Would you buy a property where the CoC is less than 8% ?

Question

I'm looking into a property that's on the border of a C neighborhood. It's a duplex (3br and 1bth on each side) and only one side is currently rented for ~$650. Rentometer median estimate is about $1100 but BP insights estimates $750. The other side is vacant. The lease for the occupied unit ends in July, and as per my agent, the tenants are expecting a rent increase. I was thinking about increasing their rent to $900 in July and charging the new tenants about $900/month as well. If that goes as expected, my COC would be 7.29% with $395 in cash flow. Would you make an offer?

Janki Shah · Answer

Thank you all for your feedback!! I forgot to add that my minimum for CoC is 8% and this was just slightly less so thought of giving it a look. I also prefer cash flow over appreciation.

@Evan you are right, I don't know if the tenants could afford the rent going up so much. However, I recently listened to a BP podcast in which Dion Mcneelay mentioned he works with the tenants and make them part of the rent decision by providing them with his analysis and costs as well as a report of current market rent rates (report from rentometer) and have them decide what would be fair for them to pay. He said that's worked well for him and they usually give a number just a little below the market rates. So I was thinking about doing that since the market rates are currently over 1000+ in that area and assume they could possibly agree to pay ~$900.

Thanks again!

Arn Cenedella · Answer

@Janki Shah

I encourage you to be very sure of your rent numbers.

I know nothing about the property and the area but bumping rent from $650 to $900 seems optimistic from a distance. It may very well happen but I would double check your estimates.

If you can get 7%+ cash on cash returns on a duplex in a non-war zone property in an area with good future long term prospects, I would buy it.

Good luck moving forward.

Aaron W. · Answer

@Janki Shah Congrats on finding a potential opportunity!

There really isn't a right or wrong answer on whether a 7% CoC is good or bad. It all depends on your investment goals. To one who is looking for appreciation upside over cash flow, this may be a great return, but to others who are looking for double-digit CoC returns, they would not even bat an eye.

If you haven't already, you should know your why in investing in real estate along with goals to help accomplish your why. Also, ask yourself if you can get this or better returns somewhere else?

Good luck!

Jane Schoensee · Answer

First time on this forum and am amazed at the quality feedback.

James Hamling · Answer

@Janki Shah A class-C at sub 8%, absolutely not! It' really that simple, no way, no how. no thanks.

You must keep in mind that with each class you descend, you must increase all contingency accounts and operational expenditures because reality is your gonna need it.

If you said a B that is a bit shaky, maybe B-, eeehhhh, maybe, maybe that's worth it, but C has this talent for venturing into D levels all too often. We are moving into a sky high taxation atmosphere, decent chances that C-class is going to be very sec8 dependent. Be very conservative in that class,

Janki Shah · Answer

@Rick Trivedi thank you! That was helpful.

Rick Trivedi · Answer

@Janki Shah - Personally I would base the cashflow based on the current numbers and price the property based on that. There are lots of deals which advertise "below market rents...opportunity to improve cashflow...", but they are below market for a reason. It will need some effort in terms of improvements or tenant recycling etc. which are additional costs (time and/or money). If you are successful in increasing rent etc. that is where the personal expertise comes in as an owners/operator, but that should be the cherry on top. 5-7-9% is all relative to location (which is everything in real estate) and hence the associated risk factor. Hope this helps.

Evan Polaski · Answer

@Janki Shah, is your 7% CoC self managed/leased or hired out?

As Arn noted, a tenant expecting rent increase and a tenant expecting a 40% rent increase are two totally different things.  Can the existing tenant even afford 900/mo?  Can the neighborhood's average incomes support it?  Personally, I look for 3x rent in NET, take home income.  More commonly, landlords want 3x rent in gross, in this case annual earnings of about $35k.

While this deal is too thin for my taste, it is just that, MY taste.  If you are happy with these returns, then go for it.  Just remember that any unexpected or non-reserved Capex items can quickly take away all your cashflow for a full year.  A roof can be $6k, new AC is $2,500-$3k, a bad tenant can run you a significant amount of turn over costs.

Jeffrey Donis · Answer

Hey Janki!

It all should come down to your criteria- if you have not come up with that I recommend doing so. It should include the class of asset you are looking to buy, what returns you are looking for, areas, and business strategy you plan on using (Value add, distressed, turnkey). This will help you in the long run- personally my team focuses on 10% coc since it is what our investors like to see. However, your goals are very likely to be different than everyone else's which is why it is so important to have a buying criteria beforehand. You can always go off of it slightly but it is a good thing to have in the back of your head when you are analyzing deals.

Would you buy a property where the CoC is less than 8% ?

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