Totally new to real estate investing. I have read lots of books and studied lots of numbers now it's time to move on something. My wife and I looked at a duplex this weekend so I ran the numbers. Seemed real easy, have punched them in tons of times (random houses on Zillow or Redfin). Well... maybe not so easy now that it's our money on the line. We are not sure if we are trying to talk ourselves out of the deal or if the numbers just aren't that great. The units are basically turn key would paint the inside and fix a couple minor things maybe 500 bucks. Tenant occupied in one unit for six more months other side is vacant. Anyway the place would cashflow at the asking price but the cash on cash ROI would only be 3% seems to be very low. Does that make this a horrible deal? The cap rate would be little over 6% witch does not seem to be to far off for the area.
Looking back at my first rental, I can't express in numbers the lessons I learned from owning my first property.
How to find and vet tenants. How to manage tenants. How to interview property managers, how to apply and get loans. How to deal with unexpected situations ... etc.
2% versus 3% versus 4% is not going to make you wealthy at this stage. But the lessons you learn from owning the asset will definitely help make you smarter going forward. Just make sure there is no "structural issue" with the property or some issue that will drain you financially.
Suggest you actually post a sample or two of it revealing address etc, let people comment on it. Some is after cash flow, others want appreciation. Vacancy rate, most want no down, cash and steep appreciation. Keep in mind there are safer investments than real estate. Good luck.
I would do a quick IRR calculation on all opportunities. Cash on cash is a performance metric strictly about residual cash on a single year. A 3% cash on cash this year can be a -10% cash on cash next year, would you still like it? Assuming your 3% CoC is average for multiple years, there are now probably money market accounts that can beat a 3%. Why would you take the risk of making those numbers from tenants when you can make them from the federally insured banks!!
As far as "cap rate"? I would discard it from your analysis of residential rentals, it is of limited use.
However, I'm actually curious about your analysis - how do you turn a 6% cap rate into a 3% CoC??? The reverse is what usually happens. You take a 6% cap rate, finance it so you can squeeze 9% or higher CoC (i.e. classic leverage strategy). Maybe we need to see some numbers...
@Immanuel Sibero I am curious as to where you would find a money market fund that is returning better than a 3% annually?
@Denton Beam Welcome to the BiggerPockets Forums!! We are glad to have you and I want to tell you that you have definitely came to the right place. In regards to your question about this scenario, we simply need more info. You are asking if a 3% ROI is good or not but let me ask you this: If you were purchasing a 200k Duplex and put down 20% which would be 50k of your own cash and you recieved a 3% return on this investment would you still tie up 50k cash in this deal knowing your annual return would be only $1500? On the other hand if you took this same scenario and are purchasing this property using an FHA loan where you are only putting down 3.5% which equates to only 6k cash down with a ROI of 3% earning you $180 annually. Although it is still cash flow the numbers seem pretty tight on this scenario.
It really comes down to your goals and what you want to accomplish in RE. Are you planning on retiring from your job using RE as a tool? Are you looking at doing it as a hobby on the side but still work your day job? Try using the BiggerPockets calculators under the tools tab which is completely free for up to 5 uses I believe. You can post it to the forums and have people analyze the deal to better assist you. If you would feel more comfortable leaving the property address off of it as well so someone doesn't snatch it up from you (not saying anyone would) you could do that as well. Hope this helps!
I didn't say you would find one, just that there might be one... :-) However, if you were to consider CD's as MMA's with commitment then Google search shows a few paying north of 3%. By they way, there are already MMA's with no commitment paying 2.45%, so we're almost there.
But the point is that a cash on cash of 3% is just not a good rental house investment... regardless of your goals. It's just not worth the risks. A quick IRR analysis can be beneficial as it paints a better picture of the true "return" of the investment. We can then determine whether that return justifies the risks associated with rental properties. For all we know, the OP's duplex could be worth double in 5 yrs (i.e. IRR of 14%+) which beats the long term stock market return handily.
Thank you everyone for responding to my post! Sorry for leaving out all the important information. Here is what I came up with using the BP calculator. I am by no means looking to get rich quick with this type of investment but my end goal would be to create enough passive income to live comfortably within the next, let's say, 15 years. Please let me know what you guys think.
@Denton Beam It would help to share the numbers and your assumptions so that people can give a more informed response. Those returns look awfully low to get excited about especially for a multi unit. COC returns are usually higher than CAP rates with rare exceptions so I'm a little skeptical of the calculations. I would also question the $500 for getting the unit cleaned up unless it was just completely rehabbed. $500 doesn't go very far.
@Denton Beam I noticed you posted the numbers of this property in a separate comment.
It might be easier to go to the initial post and click "edit" to add an additional comment on the original post so that people will see the number calculation. =)
Looking back at my first rental, I can't express in numbers the lessons I learned from owning my first property.
How to find and vet tenants. How to manage tenants. How to interview property managers, how to apply and get loans. How to deal with unexpected situations ... etc.
2% versus 3% versus 4% is not going to make you wealthy at this stage. But the lessons you learn from owning the asset will definitely help make you smarter going forward. Just make sure there is no "structural issue" with the property or some issue that will drain you financially.
The biggest thing that jumps at me is the spread betweencap rate and loan interest rate. CoC is hyper sensitive to this spread. The smaller the spread the faster CoC goes down the drain and vice versa. As I stated before, it's a common strategy to finance a project whereby the loan will leverage a 6% cap rate to an even higher CoC (i.e. upwards of 10%). However, financing a 6% cap rate with a 5.5% loan will have the opposite (i.e. detrimental) effect on CoC, and this is because there is only .5% spread between your cap rate and loan interest rate. Unless there is significant value appreciation that can be expected when you exit or you can negotiate a lower price, 3% on your money is just not worth the risks.
With that being said, do you think it would be wise to put more cash down on a property in order to get a lower interest rate? Or find deals where less is more. I ran numbers on this one at 339k with 20% down and the same interest rate of 5.5%. It got the CoC to 5.81% with 6.62% cap rate. Still not close to the CoC being higher than the cap rate. looks like that interest rate really kills but I think I would go for the deal with those numbers?