property management and maintenance myself. I live close to a large university. Of the 20 recently-sold small multis I've analyzed, nearly all have little to no cash flow and cap rates averaging 4.6%. (2048/2050 E 6th St, Tucson, AZ 85719 is one example.) Some even have substantial negative cash flow. Everything I'm reading says these cap rates are not favorable. So why are people buying these properties?

I'm thinking the buyers are A) hoping for appreciation and don't mind no cash flow, B) planning to increase NOI or hoping that market rents will rise, C) wealthy parents buying a place for Johnny/Susie to live for four years or D) house hacking. Can folks offer their insights into why buy properties with negative cash flow and low cap rates?

For anyone interested, here are my estimates for my example property: 2048/2050 E 6th St, 85719

Price: $245,500, two 1BR units, 1219 sq ft total

Rent: $1454

Maintenance: $205

P&I: $938

Taxes: $195

Cash flow: -$39

Cash on cash: -0.7%

Cap rate: 4.4%

1. Cap rates are not a return metric. Cap rates are obtained from cap rate sales comps on large buildings. They are NOT a return metric.

2. You cannot invent or calculate your own cap rate. See above.

3. Did you get your definition of Cap rate from the BP podcast or a Turnkey salesman? Please ask a knowledgeable investor or commercial real estate appraiser what a cap rate actually is.

4. Lower cap rate = more desirable, higher quality asset.

Please don't teach new investors any more misinformation than they are already bombarded with on a daily basis.

8 Reply

Russell BrazilBusiness Member

Moderator

Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes

[email protected]301-893-4635 Podcast Guest on Show #192

A 4.6% cap rate does not have negative cash flow. In fact, its net operating income is exactly 4.6% of the properties value :)

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14 Reply

Darius Ogloza

Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes

Here's a minority viewpoint: do you buy a stock based solely on the dividend that it pays out? I would guess that the answer for most people is "no." You look to a total return metric based on anticipated price appreciation that in turn reflects either an expectation in improving fundamentals or some kind of value price (i.e. the asset seems underpriced when compared to other assets). For some reason, real estate investors look only to the dividend (i.e. rent) and neglect to analyze the investment from the perspective of total expected return. For years, Microsoft paid NO dividend. According to this metric, were Microsoft buyers fools. I do not think so.

If I see a property that I believe based upon market analysis is undervalued relative to similar assets (i.e. a deep fixer) or that I would expect to grow based on the market's fundamentals (i.e. the economic explosion that turned the SF Bay Area, a hipster backwater in the 1950's, into America's economic engine) I do not make a bet based sole on the existence or absence of some dividend. I ask myself how will this asset position me over the next 10, 15 or 20 years. Sometimes, you miss (i.e. you buy WorldComm) sometimes you knock one out of the park.

14 Reply

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Andrey Y. Definitely not trying to teach anything - I am a new investor!

I made a spreadsheet and put 20 properties from my target area into it. The cap rate is calculated as follows:

Cap rate = ((Estimated annual rent x 0.95 occupancy rate - P&I - taxes - maintenance - insurance)/sale price

My estimated rent is calculated from data I collected online (Craigslist, Zumper, Estately) on the rents of studios, 1BR-4BR units my target neighborhoods. I averaged the rents and calculate the estimated rent for a given property based on the composition of units (a duplex with one studio and a 2BR would have a different estimated rent than a triplex of three 1BR).

The P&I is calculated with the PMT function in Excel and matches the output of online mortgage calculators. Maintenance is estimated at 1% of sale price. Insurance is estimated at $1000/year for every property. Happy to share the spreadsheet with you!

Granted there are a lot of estimates here, but when I do identify a property, it seems like it will be easy enough to calculate the cap rate based on actual numbers.

The low cap rates in my target neighborhoods suggest to me that these are very safe investments, so safe that buyers are willing to forgo high yields in the first few years.

So no, I haven't gotten it from a podcast or a salesman. I would love to see cap rate sales comps, but being a newbie, I don't know where to find that information.

3 Reply

Marian Smith

Real Estate Investor · Williamson County, TX · Member since 2011 · 1k+ posts · 961 votes

@Josephine Wilson Have you filled out a mock schedule E? And put down, say 30%. I think people are looking for a store of value or inflation hedge right now. plus low interest rates is an attraction. and yes, junior may be in school there now or in the near future.,

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Darius Ogloza WorldComm - that takes me back! Enron anyone? Waste Management?!

I appreciate this analogy. I guess it depends on your immediate goals. Are you looking for immediate cash flow to fund future buys or are you playing the long game, looking at appreciation over a 10 year period, as you note? Growth vs value investing, except you do it with the bank's money.

One issue I see with being a value investor here is that your debt to income ratio would become unfavorable quickly. After a few properties, you're out of the game.

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Russell Brazil What I'm reading online says NOI does not include financing, whereas cash flow does. So a negative cash flow is possible with any cap rate, depending on the financing terms. I used standard financing that would be available to me as a new investor in the calculation, i.e. conventional 30-year fixed mortgage, 20% down, 4% APR, although even this may be overly rosy.

5 Reply

OP

Tucson, AZ · Member since 2020 · 64 posts · 53 votes

@Marian Smith No, I haven't done that, but sounds like a good idea. I figured investing in a low cap rate property would result in very little taxable income since so much of the rental income would be knocked out by depreciation. But I have not actually run the numbers and appreciate the suggestion.