Why are people buying at these prices?

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Why are people buying at these prices?

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

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%

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Brian Ellwood
Rental Property Investor · Denver, CO · Member since 2018 · 191 posts · 247 votes
6y

Yeah, that wouldn't cashflow like you observed. The short answer is that these people don't know what they're doing, or they're buying with cash just to have a more predictable asset versus holding stocks or something like that. 

I've done hundreds of deals and never bought a listed property before. Don't worry too much about what's going on with listed properties, the real savvy investors are often operating off-market, unless they're in a really cheap market where rent/price ratios are inherently better. 

Is Tucson a good market, numbers wise? 

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  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    6y
    Originally posted by @Josephine Wilson:

    @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.

     Cap rate does not. But your use of leverage has nothing to do with the properties performance, nor does that leverage amount you choose to use have anything to do with how other investors purchase the property. 

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  • Terry Harris
    Rental Property Investor · Wilmington, DE · Member since 2020 · 35 posts · 19 votes
    6y

    @Brian Ellwood

    Wow great insight! How do you go about finding off market deals? Do they come to you? Or are you doing more of the research and findings on these?

    1Reply
  • Salman P.
    Tacoma, WA · Member since 2020 · 21 posts · 3 votes
    6y

    @Josephine Wilson we have the same problem going on in Tacoma Wa. Me and my gf looking for a househack. First we thought duplex but duplex are not even giving .5% rent here. Numbers are just not making any senses here, every property is going 10, 20k more than sellers asking price.. now we are thinking of a triplex fourplex or SFR with Adu . Anyone, how can I look for off market properties? Where can I find them?

    1Reply
  • Scott R.
    Investor · Beverly Hills, CA · Member since 2017 · 95 posts · 59 votes
    6y

    I'll take a C+/B- neighborhood over an A any day. For me, it's about cashflow and I know my Cash on cash is much lower with an A. I can't speak for others, but unless I'm dealing with commercial units, I dont even look at CAP rate.

    2Reply
  • Dan Cuming
    Member since 2018 · 9 posts · 3 votes
    6y

    Irrational exuberance.

    3Reply
  • Matthew Devine
    Specialist · Atlanta, GA · Member since 2018 · 11 posts · 5 votes
    6y
    Originally posted by @Scott R.:

    I'll take a C+/B- neighborhood over an A any day. For me, it's about cashflow and I know my Cash on cash is much lower with an A. I can't speak for others, but unless I'm dealing with commercial units, I dont even look at CAP rate.

    Agreed... 1-4 units I'm "more so" concerned with my COC return ...at 5+ units I factor cap rate into the equation.


    A good diversification of B+/-, C+ neighborhoods In my opinion provides a good balance along with quality tenants.  

    1Reply
  • Ian WalshBusiness Member
    Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
    6y

    Money is really cheap for long term owner occ notes right now.

    0Reply
  • Mike H.
    Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
    6y
    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%

    What is the downpayment you are assuming for these investors getting negative cash flow?  What if they put 30-40% down? 

    0Reply
  • Adam E.
    Investor · Member since 2019 · 25 posts · 24 votes
    6y

    Is my math off or is something missing? This cash flows +116.

    1Reply
  • Matt Nico
    Member since 2019 · 448 posts · 306 votes
    6y
    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%

    Is it possible that you are mis-calculating the rents? I have house-hacked every home I have bought. Rents in my area are usually $2,000 / month for my subject properties, but when I rent them by the room it skyrockets to $3,500/month. Try renting to college kids by the room in a larger 5-6 bedroom house. Just avoid HOA's. They hate it.

    -Matt

    2Reply
  • David Avery
    Flipper/Rehabber · Phoenix Arizona · Member since 2020 · 1k+ posts · 686 votes
    6y

    After living in Phoenix now for 2 months......

    I have looked at hundreds of potential properties to hold, flip, etc.  This area is tough.

    When I get 3 emails from 3 different Wholesalers on same property. And their ARV is

    $35,000 high.  People in Phoenix area's are buying everything . 

    Their are so many want to be investors.  So they say......  They will buy a property without even seeing 2 or 3 units on a 4 plex. Until day before closing.   Then their agent is talking them into it. (comish)  This is their income now if you back out!!!

    I would be willing to help you make any decisions on condition of any property within 50 miles of downtown. Understand construction better than any 50 inspectors! 

    Its a tough market because everyone here wants more Real Estate and are willing to pay 10-15 % higher.  It surprises me how the appraisals make it work !!!!

    0Reply
  • Mark Kelly
    Cotati, CA · Member since 2017 · 10 posts · 3 votes
    6y

    Using your numbers I get a positive cash flow of $116/mo. Although you didn’t list insurance.

    0Reply
  • David Avery
    Flipper/Rehabber · Phoenix Arizona · Member since 2020 · 1k+ posts · 686 votes
    6y

    Hopefully your getting more square footage then your example property.   Is it a wholesaler deal!?

    0Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    6y
    Originally posted by @Andrey Y.:
    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.

    1. CAP rate is Net Operating Income divided by property value, so when a property is listed for sale it is net operating income expressed as a percentage of sales price.

    2. You can absolutely calculate CAP rate. How do you think they come up with the numbers? It is NOI/value. When selling a property they use offer price as the value.

    3. CAP rate has been around since before the internet and there is no question about how it is calculated. Insulting others doesn't prove your point.

    4. Lower CAP rate does not mean the asset is higher quality. It means the return relative to current value is low. One reason could be that it is a high quality asset. Higher quality assets have lower risk and therefore lower return. Other explanations could be the that property is overpriced, has excessive expenses or has under market rents. Basically anything that affects NOI or value will change CAP rate.

    Nobody is saying CAP rate is a perfect measure. It is one of many different metrics you can use to evaluate and compare investments.

    9Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    6y

    @Josephine Wilson Listed plexes in my market don't pencil either. I have to establish relationships directly with the owners and be the first they call. Listed 2, 3 and 4 plexes here are .5%-ers, even worse than yours. An A-/B+ duplex bringing in $1500/mo in rent will be about $300k on the MLS.

    The good news is, high grass plexes or any plex is pretty much investor-owned. Farm a neighborhood you like and send a nice letter.  I like to hyper-focus and get to know the owners in my neighborhood of choice.   My choice is more b-class than A personally.  A class suffers first in a recession and the tenants can be picky.  

    As far as cap rates go, it is important to know what the market cap rate is. If others are ok with it taking over 20 years to re-capitalize/ get their money back, then you know how valuable it is to add to NOI. Every dollar of NOI increase = $20 in asset value increase. In the commercial space. You are still residential with small plexes so asset value is still more determined by comps. Cap rates and GRMs are ways to get relative values and can be fun to play with in the small plex world.

    Equity capture at the buy is the play for me in expensive markets like yours. The A class 16 GRM quads in my area are being bought by non-related LLC partnerships. I will wait a few years for their honeymoon to wear off.

    I haven't bought off the MLS since 2011. Take down addresses of properties you like and send the owners a nice note.

    2Reply
  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    6y
    Originally posted by @Russell Brazil:
    Originally posted by @Josephine Wilson:

    @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.

     Cap rate does not. But your use of leverage has nothing to do with the properties performance, nor does that leverage amount you choose to use have anything to do with how other investors purchase the property. 

     Exactly. You can pay cash or 100% leverage a property, both extremes yield grossly different cash flow numbers. Would you rather have $1000 cash flow after paying cash for a property or -$50 cash flow when 100% leveraged. The answer is depends, but odds are good the negative cash flow property is a better investment. Cash flow by itself doesn't tell the whole story, because it is missing cash invested.

    CAP rate looks at the investment without financing, so it is strictly NOI as a percentage of cash purchase price.

    CoC (cash on cash return) looks at the investment using NOI, financing and cash invested. This can be a better metric because is includes more variables.

    6Reply
  • Eric Bilderback
    Real Estate Agent · Sisters, OR · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    Yup I think this is the problem almost everywhere.  I haven’t bought a property for almost 4 years because the cap rates are like you are describing.  Now I wish I would have because most of the places I passed on would be worth significantly more and cash flowing strongly today.  Its tough but numbers generally don’t work all that well for myself at first after 2-3 years things settle down and I breath a sigh of relief.  I would stick to your strategy and by a nice place and double and triple check your numbers to ensure you will not loose the property.  I firm belief is in 10 years you will be ecstatic that you bought the property (in one year not so much!).  I’m not smart enough to find deals off market for pennies on the dollar wish I was I’d be rich!

    2Reply
  • Steve Vaughan
    Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
    6y
    Originally posted by @Eric Bilderback:

    Yup I think this is the problem almost everywhere.  I haven’t bought a property for almost 4 years 

    I’m not smart enough to find deals off market for pennies on the dollar wish I was I’d be rich!

    Don't sell yourself short, Eric!  A-class owners like to work with professionals.  They're used to it.  I would keep in touch with them as a potential buyer and see if they don't get a hold of you before they decide to list. Then you could always list if the buy doesn't work out. 

    My guys don't like working with professionals.  Mostly c-aged properties (60s and 70s) in B- areas.  Usually some high grass and fading/peeling paint is involved.  DIY landlords like me.    Send some letters and over time get some nice properties!   

    2Reply
  • Daniel TrimblePro Member
    Member since 2020 · 5 posts · 11 votes
    6y

    @Josephine Wilson I bought around Glen and 1st area. B-/C+ property. A property in Tucson is certainly hard to find in Tucson for a good price right now. On a positive note, my management company just sent an email of my first payment so that’s something. Keep looking and start putting offers in. 

    0Reply
  • Darius Ogloza
    Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes
    6y

    @Josephine Wilson You are very right about DTI ratio becoming a problem for scaling this strategy. Two additional points: (1) there are lenders out there who are willing to look at your balance sheet to secure their loans such that DTI becomes irrelevant or, more often, of secondary concern; and (2) with choice assets you do not need all that many properties to achieve your goal. Would you rather own 8 C class properties that rented $625/month each in some sketchy part of town with limited prospects for growth or a single high value property that generates $5,000/month rent? From a management perspective? From a capital expenditures perspective? From about any reasonable perspective?

    0Reply
  • Marc RiceBusiness Member
    Real Estate Agent · Columbus Cleveland Dayton, OH · Member since 2018 · 2k+ posts · 1k+ votes
    6y

    @Josephine Wilson

    They could be turning those 1bds into short term rentals. If it was an A class market I could easily clear $1,250/net/mo on those 1bds making it a 1% rule with airbnb.

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    0Reply
  • Justin Caputo
    Real Estate Broker · Scottsdale, AZ · Member since 2016 · 70 posts · 15 votes
    6y

    @Brian Ellwood

    Yes Tucson is an amazing market! Low prices, high caps and good university town. I have several clients buying great deals there and getting extremely good cash flow!

    1Reply
  • Curtis BidwellPro Member
    Rental Property Investor · Olympia, WA · Member since 2014 · 781 posts · 744 votes
    6y

    @Josephine Wilson I believe your rent expectation are under market.  Check the specific area, but I would expect a minimum of $900/unit in that area being close to universities.  Update them and you’ll get up to $1250/unit.  Now your an doing 1% and making comfortable money (with expected rent growth of 8%/year for next 2 years!). 

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    0Reply
  • Tim Ryan
    Investor / Mentor / Contractor · Arcadia, CA Buying Out of State · Member since 2015 · 655 posts · 622 votes
    6y

    @Josephine Wilson Yeah these are not good investment deals. Investors need to realize that the deals are sometimes not available in their “back yard”. Need to find a growth market somewhere else and invest there. This involves a whole new set is skills but is doable. I’ve been investing only out of state (2500 miles away) for years. Even today I’m getting positive cash flow. So, my advice is to learn the strategies of out of your area investing.

    0Reply
  • Andrey Y.
    Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes
    6y
    Originally posted by @Joe Splitrock:
    Originally posted by @Andrey Y.:
    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.

    1. CAP rate is Net Operating Income divided by property value, so when a property is listed for sale it is net operating income expressed as a percentage of sales price.

    2. You can absolutely calculate CAP rate. How do you think they come up with the numbers? It is NOI/value. When selling a property they use offer price as the value.

    3. CAP rate has been around since before the internet and there is no question about how it is calculated. Insulting others doesn't prove your point.

    4. Lower CAP rate does not mean the asset is higher quality. It means the return relative to current value is low. One reason could be that it is a high quality asset. Higher quality assets have lower risk and therefore lower return. Other explanations could be the that property is overpriced, has excessive expenses or has under market rents. Basically anything that affects NOI or value will change CAP rate.

    Nobody is saying CAP rate is a perfect measure. It is one of many different metrics you can use to evaluate and compare investments.

     Again, a capitalization rate is not a return metric. It is a measure of desirability, and a lower cap rate is a lower level of perceived risk.

    He cannot calculate a cap rate because cap rates are obtained by cap rate comps in that submarket, typically on 50-100+ unit properties.

    You cannot calculate your own cap rate, the (sub)market dictates cap rate, and there are no cap rates on SFHs. SFHs have nothing to do with cap rate because their purchase and sale price has NOTHING to do their their income/NOI. There are NO cap rate comps on a SFH lol, this is basic stuff my man.

    I understand you are a moderator but you have some responsibility to not spread dangerous information and advice such as higher cap rate is better, and everyone should jump at a 22% cap rate property !!!! Believe it or not, I've seen nonsense like this on one of the BP podcasts.

    Becuase if the OP truly believed this property had a "4.3 cap rate" (it doesn't) this means that he can get more than $20 for every $1 in NOI (LOL) which he can't and won't, because that is not that "cap rate" on his SFH.

    5Reply
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