# How you can profit from a Big Mortgage

117 Replies

Hey Dan,

I just wanted to quickly thank you for fixing my analysis.

I try to be pinpoint in my posts and you helped catch my error.

I'll be using that link for future reference, and I'll see ya around the forums!

Originally posted by @Dan Heuschele :
Originally posted by @Joe Villeneuve:

I thought about this last night.  Here is a poll I would like to take regarding the security and returns from cash flow properties over the last 5 years.

The question is simple and in 3 parts:  Over the last five years, adding up all of your "doors", a)- how many months of vacancy did you have, and b) how many months of income (cf) did you have, and c) - did the other rental income (CF) cover the vacancies?

Example: An investor had 100 doors (mix of multi and sf). Over the past 5 years, the REI averaged 10 vacancies/month. The answer to my 3 part question would then be -
a) - 10 vacancies/mo x 12 months x 5 years = 600 vacancies
b) - 90 non-V/mo x 12 mo x  5 years = 5400 NV
c) - Yes (if no)

In order to participate, you must have had at least 5 doors avg/year over the last 5 years.

I play but will up front state I have 2 units down due to fire since Oct (and construction has been stopped) but we had lost rent insurance so they are the same as rented and will be counted as rented.  4 of the vacancies were extended duration due to rehab, but I will count the entire vacant period.

18 units, 16 LTR units.  Only counting the LTR units.

a) We had a total of 15 vacancies, 11 were a month or less, 4 (with rehabs) averaged around 3.5 months each = ~25 months

b) 16*5*12=960 - 25 - 60 months (2 units purchased Oct 2017) - 24 months (one duplex projected cash neutral at purchase) = 851 months of income

C) of course the cash flow covers the vacancies.

I think it is missing part D: was this a primary cash flow (Midwest like), primary appreciation (NY city area, So Cal, San Fran, boston, Hawaii, Seattle, etc.), mixed (Texas, Florida, Colorado, etc.).  Answer: Primary appreciation market.

Thanks for playing Dan.  Others have sent their answers to me direct.

As far as missing "D"...I'm not.  The quiz is directed specifically Cash Flow, and you'll see why when the  answers stop rolling in and I compile them.

I agree with some of @Andrey Y. (especially the part that initial cash flow does not equate to actual cash flow) view but the issue is the post does not mention any of the difficulties:

• Not everyone could qualify for a BAM.
• BAM not only are more difficult to qualify for, but they typically have higher associated costs (excluding for VA or FHA - so for most non-owner occupied they have higher costs).
• SFR to quad purchased at retail are initially cash flow negative in many of the high appreciating markets. A purchaser must be in a position to handle this negative cash flow until the appreciation can create positive cash flow. We have seen this took basically 10 years to recover at the GR.
• The appreciation has gone in cycles.  If you purchased a BAM in 2006 in So Cal you likely were not even in value until ~2017.  If the cash flow is poor, that is a lot of years with minimal return.
• We are ~8 years in a long RE appreciation cycle.  This means a lot of appreciation has occurred.  Regardless of what you believe for the short-term, anyone who purchases today has missed out on much of the appreciation.
• Extracting equity has more expense than using cash flow. Refi, HELOC, sell all have costs (financial and time). In addition, refi appraisals are historically conservative in my market.

I have had good success in my expensive, low initial cash flow market.  I believe most So Cal investors who invest in Midwest turnkey properties likely would have been better served investing locally.

However, if I were in one of those low cost Midwest market, I have confidence that I could make RE work in that market.

Mostly I believe smart RE investors can profit in virtually any RE market.  I believe beginners should invest in their local market. A market they are intimate with. A market where they can easily perform heroics (such as taking on all maintenance) if necessary.  Beginners should not be considering the BAM, even in coastal So Cal markets.

I do not believe it is as cut and dry that high appreciation markets are best, high cash flow markets are best, or a market with good cash flow and good appreciation is best.  They can all work for the smart RE investor.

"We have seen this took basically 10 years to recover at the GR" should have been on the bullet below where it appears.

Originally posted by @Dan Heuschele :
Originally posted by @Joe Villeneuve:

I thought about this last night.  Here is a poll I would like to take regarding the security and returns from cash flow properties over the last 5 years.

The question is simple and in 3 parts:  Over the last five years, adding up all of your "doors", a)- how many months of vacancy did you have, and b) how many months of income (cf) did you have, and c) - did the other rental income (CF) cover the vacancies?

Example: An investor had 100 doors (mix of multi and sf). Over the past 5 years, the REI averaged 10 vacancies/month. The answer to my 3 part question would then be -
a) - 10 vacancies/mo x 12 months x 5 years = 600 vacancies
b) - 90 non-V/mo x 12 mo x  5 years = 5400 NV
c) - Yes (if no)

In order to participate, you must have had at least 5 doors avg/year over the last 5 years.

I play but will up front state I have 2 units down due to fire since Oct (and construction has been stopped) but we had lost rent insurance so they are the same as rented and will be counted as rented.  4 of the vacancies were extended duration due to rehab, but I will count the entire vacant period.

18 units, 16 LTR units.  Only counting the LTR units.

a) We had a total of 15 vacancies, 11 were a month or less, 4 (with rehabs) averaged around 3.5 months each = ~25 months

b) 16*5*12=960 - 25 - 60 months (2 units purchased Oct 2017) - 24 months (one duplex projected cash neutral at purchase) = 851 months of income

C) of course the cash flow covers the vacancies.

I think it is missing part D: was this a primary cash flow (Midwest like), primary appreciation (NY city area, So Cal, San Fran, boston, Hawaii, Seattle, etc.), mixed (Texas, Florida, Colorado, etc.).  Answer: Primary appreciation market.

Who do you get your lost rent insurance from?  Were there any problems getting the payments?

Originally posted by @Sue K. :
Originally posted by @Dan Heuschele:
Originally posted by @Joe Villeneuve:

I thought about this last night.  Here is a poll I would like to take regarding the security and returns from cash flow properties over the last 5 years.

The question is simple and in 3 parts:  Over the last five years, adding up all of your "doors", a)- how many months of vacancy did you have, and b) how many months of income (cf) did you have, and c) - did the other rental income (CF) cover the vacancies?

Example: An investor had 100 doors (mix of multi and sf). Over the past 5 years, the REI averaged 10 vacancies/month. The answer to my 3 part question would then be -
a) - 10 vacancies/mo x 12 months x 5 years = 600 vacancies
b) - 90 non-V/mo x 12 mo x  5 years = 5400 NV
c) - Yes (if no)

In order to participate, you must have had at least 5 doors avg/year over the last 5 years.

I play but will up front state I have 2 units down due to fire since Oct (and construction has been stopped) but we had lost rent insurance so they are the same as rented and will be counted as rented.  4 of the vacancies were extended duration due to rehab, but I will count the entire vacant period.

18 units, 16 LTR units.  Only counting the LTR units.

a) We had a total of 15 vacancies, 11 were a month or less, 4 (with rehabs) averaged around 3.5 months each = ~25 months

b) 16*5*12=960 - 25 - 60 months (2 units purchased Oct 2017) - 24 months (one duplex projected cash neutral at purchase) = 851 months of income

C) of course the cash flow covers the vacancies.

I think it is missing part D: was this a primary cash flow (Midwest like), primary appreciation (NY city area, So Cal, San Fran, boston, Hawaii, Seattle, etc.), mixed (Texas, Florida, Colorado, etc.).  Answer: Primary appreciation market.

Who do you get your lost rent insurance from?  Were there any problems getting the payments?

It is lost rent insurance in the event that something like a fire causes the unit to not be able to be occupied. It does not cover lost rent due to tenant turn over, etc.   it is an option in the property insurance similar to having rental car insurance as part of your auto insurance.

When the fire occurred, the insurance paid us for 4 months rent.  It is now at 5 months and the construction work has stopped due to the virus.   It is nice to have those 2 units’ of rent guaranteed.

Originally posted by @Dan Heuschele :
Originally posted by @Sue K.:
Originally posted by @Dan Heuschele:
Originally posted by @Joe Villeneuve:

I thought about this last night.  Here is a poll I would like to take regarding the security and returns from cash flow properties over the last 5 years.

The question is simple and in 3 parts:  Over the last five years, adding up all of your "doors", a)- how many months of vacancy did you have, and b) how many months of income (cf) did you have, and c) - did the other rental income (CF) cover the vacancies?

Example: An investor had 100 doors (mix of multi and sf). Over the past 5 years, the REI averaged 10 vacancies/month. The answer to my 3 part question would then be -
a) - 10 vacancies/mo x 12 months x 5 years = 600 vacancies
b) - 90 non-V/mo x 12 mo x  5 years = 5400 NV
c) - Yes (if no)

In order to participate, you must have had at least 5 doors avg/year over the last 5 years.

I play but will up front state I have 2 units down due to fire since Oct (and construction has been stopped) but we had lost rent insurance so they are the same as rented and will be counted as rented.  4 of the vacancies were extended duration due to rehab, but I will count the entire vacant period.

18 units, 16 LTR units.  Only counting the LTR units.

a) We had a total of 15 vacancies, 11 were a month or less, 4 (with rehabs) averaged around 3.5 months each = ~25 months

b) 16*5*12=960 - 25 - 60 months (2 units purchased Oct 2017) - 24 months (one duplex projected cash neutral at purchase) = 851 months of income

C) of course the cash flow covers the vacancies.

I think it is missing part D: was this a primary cash flow (Midwest like), primary appreciation (NY city area, So Cal, San Fran, boston, Hawaii, Seattle, etc.), mixed (Texas, Florida, Colorado, etc.).  Answer: Primary appreciation market.

Who do you get your lost rent insurance from?  Were there any problems getting the payments?

It is lost rent insurance in the event that something like a fire causes the unit to not be able to be occupied. It does not cover lost rent due to tenant turn over, etc.   it is an option in the property insurance similar to having rental car insurance as part of your auto insurance.

When the fire occurred, the insurance paid us for 4 months rent.  It is now at 5 months and the construction work has stopped due to the virus.   It is nice to have those 2 units’ of rent guaranteed.

Which insurance company do you use?  This is great to know.  I am a believer in insurance.  I pay for a loss of use rider for my rental insurance now.  I used to tell new tenants they should spring for it.  Inevitably, a tenant would have to move out for a day or three because of a flooded apartment or whatever, and they look at you with puppy dog eyes and you have to say, "Remember when I explained about renters insurance and how cheap it is and how you should also pay for the loss of use rider?"

We didn't require tenants carry insurance, but the contract explained it, suggested it, etc.  I mean, yeesh, I have riders for everything and it's still only \$20/month including earthquake insurance.  If I was to manage again, I'd require not only insurance, but a loss of use rider, too.  That's what they inevitably need and it turns into a hassle.  It would have been so nice to say, "remember that insurance you are paying for that is required?  No worries!  They'll cover everything!"  That would have been a way more fun conversation.

Sorry to get off-topic!

I thought the point of BP and having a community to help each other in real estate/investing is to prove that you don’t need to be RICH to invest? You just need to educate, work hard and know your numbers.

But anyways, I think calling off cash flow for appreciation isn’t completely wrong, but it’s definitely not right either. Basic investing rules are that appreciation should be a bonus in any RE investment because you’re putting your investment in the hands of the market.

I would like to say I’m a newbie and you and everyone here probably have a lot more experience/portfolio/everything else than I, but it doesn’t make sense because it seems like you are assuming “poor” investors are dumb investors and just because they don’t have a high W2 income or a big portfolio already, that it doesn’t mean they don’t know how to run their numbers. There are plenty of people just starting out who NEED their first investment properties to have profit, even if most of it goes to CapEX/Expenses. If they’re doing their numbers correctly, then I believe high CapEX isn’t called dumb, it’s called conservative. And it sets the building block for the “poor” investor’s portfolio who are just starting out to keep their properties above water during a recession or oh I don’t know, maybe a random virus from across the ocean?!?!

Cash flow is just math, and as long as you can do the math right and come out positive to keep building a strong portfolio relative to your market, then why would it ever be a bad thing? Feel free to correct me if I’m wrong, like I said I’m a newbie and I’m all ears.

Originally posted by @Sue K. :
Originally posted by @Dan Heuschele:
Originally posted by @Sue K.:
Originally posted by @Dan Heuschele:
Originally posted by @Joe Villeneuve:

I thought about this last night.  Here is a poll I would like to take regarding the security and returns from cash flow properties over the last 5 years.

The question is simple and in 3 parts:  Over the last five years, adding up all of your "doors", a)- how many months of vacancy did you have, and b) how many months of income (cf) did you have, and c) - did the other rental income (CF) cover the vacancies?

Example: An investor had 100 doors (mix of multi and sf). Over the past 5 years, the REI averaged 10 vacancies/month. The answer to my 3 part question would then be -
a) - 10 vacancies/mo x 12 months x 5 years = 600 vacancies
b) - 90 non-V/mo x 12 mo x  5 years = 5400 NV
c) - Yes (if no)

In order to participate, you must have had at least 5 doors avg/year over the last 5 years.

I play but will up front state I have 2 units down due to fire since Oct (and construction has been stopped) but we had lost rent insurance so they are the same as rented and will be counted as rented.  4 of the vacancies were extended duration due to rehab, but I will count the entire vacant period.

18 units, 16 LTR units.  Only counting the LTR units.

a) We had a total of 15 vacancies, 11 were a month or less, 4 (with rehabs) averaged around 3.5 months each = ~25 months

b) 16*5*12=960 - 25 - 60 months (2 units purchased Oct 2017) - 24 months (one duplex projected cash neutral at purchase) = 851 months of income

C) of course the cash flow covers the vacancies.

I think it is missing part D: was this a primary cash flow (Midwest like), primary appreciation (NY city area, So Cal, San Fran, boston, Hawaii, Seattle, etc.), mixed (Texas, Florida, Colorado, etc.).  Answer: Primary appreciation market.

Who do you get your lost rent insurance from?  Were there any problems getting the payments?

It is lost rent insurance in the event that something like a fire causes the unit to not be able to be occupied. It does not cover lost rent due to tenant turn over, etc.   it is an option in the property insurance similar to having rental car insurance as part of your auto insurance.

When the fire occurred, the insurance paid us for 4 months rent.  It is now at 5 months and the construction work has stopped due to the virus.   It is nice to have those 2 units’ of rent guaranteed.

Which insurance company do you use?  This is great to know.  I am a believer in insurance.  I pay for a loss of use rider for my rental insurance now.  I used to tell new tenants they should spring for it.  Inevitably, a tenant would have to move out for a day or three because of a flooded apartment or whatever, and they look at you with puppy dog eyes and you have to say, "Remember when I explained about renters insurance and how cheap it is and how you should also pay for the loss of use rider?"

We didn't require tenants carry insurance, but the contract explained it, suggested it, etc.  I mean, yeesh, I have riders for everything and it's still only \$20/month including earthquake insurance.  If I was to manage again, I'd require not only insurance, but a loss of use rider, too.  That's what they inevitably need and it turns into a hassle.  It would have been so nice to say, "remember that insurance you are paying for that is required?  No worries!  They'll cover everything!"  That would have been a way more fun conversation.

Sorry to get off-topic!

We mostly use USAA, but the property that caught fire is insured by Farmers.   So far they have been nice to work with.  The wife contacted them about the construction having stopped and they understood which of course is reasonable because safety first and it is not our fault.

Our lease requires tenants to have rental insurance, but we do not verify that the tenants maintain it.  Both tenants impacted by the fire had let their renters insurance expire.   It was unfortunate for both of them.  We are not their parents.  We try to ensure they are protected from events like this, but we are not going to micromanage it.

Originally posted by @Dan Heuschele :
Originally posted by @Sue K.:
Originally posted by @Dan Heuschele:
Originally posted by @Sue K.:
Originally posted by @Dan Heuschele:
Originally posted by @Joe Villeneuve:

I thought about this last night.  Here is a poll I would like to take regarding the security and returns from cash flow properties over the last 5 years.

The question is simple and in 3 parts:  Over the last five years, adding up all of your "doors", a)- how many months of vacancy did you have, and b) how many months of income (cf) did you have, and c) - did the other rental income (CF) cover the vacancies?

Example: An investor had 100 doors (mix of multi and sf). Over the past 5 years, the REI averaged 10 vacancies/month. The answer to my 3 part question would then be -
a) - 10 vacancies/mo x 12 months x 5 years = 600 vacancies
b) - 90 non-V/mo x 12 mo x  5 years = 5400 NV
c) - Yes (if no)

In order to participate, you must have had at least 5 doors avg/year over the last 5 years.

I play but will up front state I have 2 units down due to fire since Oct (and construction has been stopped) but we had lost rent insurance so they are the same as rented and will be counted as rented.  4 of the vacancies were extended duration due to rehab, but I will count the entire vacant period.

18 units, 16 LTR units.  Only counting the LTR units.

a) We had a total of 15 vacancies, 11 were a month or less, 4 (with rehabs) averaged around 3.5 months each = ~25 months

b) 16*5*12=960 - 25 - 60 months (2 units purchased Oct 2017) - 24 months (one duplex projected cash neutral at purchase) = 851 months of income

C) of course the cash flow covers the vacancies.

I think it is missing part D: was this a primary cash flow (Midwest like), primary appreciation (NY city area, So Cal, San Fran, boston, Hawaii, Seattle, etc.), mixed (Texas, Florida, Colorado, etc.).  Answer: Primary appreciation market.

Who do you get your lost rent insurance from?  Were there any problems getting the payments?

It is lost rent insurance in the event that something like a fire causes the unit to not be able to be occupied. It does not cover lost rent due to tenant turn over, etc.   it is an option in the property insurance similar to having rental car insurance as part of your auto insurance.

When the fire occurred, the insurance paid us for 4 months rent.  It is now at 5 months and the construction work has stopped due to the virus.   It is nice to have those 2 units’ of rent guaranteed.

Which insurance company do you use?  This is great to know.  I am a believer in insurance.  I pay for a loss of use rider for my rental insurance now.  I used to tell new tenants they should spring for it.  Inevitably, a tenant would have to move out for a day or three because of a flooded apartment or whatever, and they look at you with puppy dog eyes and you have to say, "Remember when I explained about renters insurance and how cheap it is and how you should also pay for the loss of use rider?"

We didn't require tenants carry insurance, but the contract explained it, suggested it, etc.  I mean, yeesh, I have riders for everything and it's still only \$20/month including earthquake insurance.  If I was to manage again, I'd require not only insurance, but a loss of use rider, too.  That's what they inevitably need and it turns into a hassle.  It would have been so nice to say, "remember that insurance you are paying for that is required?  No worries!  They'll cover everything!"  That would have been a way more fun conversation.

Sorry to get off-topic!

We mostly use USAA, but the property that caught fire is insured by Farmers.   So far they have been nice to work with.  The wife contacted them about the construction having stopped and they understood which of course is reasonable because safety first and it is not our fault.

Our lease requires tenants to have rental insurance, but we do not verify that the tenants maintain it.  Both tenants impacted by the fire had let their renters insurance expire.   It was unfortunate for both of them.  We are not their parents.  We try to ensure they are protected from events like this, but we are not going to micromanage it.

Oh man, hard lesson there.  Totally agree on not babysitting adults.

Originally posted by @Jacky Tu :

@Andrey Y.

I thought the point of BP and having a community to help each other in real estate/investing is to prove that you don’t need to be RICH to invest? You just need to educate, work hard and know your numbers.

But anyways, I think calling off cash flow for appreciation isn’t completely wrong, but it’s definitely not right either. Basic investing rules are that appreciation should be a bonus in any RE investment because you’re putting your investment in the hands of the market.

I would like to say I’m a newbie and you and everyone here probably have a lot more experience/portfolio/everything else than I, but it doesn’t make sense because it seems like you are assuming “poor” investors are dumb investors and just because they don’t have a high W2 income or a big portfolio already, that it doesn’t mean they don’t know how to run their numbers. There are plenty of people just starting out who NEED their first investment properties to have profit, even if most of it goes to CapEX/Expenses. If they’re doing their numbers correctly, then I believe high CapEX isn’t called dumb, it’s called conservative. And it sets the building block for the “poor” investor’s portfolio who are just starting out to keep their properties above water during a recession or oh I don’t know, maybe a random virus from across the ocean?!?!

Cash flow is just math, and as long as you can do the math right and come out positive to keep building a strong portfolio relative to your market, then why would it ever be a bad thing? Feel free to correct me if I’m wrong, like I said I’m a newbie and I’m all ears.

Excellent post.

Originally posted by @Brian Ploszay :

@Tony Kim    I've been thinking about this post for awhile.  Because it doesn't really explain what I've experienced.   IRRs reflect leveraged returns, so they are not easily comparable.  So I prefer to use Cap Rates, which is a non-leveraged rate of return.

Assume I have properties that have a 9 percent rate of return (cap rate) plus 4 percent annual appreciation.  That might theoretically be equivalent to a Los Angeles 3 Cap property that has an annual 10 percent annual appreciation.

Money inevitably flows pretty quickly to good opportunities, flattening out yield curves.  In other words, prices go up, and the next crop of buyers don't get that super yield anymore.

50 years of data of Southern California actually need to be interpreted.  It hasn't always been the same economy.  What is more interesting is what is happening now.

The boom that you experienced is wholly due to the super high building constraints that California faces for new housing stock.  For 20, maybe 30 years, they haven't been able to build to keep up with demand.  So housing is expensive now, in a region that certainly has a lot of land and ability to grow vertically.  The high prices have driven some middle class out of the State, created growth of homelessness, etc...

Back to rates of return.  For sure, a place like Southern California had outsized returns, probably from the years 2012 to 2018.  These are appreciation returns mainly.  But there was real rental growth.

But these investments are tough. Lots of smaller rentals would have negative amortization if I bought them. Feeding investments is risky in my opinion. For larger deals, banks still would require LTV ratios, so you will have to put down large downpayments. That impedes your IRR. And using that much capital restricts your growth.

My conclusion is that legacy owners have golden properties.  Newcomers bought risk, that is amplifying the last two weeks.

Few more observations:  I see lots of California investors looking outside of their state for returns.  Novice investors are buying quasi toxic turn key properties in areas with regional decline.  This will not turn out well for them.  I heard a statistic that the far majority of turnkey buyers were from California.  On a larger scale, cash flush real estate investors from California have definitely targeted other states, including my City.  Probably they correctly feel that relying on a appreciation only model has risks.

The real game in California residential real estate is development.  And it is a tough to do.  The ability to get approval / zoning changes to build apartment buildings.  Drive around Echo Park and you'll see a new neighborhood emerging.  Wealth is being created through building housing stock that is totally in demand.

Proposed Law SB50 would have been a game changer.  It would create the biggest building boom since the 1960s.  Instead there is a water down law that got passed, basically allowing people to convert garages to mini apartments, etc..

Your first line. A cap rate is absolutely NOT the non-leveraged rate of return. The is the newbie definition people are told about on BP, and advertised by Turnkey companies. A cap rate is non a financial metric. It is the perception of an investors risk of that submarket or neighborhood. This is something you should hopefully have realized after your first 1 or 2 years investing in real estate.

@Andrey  Y.    I know very well what a cap rate is.   And how to calculate it.  And what it means and how to use it to analyze.   Also IRRs.  Yes, cap rate is a financial metric.   Enough of this post and your way of thinking.

Originally posted by @Andrey Y. :
Originally posted by @Brian Ploszay:

@Tony Kim    I've been thinking about this post for awhile.  Because it doesn't really explain what I've experienced.   IRRs reflect leveraged returns, so they are not easily comparable.  So I prefer to use Cap Rates, which is a non-leveraged rate of return.

Assume I have properties that have a 9 percent rate of return (cap rate) plus 4 percent annual appreciation.  That might theoretically be equivalent to a Los Angeles 3 Cap property that has an annual 10 percent annual appreciation.

Money inevitably flows pretty quickly to good opportunities, flattening out yield curves.  In other words, prices go up, and the next crop of buyers don't get that super yield anymore.

50 years of data of Southern California actually need to be interpreted.  It hasn't always been the same economy.  What is more interesting is what is happening now.

The boom that you experienced is wholly due to the super high building constraints that California faces for new housing stock.  For 20, maybe 30 years, they haven't been able to build to keep up with demand.  So housing is expensive now, in a region that certainly has a lot of land and ability to grow vertically.  The high prices have driven some middle class out of the State, created growth of homelessness, etc...

Back to rates of return.  For sure, a place like Southern California had outsized returns, probably from the years 2012 to 2018.  These are appreciation returns mainly.  But there was real rental growth.

But these investments are tough. Lots of smaller rentals would have negative amortization if I bought them. Feeding investments is risky in my opinion. For larger deals, banks still would require LTV ratios, so you will have to put down large downpayments. That impedes your IRR. And using that much capital restricts your growth.

My conclusion is that legacy owners have golden properties.  Newcomers bought risk, that is amplifying the last two weeks.

Few more observations:  I see lots of California investors looking outside of their state for returns.  Novice investors are buying quasi toxic turn key properties in areas with regional decline.  This will not turn out well for them.  I heard a statistic that the far majority of turnkey buyers were from California.  On a larger scale, cash flush real estate investors from California have definitely targeted other states, including my City.  Probably they correctly feel that relying on a appreciation only model has risks.

The real game in California residential real estate is development.  And it is a tough to do.  The ability to get approval / zoning changes to build apartment buildings.  Drive around Echo Park and you'll see a new neighborhood emerging.  Wealth is being created through building housing stock that is totally in demand.

Proposed Law SB50 would have been a game changer.  It would create the biggest building boom since the 1960s.  Instead there is a water down law that got passed, basically allowing people to convert garages to mini apartments, etc..

Your first line. A cap rate is absolutely NOT the non-leveraged rate of return. The is the newbie definition people are told about on BP, and advertised by Turnkey companies. A cap rate is non a financial metric. It is the perception of an investors risk of that submarket or neighborhood. This is something you should hopefully have realized after your first 1 or 2 years investing in real estate.

Dude, why are you so argumentative to anyone who doesn't share exactly your opinion?

Ok Brian used one term slightly incorrectly,  Cap rate is a valuation metric for MF properties, not a return metric, per se.  But you also commit the error of Argument from Fallacy, by discounting his point wholesale due only to that one mistake in phraseology.

If you replace cap rate with non levered cash on cash return, his point still stands and is a valid one.

@Andrey Y. I saw your posts on the SBA Disaster Loan thread a couple days ago.  Sounds like you're having problems paying for your BAM? :-)

And therein lies the problem with what you're suggesting.  Obviously the best way to get rich in real estate is through appreciation long-term, but you have to be able to survive the downturns.  And it's hard to do that if you don't have strong, stable positive cashflows.  Unless you're telling people to rely on their high income job to make payments on these BAM, which also isn't reliable during a downtown.

Have you been through a large recession yet?  I think I saw one of your posts on another thread that you've been investing for around 8 years?  I firmly believe that those who haven't been through a full real estate cycle are still newbies (including myself).  You may have learned real estate through some big guys who made it through a crash, but there are more investors that didn't make it than those who did, and there are perhaps better learning opportunities from them.

Originally posted by @Bill F. :
Originally posted by @Andrey Y.:
Originally posted by @Brian Ploszay:

@Tony Kim    I've been thinking about this post for awhile.  Because it doesn't really explain what I've experienced.   IRRs reflect leveraged returns, so they are not easily comparable.  So I prefer to use Cap Rates, which is a non-leveraged rate of return.

Assume I have properties that have a 9 percent rate of return (cap rate) plus 4 percent annual appreciation.  That might theoretically be equivalent to a Los Angeles 3 Cap property that has an annual 10 percent annual appreciation.

Money inevitably flows pretty quickly to good opportunities, flattening out yield curves.  In other words, prices go up, and the next crop of buyers don't get that super yield anymore.

50 years of data of Southern California actually need to be interpreted.  It hasn't always been the same economy.  What is more interesting is what is happening now.

The boom that you experienced is wholly due to the super high building constraints that California faces for new housing stock.  For 20, maybe 30 years, they haven't been able to build to keep up with demand.  So housing is expensive now, in a region that certainly has a lot of land and ability to grow vertically.  The high prices have driven some middle class out of the State, created growth of homelessness, etc...

Back to rates of return.  For sure, a place like Southern California had outsized returns, probably from the years 2012 to 2018.  These are appreciation returns mainly.  But there was real rental growth.

But these investments are tough. Lots of smaller rentals would have negative amortization if I bought them. Feeding investments is risky in my opinion. For larger deals, banks still would require LTV ratios, so you will have to put down large downpayments. That impedes your IRR. And using that much capital restricts your growth.

My conclusion is that legacy owners have golden properties.  Newcomers bought risk, that is amplifying the last two weeks.

Few more observations:  I see lots of California investors looking outside of their state for returns.  Novice investors are buying quasi toxic turn key properties in areas with regional decline.  This will not turn out well for them.  I heard a statistic that the far majority of turnkey buyers were from California.  On a larger scale, cash flush real estate investors from California have definitely targeted other states, including my City.  Probably they correctly feel that relying on a appreciation only model has risks.

The real game in California residential real estate is development.  And it is a tough to do.  The ability to get approval / zoning changes to build apartment buildings.  Drive around Echo Park and you'll see a new neighborhood emerging.  Wealth is being created through building housing stock that is totally in demand.

Proposed Law SB50 would have been a game changer.  It would create the biggest building boom since the 1960s.  Instead there is a water down law that got passed, basically allowing people to convert garages to mini apartments, etc..

Your first line. A cap rate is absolutely NOT the non-leveraged rate of return. The is the newbie definition people are told about on BP, and advertised by Turnkey companies. A cap rate is non a financial metric. It is the perception of an investors risk of that submarket or neighborhood. This is something you should hopefully have realized after your first 1 or 2 years investing in real estate.

Dude, why are you so argumentative to anyone who doesn't share exactly your opinion?

Ok Brian used one term slightly incorrectly,  Cap rate is a valuation metric for MF properties, not a return metric, per se.  But you also commit the error of Argument from Fallacy, by discounting his point wholesale due only to that one mistake in phraseology.

If you replace cap rate with non levered cash on cash return, his point still stands and is a valid one.

That is just pointless chatter of someone that has never invested through or studied real estate cycles. Where is the discussion going when one side is spouting ignorance.

Also it is just happenstance that coc and cap rate meet at some point. If he thinks his cap rate "return" is an accurate coc then consider him dividing his NOI by HIS purchase price and declaring a 10% "return" and a 10% coc. Now assume you correctly use a cap rate as a valuation tool because you know it is not a "return" even if you pay cash and the market cap is 12% so he overpaid \$166,667 just on a \$100,000 NOI !!! Where is his 10% "return" and his 10% coc now?

Originally posted by @Nghi Le :

@Andrey Y. I saw your posts on the SBA Disaster Loan thread a couple days ago.  Sounds like you're having problems paying for your BAM? :-)

And therein lies the problem with what you're suggesting.  Obviously the best way to get rich in real estate is through appreciation long-term, but you have to be able to survive the downturns.  And it's hard to do that if you don't have strong, stable positive cashflows.  Unless you're telling people to rely on their high income job to make payments on these BAM, which also isn't reliable during a downtown.

Have you been through a large recession yet?  I think I saw one of your posts on another thread that you've been investing for around 8 years?  I firmly believe that those who haven't been through a full real estate cycle are still newbies (including myself).  You may have learned real estate through some big guys who made it through a crash, but there are more investors that didn't make it than those who did, and there are perhaps better learning opportunities from them.

Your assumption is incorrect. The only people in that thread that are actually having trouble paying off their mortgage are cash flow investors.

If I can get a \$50,000 low-interest loan and a \$10,000 grant I am definitely going to take it. As is anyone else who is a small business landlord. 90% of the people commenting on that thread are going to get exactly \$0 by the way.

I am mentored by 30+ year veterans in real estate, who know what a cap rate it and how it's actually used. Not by Turnkey salesmen.

Just sold and 1031 exchanged a 5 bagger where there was no tenant in it for 5 months now. I invest for profit so I don't the tenant doesn't need to pay off my water bill.

Originally posted by @Andrey Y. :
Originally posted by @Brian Ploszay:

@Tony Kim    I've been thinking about this post for awhile.  Because it doesn't really explain what I've experienced.   IRRs reflect leveraged returns, so they are not easily comparable.  So I prefer to use Cap Rates, which is a non-leveraged rate of return.

Assume I have properties that have a 9 percent rate of return (cap rate) plus 4 percent annual appreciation.  That might theoretically be equivalent to a Los Angeles 3 Cap property that has an annual 10 percent annual appreciation.

Money inevitably flows pretty quickly to good opportunities, flattening out yield curves.  In other words, prices go up, and the next crop of buyers don't get that super yield anymore.

50 years of data of Southern California actually need to be interpreted.  It hasn't always been the same economy.  What is more interesting is what is happening now.

The boom that you experienced is wholly due to the super high building constraints that California faces for new housing stock.  For 20, maybe 30 years, they haven't been able to build to keep up with demand.  So housing is expensive now, in a region that certainly has a lot of land and ability to grow vertically.  The high prices have driven some middle class out of the State, created growth of homelessness, etc...

Back to rates of return.  For sure, a place like Southern California had outsized returns, probably from the years 2012 to 2018.  These are appreciation returns mainly.  But there was real rental growth.

But these investments are tough. Lots of smaller rentals would have negative amortization if I bought them. Feeding investments is risky in my opinion. For larger deals, banks still would require LTV ratios, so you will have to put down large downpayments. That impedes your IRR. And using that much capital restricts your growth.

My conclusion is that legacy owners have golden properties.  Newcomers bought risk, that is amplifying the last two weeks.

Few more observations:  I see lots of California investors looking outside of their state for returns.  Novice investors are buying quasi toxic turn key properties in areas with regional decline.  This will not turn out well for them.  I heard a statistic that the far majority of turnkey buyers were from California.  On a larger scale, cash flush real estate investors from California have definitely targeted other states, including my City.  Probably they correctly feel that relying on a appreciation only model has risks.

The real game in California residential real estate is development.  And it is a tough to do.  The ability to get approval / zoning changes to build apartment buildings.  Drive around Echo Park and you'll see a new neighborhood emerging.  Wealth is being created through building housing stock that is totally in demand.

Proposed Law SB50 would have been a game changer.  It would create the biggest building boom since the 1960s.  Instead there is a water down law that got passed, basically allowing people to convert garages to mini apartments, etc..

Your first line. A cap rate is absolutely NOT the non-leveraged rate of return. The is the newbie definition people are told about on BP, and advertised by Turnkey companies. A cap rate is non a financial metric. It is the perception of an investors risk of that submarket or neighborhood. This is something you should hopefully have realized after your first 1 or 2 years investing in real estate.

HI Brian,

Andrey's response made me think some more about what you were saying about cap rates. I agree with your points in theory, but aren't you making the assumption of a competitive market? This flattening out of the cap rates would occur if the market place for the higher double-digit cap rate properties and the market place for the lower 3-6 cap rate properties in Los Angeles consisted of the same set of buyers. I'm sure there is some overlap, but most likely very minimal. So Cal will never have high cap rates....and other markets where there are still properties in the 9-12 cap range will never experience the type of increase needed to move to the 3-6 range... at least not in my lifetime.

Also, I humbly submit that since your preference is to look at things from a cap rate perspective, I think that actually make the case for So Cal-type of markets. If CoC isn't considered, I think it is a no brainer that lower cap properties with high appreciation potential are much more attractive.

Originally posted by @Tony Kim :
Originally posted by @Andrey Y.:
Originally posted by @Brian Ploszay:

@Tony Kim    I've been thinking about this post for awhile.  Because it doesn't really explain what I've experienced.   IRRs reflect leveraged returns, so they are not easily comparable.  So I prefer to use Cap Rates, which is a non-leveraged rate of return.

Assume I have properties that have a 9 percent rate of return (cap rate) plus 4 percent annual appreciation.  That might theoretically be equivalent to a Los Angeles 3 Cap property that has an annual 10 percent annual appreciation.

Money inevitably flows pretty quickly to good opportunities, flattening out yield curves.  In other words, prices go up, and the next crop of buyers don't get that super yield anymore.

50 years of data of Southern California actually need to be interpreted.  It hasn't always been the same economy.  What is more interesting is what is happening now.

The boom that you experienced is wholly due to the super high building constraints that California faces for new housing stock.  For 20, maybe 30 years, they haven't been able to build to keep up with demand.  So housing is expensive now, in a region that certainly has a lot of land and ability to grow vertically.  The high prices have driven some middle class out of the State, created growth of homelessness, etc...

Back to rates of return.  For sure, a place like Southern California had outsized returns, probably from the years 2012 to 2018.  These are appreciation returns mainly.  But there was real rental growth.

But these investments are tough. Lots of smaller rentals would have negative amortization if I bought them. Feeding investments is risky in my opinion. For larger deals, banks still would require LTV ratios, so you will have to put down large downpayments. That impedes your IRR. And using that much capital restricts your growth.

My conclusion is that legacy owners have golden properties.  Newcomers bought risk, that is amplifying the last two weeks.

Few more observations:  I see lots of California investors looking outside of their state for returns.  Novice investors are buying quasi toxic turn key properties in areas with regional decline.  This will not turn out well for them.  I heard a statistic that the far majority of turnkey buyers were from California.  On a larger scale, cash flush real estate investors from California have definitely targeted other states, including my City.  Probably they correctly feel that relying on a appreciation only model has risks.

The real game in California residential real estate is development.  And it is a tough to do.  The ability to get approval / zoning changes to build apartment buildings.  Drive around Echo Park and you'll see a new neighborhood emerging.  Wealth is being created through building housing stock that is totally in demand.

Proposed Law SB50 would have been a game changer.  It would create the biggest building boom since the 1960s.  Instead there is a water down law that got passed, basically allowing people to convert garages to mini apartments, etc..

Your first line. A cap rate is absolutely NOT the non-leveraged rate of return. The is the newbie definition people are told about on BP, and advertised by Turnkey companies. A cap rate is non a financial metric. It is the perception of an investors risk of that submarket or neighborhood. This is something you should hopefully have realized after your first 1 or 2 years investing in real estate.

HI Brian,

Andrey's response made me think some more about what you were saying about cap rates. I agree with your points in theory, but aren't you making the assumption of a competitive market? This flattening out of the cap rates would occur if the market place for the higher double-digit cap rate properties and the market place for the lower 3-6 cap rate properties in Los Angeles consisted of the same set of buyers. I'm sure there is some overlap, but most likely very minimal. So Cal will never have high cap rates....and other markets where there are still properties in the 9-12 cap range will never experience the type of increase needed to move to the 3-6 range... at least not in my lifetime.

Also, I humbly submit that since your preference is to look at things from a cap rate perspective, I think that actually make the case for So Cal-type of markets. If CoC isn't considered, I think it is a no brainer that lower cap properties with high appreciation potential are much more attractive.

Cap rates are used as an income approach to value. They are not a magical "profitability" metric. See how substituting market value for cap rates gives you a more accurate description?

HI Brian,

Andrey's response made me think some more about what you were saying about cap rates(market value). I agree with your points in theory, but aren't you making the assumption of a competitive market? This flattening out of the cap rates(market values) would occur if the market place for the higher double-digit cap rate(lower market value) properties and the market place for the lower 3-6 cap rate (higher market value) properties in Los Angeles consisted of the same set of buyers. I'm sure there is some overlap, but most likely very minimal. So Cal will never have high cap rates..(low market values)..and other markets where there are still properties in the 9-12 cap range (low market value) will never experience the type of increase needed to move to the 3-6 range(high market value)... at least not in my lifetime.Also, I humbly submit that since your preference is to look at things from a cap rate perspective,(market value) I think that actually make the case for So Cal-type of markets. If CoC isn't considered, I think it is a no brainer that lower cap properties (high market value)with high appreciation potential are much more attractive.

Good discussion. Be safe, guys!