Why are people buying at these prices?

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

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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Darius Ogloza
Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes
6y
Sometimes semantics interfere with communication. If I have an asset that generates $10,000 in cash after payment of expenses, and I purchase that asset for $100,000 cash, I figure I am earning 10% on my cash investment. Whether I call that cap rate or not, the number is meaningful insofar as it allows me to compare the return against an asset of similar risk (as I measure risk) that costs $110,000. This perhaps would not be true in a perfectly efficient market, but the market for commercial or residential real estate is just not that efficient.
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Brian Ellwood
Rental Property Investor · Denver, CO · Member since 2018 · 191 posts · 247 votes
6y
Originally posted by @Terry Harris:
@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?

I market directly to them using direct mail

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Nicholas U.Pro Member
Member since 2020 · 65 posts · 44 votes
6y
Yes this is annoying but there are a few things going on here. The first is you are correct it probably won't cash flow so the people that are buying it are either not doing the right type of research or they have plenty of capital and just want to use it. The second is that it is sounds like it is a highly desirable area. You aren't going to cash flow around college campuses generally. The trade off is that you don't usually have trouble finding tenants and there may be room for appreciation depending upon what the future growth looks like around there.
I avoid college campuses and focus outside of them generally. If a big new apartment building goes up it can be hard to compete.
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Dion McNeeleyPro Member
Rental Property Investor · Port Orchard, WA · Member since 2018 · 116 posts · 123 votes
6y
Right now investors are avoiding the stock market while it is playing vertical pong. They need a place to keep cash. Investors are buying places that will have negative rental cash flow and do not care. It is better than losing 20-50% because Elon tweets that his company is overvalued again.
Fear of the 1031 going away if we get a democrat president has man people selling now and taking advantage of the tax break.
As people move out of cities because of covid allowing many to work from home. Avoiding large populations during a pandemic. Getting away from the riots. Prices in rural areas will continue to go up for several years. (That last one is just my opinion and not based on any real data) So a lot of investors must agree with me and are trying to get the properties now at 20% above appraised values instead of in three years when those values increase 50%
Podcast Guest on Show Financial Freedom in 10 Years and $200K Cash Flow with a Small Portfolio
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Adam Pickett
Rental Property Investor · St louis, MO · Member since 2017 · 8 posts · 1 vote
6y
@Josephine Wilson I wouldn't recommend doing that deal. Always have a cushion. If something goes wrong (even in a class A property) you run the risk of coming out of pocket. Keep in mind it's a class A property so you will be coming out of pocket for class A materials. Appreciation is not guaranteed.
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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 @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.

You could call CAP rate a return metric, although it is not the best metric. It is really used more for quickly comparing investments. Consider this example. Two identical properties are located next door to each other and one is advertised at $100,000 at 5% CAP rate, the other is advertised for $50,000 at 10% CAP rate. Let's assume the "market CAP rate" is 7%. (Keep in mind the market CAP rate is just average of CAP rates for comparable properties that have sold recently in the market). Given this information we can conclude the 5% CAP property is overprice and the 10% CAP is under priced to the market. This is the purpose of CAP rate. To understand at a high level how returns compare between investments. If the properties were not identical, there could be other explanations or things to consider before buying.
Generally speaking higher returns mean higher risk with any investment, but as real estate investors we are chasing higher returns and accepting higher risk. If you want low risk, purchase a 2% FDIC savings account. Most people would agree that an FDIC account is lower risk, but not necessarily a better investment. Demand drives price higher, so more desirable properties often have lower return. Of course there are exceptions. The goal of investor is to look within a market to find the "hidden gem". That could be a property with low CAP rate, but opportunity to increase rents. That could be a property with higher CAP rate that is undervalued. Using any one metric is oversimplifying. Condition of the property, cash flow, cash on cash return, future appreciation, financing terms, tax benefits, etc. are just some of the other things to consider.
I think you are getting hung up on market CAP rate, but forgetting that market CAP rate is just an average of all the individual CAP rates. It moves up and down and income or value of individual properties change.
As far as SFH comments, you are the one who brought that into this conversation. The OP said it is multifamily (not SFH as you state) and she is a woman (not a man as you state).
2 Reply
Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Mark Kelly and @Adam E. Good catch. My cash flow calculation includes insurance of $83/month and also a vacancy rate of 5%. Should have mentioned those!

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Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Nicholas U.

@Nicholas U. We have several large apartment buildings going up. Wise to proceed with caution under those conditions. I'm going to take a look at some other neighborhoods.

@Dion McNeeley Good insights. That may be what's happening here.

1 Reply
Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Tim Ryan Good point. I'm going to look at some neighborhoods at bit farther away before I give up on Tucson altogether. I just can't see going OOS on my first property.
0 Reply
Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Curtis Bidwell Yup, that had been on my mind. My rents are averages from units advertised online, but a lot of student housing is dumps. I kind of suspect, as you note, that I could make some upgrades, do some nice advertising, maybe attract childless university staff rather than students, and get my cash flow into a decent range. It's a bit more of a gamble though.
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Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Dan Cuming You may be right, Mr. Greenspan.

@Marc Rice True, but I'm not sure I want to deal with so many different people. Not sure STR is my thing.

@Daniel Trimble Your first payment - I bet that feels good. Congrats and good luck!

@Eric Bilderback Good perspective. If I can get through a few years of worry, there may be the big pay off in appreciation.
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Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@David Avery It is not a wholesaler deal. It's someone else's deal that closed in January. I'm examining some recent deals in my target area to get a sense of the market. I was just perplexed as to why someone would buy it at that price.
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Mason Aulsbrook
Member since 2020 · 12 posts · 0 votes
6y
@Brian Ellwood I’m just getting started and cannot do anything in this market. How can I buy off market?
0 Reply
Gerry Logan
Accountant · Chicago · Member since 2020 · 14 posts · 21 votes
6y
Hi Josephine - I am also a newbie about to close my first 10 unit property in Milwaukee, WI in a C to C+ area. I was also afraid at first to buy in this area. However, in Milwaukee evictions are rather quick and cheap. Additionally, the CAP rates are much higher. I found a great property manager and decided to pull the trigger.
Regarding your purchase of a duplex. I agree with what everyone is saying about simply not being educated. When your dealing with property with less then 5 units its considered residential and the loan goes through your traditional residential funding and appraisal. There are very few people that go into buying a duplex and calculating cap rates.
My partner on my deal also purchased a 3-unit off market building in 2019. He was able to purchased the building using the investment calculator and negotiated a great price for himself. About 60 days ago he was contacted by a gentleman that offered to buy that same property. This person was not a sophisticated investor and wanted to buy the building to live in it with his family. Long story short the purchase price was almost 100K over the sale price from 1 year ago. The appraisal also came up to the new purchase price. The person buying the property will get the full disclosure at the closing and realize how much the gain was in a years time frame.
2 Reply
Jim D.
Member since 2019 · 65 posts · 68 votes
6y
Originally posted by @Josephine Wilson:
@David Avery It is not a wholesaler deal. It's someone else's deal that closed in January. I'm examining some recent deals in my target area to get a sense of the market. I was just perplexed as to why someone would buy it at that price.

I agree with Dion McNeeley when he says "They need a place to keep cash. Investors are buying places that will have negative rental cash flow and do not care. It is better than losing 20-50% because Elon tweets that his company is overvalued again."

I've posted similar thoughts a couple times in the last year or so and I'm surprised it doesn't get more attention - there are lots of wealthy people that simply need a place to park some cash and/or are chasing yield. People are tired of getting <1% on a cash bank deposit and feel they have more than enough in the stock market, so they are looking for an alternative or diversification. I've told the tale of my friend, who has said he doesn't care if he gets 2.5% CoC or 7% CoC in real estate...he just doesn't want any more in the bank nor stocks or bonds.

Yes, there are foolish people buying at these prices that just don't know any better as other folks have pointed out. There are investors who are "in between" that just wanna lock in crazy-low interest rates perhaps with higher down payment and "buy" some cash flow (maybe some of these people are hedging against inflation too). And some buyers / house hackers just need a place to live. But in my opinion, the number of buyers that are simply looking for a place to park some cash is vastly understated. The 'hunt for yield' as they say has been going on for some time with ultra-low interest rates on deposits.

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Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Jim D. Just because I don't know any of these people who need places to park cash does not mean they don't exist, eh? But it doesn't have the liquidity of a bond fund, plus you pay a hefty commission when you need to exit. I get the diversification, though.
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Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Steve Vaughan I am really digging your strategy, from the off-market relationships to looking for B over A. But I have to admit, I really don't get the off-market seller. I mean, what the heck is in it for them? Sorry, I know this is a newbie question because clearly there are lots of off-market sellers. But, no matter what the condition of the property, they will get top dollar if it gets put on the MLS. All they have to do is make one call to a RE agent to get top dollar. Why would they sell to you? Is it all about saving themselves a commission?
My research is pointing toward targeting an area, getting a list and writing a letter to them. We have a lot of older people owning properties outright or kids who inherited the property. We have a lot of big high-rise student housing going up and I think the rental market for students will be softening. I'm hoping they have started to feel this (along with the students not being around due to Covid) and are thinking of selling. But I feel like I would have more success if I have a better sense of their motivations. It just seems to me like a bad move for them.
1 Reply
Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Darius Ogloza What sort of lenders are flexible on DTI, community banks? Under the DTI, I have about $500,000 to play with before I get maxed out. That's two small properties or one larger one. Not sure I want to use it up on properties without cash flow, as opposed to having cash flow that can push me above $500K. I get your argument though.
And I am totally with you on C versus A, although I'm looking more at B now to provide a bit of a buffer in a downturn but hopefully still get reliable tenants.
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Travis Gregory
Rental Property Investor · Morgan Hill, CA · Member since 2020 · 17 posts · 11 votes
6y
Originally posted by @Josephine Wilson:
@Steve Vaughan I am really digging your strategy, from the off-market relationships to looking for B over A. But I have to admit, I really don't get the off-market seller. I mean, what the heck is in it for them? Sorry, I know this is a newbie question because clearly there are lots of off-market sellers. But, no matter what the condition of the property, they will get top dollar if it gets put on the MLS. All they have to do is make one call to a RE agent to get top dollar. Why would they sell to you? Is it all about saving themselves a commission?
I would also like to know more about off-market sales, what seller's get out of it and how one even goes about finding them. Is it generally the realtor who finds them or do you have to be pretty networked within the location to find an off market property? Does a new out of state buyer have any hopes of coming across something off market? Thanks!
1 Reply
Jim D.
Member since 2019 · 65 posts · 68 votes
6y
@Josephine Wilson haha, yeah, I don't have to worry about "needing to park cash" though it would be a good problem to have. In all seriousness, you make a great point that folks who are using real estate for this purpose are sacrificing liquidity and subject to thousands of dollars upon sale.
I have to admit, I've been pondering if I should be a little more aggressive in finding my next deal in part because interest rates are so low. Not that I'm going to sacrifice my own criteria altogether just to add a property to my portfolio...but I am wondering if this is a time to relax my criteria ever-so-slightly to take advantage of low rates and my own concern about potential / eventual inflation. In other words, speaking to the topic of your post, clearly I have reasons why I might consider buying at today's prices, even if I think they're a bit frothy.
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Steve Vaughan
Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
6y
Originally posted by @Josephine Wilson:
@Steve Vaughan I am really digging your strategy, from the off-market relationships to looking for B over A. But I have to admit, I really don't get the off-market seller. I mean, what the heck is in it for them?

I think the main reason sellers would choose me over a full listing with an agent is ease and the idea of saving commissions. It's not just a 'call to an agent' to sell a place.

Listing agreements here are 9 pages long and is usually a 6 month commitment. In that agreement you agree to pay for the privilege of the buyer's agent to negotiate against you. Not everyone believes in that system. I sure don't. My current purchase is 'saving' the seller $57,000 in commission, so there's always that.

My purchase contract is 3 pages long. Offers with an agent here are 17 pages long. 19 if built before 1978.

With multis, you have to notify tenants every time a potential buyer or agent wants to look. How many times until that isn't fun?

Then there's the inspector and appraiser. I usually go through once and do my inspection while there. No inspector later. No appraiser. I won't beat you up with little inspection corrections either. I offered after seeing the open amd obvious.

We won't be under contract for 3 weeks when the FHA or VA appraiser fails the property or has cumbersome subject to's. Then back on the market to start over again or at least notify the tenants again for work to be done or a specialist to look at it.

I'd say 3 out of 4 list like you would think. 7 of 8 if A-class. The people that call me DIY and don't do agents or PMs normally. Plus landlords are cheap and want to save money so they think.
1 Reply
Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Steve Vaughan How many of your sellers are libertarians? This sounds to me like a libertarian perspective. But yes, I also get what you are saying about convenience and speed. I could see that appealing. You have to be pretty confident in your appraisal and inspection skills, and have a lot of cash to do this, I'm thinking.
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Jack LuzeckyPro Member
Property Manager · Saint Louis, MO · Member since 2017 · 76 posts · 56 votes
6y
Real estate, at the moment, is a safe place to put your money to work. A lot of cash investors are swarming the markets. Its a great deal if an investor can take in some positive monthly cash flow and resell the property with little to no loss.
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Wren Lemmon
Rental Property Investor · Thibodaux, LA · Member since 2020 · 1 post · 0 votes
6y
@Brian Ellwood any tips on strategically identifying off market listings? I’m in the Southwest Louisiana region and while most forums are geared toward our large metro areas, I’m trying to gain knowledge to overcome fear of a first deal crashing and burning. Any insight is appreciated.
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Todd Groom
Rental Property Investor · Tampa, FL · Member since 2020 · 77 posts · 42 votes
6y
A lot of people’s 1031’s are running out and they are pushing the prices up. I know that’s one reason I’ve seen people doing it. There’s nothing to buy at their price range. Making zero money is better than loosing hundreds of thousands to taxes. A big investor told me he’s got millions in 1031 money and clock was ticking.
Another I had read about is on the west coast the Chinese are parking their money in homes. Overpaying just to put it somewhere like a bank account. Not sure how true but had read about it in a report.
Here in Tampa we are overpaying but it’s still with in our requirements. 2 times now we have over Bid around $5,000 over a property with multiple offers. But still had a 12-15% cash on cash return and 25% equity so it’s worth it.
It’s a really crazy market.
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