Why are people buying at these prices?

Buying & Selling Real Estate

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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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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Nick Gerli
Investor · Austin, TX · Member since 2020 · 72 posts · 77 votes
6y
People seem to be banking on future value appreciation. I think they could be on to something.
Over the last decade, the US has built fewer homes than it did in the 1980s or 1990s. Despite a population that is 100 million higher today.
This likely equates to a shortage of housing, which is more exacerbated in certain areas (California) than others (Texas).
2 Reply
Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
Hey, @Travis Biziorek, sorry took a break from BP for a while, no doubt partly to observe the political thriller unfolding in DC. At any rate, yeah, I see what you are saying. But isn't landlording just a hassle for retirees, or they pay for property management that eats into the income? Maybe the numbers still work out better than passive investments.
0 Reply
Travis Biziorek
Investor · Arroyo Grande, CA · Member since 2014 · 1k+ posts · 1k+ votes
6y
Originally posted by @Josephine Wilson:
Hey, @Travis Biziorek, sorry took a break from BP for a while, no doubt partly to observe the political thriller unfolding in DC. At any rate, yeah, I see what you are saying. But isn't landlording just a hassle for retirees, or they pay for property management that eats into the income? Maybe the numbers still work out better than passive investments.

You're grasping at straws here, IMO, Josephine. Maybe the numbers still work out better than passive investments? You mean, the worse than inflation returns that bonds present?
Property managers generally take ~15%. So calculate any rate of return you'd get... 4%, 8%, 10%, whatever and take 90% of that and compare it to the rate of return in a savings account, treasury bond, etc. It still blows it out of the water.
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Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Travis Biziorek I'm not arguing with you, I'm just trying to square what you are saying with the fact that my bond funds throw off a decent amount of income every year and I don't have to lift a finger. Then again, it may seem like a lot because I think about it only at tax time when I have to pay the full income tax rate on them.

...Okay, just checked and my bond funds threw off 2.2% in dividends and cap gains distributions in 2019. It does seem kind of lame. So I'm looking at (dividends+cap gains distributions)/total invested x 100. Is this the comparison with CoC? I'm not looking at appreciation at all. Don't hose me here; I know nothing about mutual funds aside from the tax loss/gain harvesting I do from time to time.
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Travis Biziorek
Investor · Arroyo Grande, CA · Member since 2014 · 1k+ posts · 1k+ votes
6y
Originally posted by @Josephine Wilson:
@Travis Biziorek I'm not arguing with you, I'm just trying to square what you are saying with the fact that my bond funds throw off a decent amount of income every year and I don't have to lift a finger. Then again, it may seem like a lot because I think about it only at tax time when I have to pay the full income tax rate on them.

...Okay, just checked and my bond funds threw off 2.2% in dividends and cap gains distributions in 2019. It does seem kind of lame. So I'm looking at (dividends+cap gains distributions)/total invested x 100. Is this the comparison with CoC? I'm not looking at appreciation at all. Don't hose me here; I know nothing about mutual funds aside from the tax loss/gain harvesting I do from time to time.

So no, not yet correct.

A capital gains distribution is paid from the sale of stock/bonds. So that's from the sale of your bonds, aka capital gains. That'd be like selling one property in your investment property portfolio and the proceeds would be "capital gains distributions" while the rent you received that year from that home would be cashflow (or dividends in the case of your bond fund).

If you want to compare apples-to-apples when looking at cashflow (and there's no reason you shouldn't), you'd have to ONLY compare it to the dividends your bond fund paid out.
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Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Travis Biziorek My calculation is off because I forgot my denominator changed during the year. So that aside, I want to say the apples-to-apples comparison is SEC yield to CoC. But I seem to recall earlier in this thread that you indicated it wasn't. I'm surprised not to be finding a discussion of these comparisons online.

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Travis Biziorek
Investor · Arroyo Grande, CA · Member since 2014 · 1k+ posts · 1k+ votes
6y
Originally posted by @Josephine Wilson:
@Travis Biziorek My calculation is off because I forgot my denominator changed during the year. So that aside, I want to say the apples-to-apples comparison is SEC yield to CoC. But I seem to recall earlier in this thread that you indicated it wasn't. I'm surprised not to be finding a discussion of these comparisons online.
I don't know what 'the "SEC yield" is, but I still feel you're over complicating it.
When you put money into a bond fund it is used to buy bonds.
When you buy real estate, you own houses.
The bond/house is the asset that produces income. In the case of the bond, that's a dividend. In the cash of a rental property, it's rent.
Your net cashflow is that dividend/rent minus any expenses (bond funds generally have a fee).
When you sell any of those assets, those are capital gains or loss. That's the same whether you sell a bond or a house. You're selling the underlying, cash producing asset in either case.
You can compare the dividend and rent payments as apples-to-apples. You can compare the cap gains as apples-to-apples. But you cannot mix and match unless EVERYTHING has been wound down (e.g. you've completely out of your bond fund and real estate and can therefore evaluate total, blended returns).
It's far less complicated than our conversation has been making it.

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Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Travis Biziorek Agree on all that. My point is just that if the yield on a bond fund (dividends/total invested) is 4% and the CoC is 4%, you are talking about equal investments in terms of income. You can find bond funds with yields of 4%.
0 Reply
Travis Biziorek
Investor · Arroyo Grande, CA · Member since 2014 · 1k+ posts · 1k+ votes
6y
Originally posted by @Josephine Wilson:
@Travis Biziorek Agree on all that. My point is just that if the yield on a bond fund (dividends/total invested) is 4% and the CoC is 4%, you are talking about equal investments in terms of income. You can find bond funds with yields of 4%.

I can find bond funds with 12%, too. That doesn't mean they aren't far riskier than buying real estate. But again, it's not apples-to-apples when you simply say "my bond fund returns 4% and my real estate investment returns CoC of 4%". If you REALLY want to know what's the better investment you need to look at blended returns.
What happens when the value of your bonds go down? You'll be earning a higher dividend but your capital bonds (assets) will be worth less. The two are inversely correlated. Your yield will not go up unless the value of your assets goes down. That's not true in real estate. In fact, you generally see the price of real estate (the asset) go up over time as well as rents.
That 4% CoC is a starting point (I think I mentioned that in my first response). In 10 years, it will likely be MUCH higher.
Listen, I'm not here to convince you of anything. If you're happy with your bond fund performance, by all means... stash your cash there.
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Fred Cannon
Rental Property Investor · St Augustine, FL · Member since 2019 · 265 posts · 279 votes
6y
@Josephine Wilson not understanding why the rent is so low on a class A property. I would think you should be getting 1100 or more per month for a one bedroom in a class A area Especially if you are paying 250k for a duplex.
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Fred Cannon
Rental Property Investor · St Augustine, FL · Member since 2019 · 265 posts · 279 votes
6y
@Scott R. I'm with you I just look at cash flow. I'm not an accountant but I do know that 2 is greater that 1 so if I spend one dollar and I make 2, I have cash flow. I do like appreciation also. Good neighborhoods with cash flow. The basics of a great investment property. That's the way I analyze a deal. Everyone has their niche and different goals.
0 Reply
Angelo Forzano
Member since 2020 · 54 posts · 30 votes
6y
@Josephine Wilson. Their looking for property appreciation, some could be owner occupied which is a totally different scenario and don't forget 1031 exchanges!
1 Reply
Josephine Wilson
OP
Tucson, AZ · Member since 2020 · 64 posts · 53 votes
6y
@Travis Biziorek Good points there. I'm on BP because I can do better in RE than in the bond fund. I'm a natural debater - that may be coming out! But I pretty much agree with you on all points. :-)

@Fred Cannon I know more now and think it's a B property, and also think I was slightly underestimating rents.
0 Reply
Mike H.
Rental Property Investor · Atlanta, GA · Member since 2017 · 127 posts · 75 votes
6y
It could be they are already in the market. Using 1031 they want to keep their gains on the market. VS you who are possibly brining new funds in to the market.
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Ian WalshBusiness Member
Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
6y
Money is cheap right now and there is hype to move post covid so there is a bit of a feeding frenzy in the retail and investment market.
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Shiva Bhaskar
Investor · Los Angeles, CA · Member since 2017 · 523 posts · 476 votes
6y
I'm in a market with low cap rates, and many properties that do not cash flow, unless you put 40% down (LA County) so I have a few ideas:

1. They are clueless as @Brian mentioned. More common than you think.
2. Rich folks or foreign investors looking to park cash. AZ is on people's radar, which means money from Asia is coming in. Some of these people want to get the cash out of China or Hong Kong or Korea, and put it somewhere stable, and they don't care about returns. I see a lot of this locally.
3. They are rehabbing to increase rents. So, low cash flow now, but they have a turnaround plan to bump rents and increase value over next 2 to 4 years. Then, they might sell or refi. In our market, I see properties that were purchased at a 4% cap, at current rents. However, the investor is able to turn these into a 6% cap over the next 3 years, and sells or refinances with a 50% increase in property value.

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Shiva Bhaskar
Investor · Los Angeles, CA · Member since 2017 · 523 posts · 476 votes
6y
Originally posted by @John Erlanger:
Originally posted by @Shiva Bhaskar:
I see properties that were purchased at a 4% cap, at current rents. However, the investor is able to turn these into a 6% cap over the next 3 years, and sells or refinances with a 50% increase in property value.

If the cap rate goes up the value goes down. If you are buying at 4% and selling at 6% you have to increase NOI to an impossible amount just to break even.

I should have clarified - you can sell these properties that you've taken to a 6 cap, in the low 4's range down the line. I was calculating the new cap 6% rate based on new NOI divided by the purchase price plus rehab/turnaround costs. Based on that, yes, you have added a lot of value, and as you said, it's not easy.
That level of value add in that time frame is relatively rare (in our market at least), but the people who have figured out how to make deals with rent-regulated tenants, and take the units to market rents, do absurdly well out here. Not easy per se, but there are investors who have it down to almost a science. Not everyone's game, but very profitable for some folks.

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Mitch Messer
Lender · Playa del Carmen, México · Member since 2014 · 2k+ posts · 1k+ votes
5y
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?

Terry, I can't DM here on BiggerPockets, but you can reach me by phone, text or email. My info is in my signature block below (provided you're NOT on the phone app).

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