Minimum Cash Flow ?

Question

Hi,

Whats the minimum amount of positive cash flow you would take when investing in real estate ? minimum you would take on a 2 family ? 3 family ? 4 family ? 5 and above ?

Ryan Webber · Answer

First year profit divided by total money out of pocket.

Ryan Webber · Answer

Cap rate has nothing to do with the condition of the property.  Capitalization rate is the cash on cash return on the property if you paid cash for it.  It takes financing differences out of the equation and depicts the profitability of a property on its own merits.  To figure the cap rate, you take the gross rents plus any miscellaneous income (laundry, coke machines, etc.) and subtract ALL expenses except for the debt service (the mortgage payment).  This is called the Net Operating Income (NOI).  This number you divide by the purchase price, and that is the cap rate.

Here's an example.

Gross rents are $1,000 per month or $12,000 per year.  If ALL the operating expenses (maintenance, utilities, vacancy, insurance, taxes, management, advertising, and everything else except a mortgage payment) equaled $2,000 annually then your NOI or Net Operating Income would be $10,000.  You would take that $10,000 and divide it by the purchase price to determine the cap rate.  If you were purchasing the property for $100,000 then it would be a 10% cap rate or $10,000/$100,000.  If you bought it for $80,000 then you would have a 12.5% cap rate or $10,000/$80,000.

I do agree with Rochelle that finding higher cap rate properties is completely possible, but you won't be buying them in California or the East Coast.  I'm typically won't buy a property for rental purposes with less than a 15% cap rate or so.  I don't come across them everyday, but every once in awhile I will find one.  I just put one under contract with a 16% cap rate.

Ryan Webber · Answer

I'm sorry I never answered Jrtucker's questions.  15% caps are nice, but they do usually come with property that needs work.  I have found several that don't, but I was referring to properties with past/current performance of the 15% cap but most likely do need varying amounts of attention.

The 16% cap I was referring to would actually be a 15.4% with my minimum estimated repairs factored in.  That is factored on current rents, which in my opinion could be raised 10% with some additional repairs.  With raised rents and my full repair estimate to get the rents up, it would be a 17% cap.

Ro Williams · Answer

I just wanted to say thanks to all of you. I am a new investor, and I am learning so much from this site. I look forward to sharing my knowledge and experiences soon.  From what I have learned from book and tapes so far I am going to focus on Lease/Options and Foreclosures.  My credit is not that great, and I have no cash, so.. it is also what I am confident with at this time.  :D

Scott Miller · Answer

In reality, nobody can answer that question but you, because only you set your ROI goals.

I tend to lean towards the conservative; I advise my investor buyers of duplexes/triplexes/fourplexes to use the same value decisions/calculations prescribed to by commercial lenders (DSCR, NOI, etc.) to ensure that there is ample cash flow in the property.

Here is a simple formula for figuring out the min. cash flow required:

NOI x DSCR = Min. Monthly Cash Flow Required for viable ROI

NOI = Monthly Rental Income - Monthly Service Debt/Operating Expenses
DSCR = 1.25 (benchmark ratio used by a majority of commercial lenders/loan products)

Using this simple formula will certainly disqualify alot of deals you run into, but any that pass this smell test, will cash flow for certain.

Try it; it works!

Regards,

Scott Miller

Josh Tucker · Answer

A 15%+ cap rate is nice and will almost guarantee you positive cash flow. However are these properties at a 15%+ cap rate rental ready? Or do they need serious upgrades above and beyond your normal wear and tear? And are the Rental numbers you are basing your cap number from past performances or projected financials?

N/A N/A · Answer

Take all your potential rents of a prospective property times 12 months.  Then multiply that number by the condition of the property.  For example, if the property is in excellent condition use 80-85%.  If its in horrible condition, use 30%.  
So, if this is a four-plex and the rents are $500 each, your potential rents are $2000 per month.  Multiply that by 12 months and you have $24,000.
Say the property is in average condition, rate it as 70%.
Multiply $24,000 by 70% and you would get 16,800.  Add a zero and this would tell you what you need to pay to have a 10% cap; $168,800.  If you pay $200,000 you would have an 8% cap.However; caps can work if you have no extra expenses.  There are other things to take into consideration such as:
1.  if  the landlord pays utilities besides the water.  Especially if the landlord pays the gas bill and the property is in a colder climate.
2.  if the vacancy rate is below 90% on the average
3.  are there major expenses needed such as a new roof?
4.  what are your costs for management and maintenance?

Look at the costs for all these figures in past years and see if the numbers make sense with the cap or do you need to figure a lower number instead of 70%.

Everyone will tell you that you can't find properties with a good cap but that's not true.  I know people that won't buy a property less then an 11% cap.  You just keep looking until you find the right property, or you offer a lower price and the seller accepts that price.  You have to make sure the numbers work, or you will lose big time!  But if you buy and the numbers work, you should be successful.
rochelle

Josh Tucker · Answer

CCR over what? month, year, 3 years?

Josh Tucker · Answer

Just as a begining rule of thumb I would shoot for $100 a unit.

Josh

Ryan Webber · Answer

I shoot for $100 per unit minimum.  I also factor my cash on cash return (CCR).  I want 40% minimum on my CCR.