Raymond, I’ve been looking a lot at this recently. For me it’s two things - CAP rate at purchase needs to be at least 6% with the ability to increase to 7 or 8 and the cash flow of the property needs to be at least $500 dollars above the PIT. I’m currently operating on lower reserves and I need the actual cash flow to be useful enough to contribute towards the O&M.
Since you're looking at a 3 unit property, cap rate is irrelevant when valuing 1 to 4 unit residential properties. The sales price of recently sold comparable properties are used instead. You can calculate a cap rate on anything that produces NOI but it would not help much in determining whether it's a good investment. You can make a killing buying a 3CAP property and lose your shirt buying a 15CAP property. When people say they require at least 6CAP at purchase, they have probably missed out on 3 or 4 CAPS properties that are money makers.
As far as analyzing if a property is a good investment or not, analyze it like any other investments that are available to you (i.e. stocks bonds, mutual funds, etc.). Investment is about achieving a balance between Risk/Return. Determine your risk tolerance first (i.e. everyone has different tolerance). Then, calculate the return of all investment opportunities available to you (i.e. cash on cash, IRR, yield, etc) and pick the one with the highest return GIVEN your level of risk tolerance. Also perform the analysis on the entire lifetime of the investment. The experienced investors (in real estate, i'm a newbie myself) always bring up "exit strategy" which means you need to make assumption of the end game of your investment. Is it 5 years, 10 years, or 50+ years (i.e. passing it on to your children)?
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