15 unit. 750K asking price. 650 rents. Good deal?

31 Replies

Hi guys

I'm considering this one.

Area is safe.

15 units, 2br each 800 sq ft, 1 bath

Rents 600 each

coin laundry in basement.

All updates are done. Needs nothing.

The asking price is 750K

Is that price good?

If not what price should I pay?

Also how much would I expect to pay for a management company?

There is no way to tell without knowing two things.

1. NOI. If the landlord pays for all utilities vs. the tenant pays the NOI will dramatically swing. You also need to check to see if the rents are market or now plus how long the contracts have been in place. Then you will have an idea concerning the quality of the NOI.

2. CAP rate for similar properties in the area.

With those two numbers you stand a chance to see how well the price stacks up compared to the area.

There is lots more to know before deciding the price is right. The above two are the critical 2 questions when starting.

Originally posted by "Laurens":
Hi guys

I'm considering this one.

Area is safe.

15 units, 2br each 800 sq ft, 1 bath

Rents 600 each

coin laundry in basement.

All updates are done. Needs nothing.

The asking price is 750K

Is that price good?

If not what price should I pay?

Also how much would I expect to pay for a management company?

The formula for NOI and then the value based on the prevailing CAP rate is standard. What the CAP rate is at any one time or any one market varies.

There is still plenty of room for prices to vary based on what someone things they are dealing with (are the numbers real) and if they see room for improvement (change or use, upgrades, stabilize the rent roll if there is a high vacancy factor).

Note that you rarely get actual expense number. You really want to pay for the income the way it is and not how it could be if the owner pulled out their finger.

John Corey

Laurens,

Here is the way I see this deal.

Gross rents: $9,000 per month
Operating Expenses: $4,500 per month
NOI: $4,500 per month

Mortgage: (20 yr, 8%): $6,273 per month

Monthly LOSS: $1,773 per month OUCH!

This is a BAD DEAL!

BTW, forget the CAP rate nonsense. All the cap rate really tells you is what others are paying for property in your area. Since the majority of newbies fail in a short period of time, all the cap rate is telling you is what the losers are paying (overpaying) for their property. When I buy rentals, I don't care what anyone else paid, I care about the cash flow and equity. I certainly wouldn't buy a property that will lose money each month!!!

Good Luck,

Mike

MikeOH,

I agree with you 100%. I'm also more interested in the cashflow and equity. Most of the time when sellers/agents give you the numbers debt is not included. Don't forget to include taxes if you haven't. If the property is an older property with older systems, set-aside about 20% of rental income, in a reserve account (interest bearing account) for major repairs/upgrades.

Ron

:groovy:

Forget the CAP rate?

Since the majority of newbies fail in a short period of time, all the cap rate is telling you is what the losers are paying (overpaying) for their property.

We are talking about a multi-family commercial property. Why forget the CAP rate? That sounds like buying houses without doing comps to see how a deal compares to the market.

No one said to be naive or to do bad deals. If you want to invest in the commercial sector then forgetting to consider the CAP rate is a sure fire way to label yourself as a naive newbie.

When ever you buy you want to know how the price stacks up compared to the other properties being offered for sale and those that have sold recently.

There appears to be no argument about NOI. As two people pointed out you need to make sure all the expenses (other than debt) is accurately reflected in the NOI. A reserve for repairs and other costs that do not happen each month is where some people become unstuck. MikeOH's approximation for expenses leads to a pretty accurate NOI. Do look at the historical numbers if you can get them as you can sometimes tell if the owner has been under investing the maintenance.

John Corey

YES - FORGET THE CAP RATE.

As I said, all the cap rate tells you is what the failures paid for their properties. Frankly, I don't care what the failures paid (overpaid) for their properties because I am not following in their footsteps.

I am interested in the real numbers. I am interested in CASH FLOW and EQUITY. Cash flow pays the bills; allows you to eat; and provides cash for luxuries. Equity allows you to become wealthly. Cap Rate allows you to....oops, that's right, cap rate doesn't do anything for you. It's just a hocus pocus number that makes people feel like they are big time investors. Thanks anyway!

Mike

Cap Rate is absolutely an important consideration. The investors that make the most money in our business are the ones who use leverage. From the small time guy to the institutional pension fund leverage is the key to creating the most equity quickly. Since the debt markets are dynamic in nature as related to interest rates and debt structures cap rate is the one constant that can be used as a guide to compare the deal to current demand. I agree that the final calculation needs to be return on cash in the deal and that return must be positive but cap rate is still a necessary guage.

MikeOH,

You know better. Cash flow and equity are not at odds with CAP rate. I assume you are fine with NOI calculations.

Lets agree to not use the word for a minute.

How do you decide on the price you want to offer after you have determined there is cash flow and that there will be equity? Focus on a 15 unit building so looking at comparables in the traditional residential sense does not work. Stick to suggestions that work for commercial property.

So, how do you determine the price you want to offer?

Originally posted by "MikeOH":
YES - FORGET THE CAP RATE.

As I said, all the cap rate tells you is what the failures paid for their properties. Frankly, I don't care what the failures paid (overpaid) for their properties because I am not following in their footsteps.

I am interested in the real numbers. I am interested in CASH FLOW and EQUITY. Cash flow pays the bills; allows you to eat; and provides cash for luxuries. Equity allows you to become wealthly. Cap Rate allows you to....oops, that's right, cap rate doesn't do anything for you. It's just a hocus pocus number that makes people feel like they are big time investors. Thanks anyway!

Mike

RIDICULOUS!

Cap rate is defined as NOI divided by the value (or sales price).

The market cap is determined by using the financial data (NOI and sales price) of similar properties which recently sold in that market. In other words, the market cap is determined by looking at COMPS! So far, so good. However, who is determining the NOI for these properties? Where are they getting the financial data? We all know that sellers overestimate the gross rents and underestimate the expenses. REI - you yourself didn't know what the proper expense numbers were just a few days ago and even asked me for a reference. If you have 20+ years of investing experience and yet you didn't know this vital information, who else do you think does. So, the bottom line is that the cap rate is just a big joke. The financial data used to determine the market cap is pure fiction; the resulting market cap is therefore nonsense; and the majority of residential units in the United States are owned by small investors - the majority of whom fail.

I fully understand the theory and facts surrounding Cap Rate, however I would not use it because it's just nonsense. The majority of people I hear talk about cap rate are newbies who want to sound important.

How do you decide on the price you want to offer after you have determined there is cash flow and that there will be equity?

That's very simple. For residential rentals, which is what we're talking about, I do a cash flow analysis and determine the price that will allow me to have a positive cash flow of $100 per unit per month using the real world expense numbers and 100% financing (even if I'm putting something down). To get that monthly cash flow, you will ALWAYS have significant equity (at least 30% in almost all cases).

Mike

I agree with Mike. I just worked it out the numbers for Antwan on another thread. The list price is 795K, but to make the property cash flow, he would have to get the property for 395K and I was being generous on the terms of the loan. Even if he got the property for 595K, he was still going to loose money every month. Based on his cap rate this property would have been a fine purchase. So cap rate has to be junk when it comes to figuring out whether a property will produce a profit.

So cap rate has to be junk when it comes to figuring out whether a property will produce a profit.

Actually, the cap rate is valuable for one thing. If you're looking for a very simple way to go broke, just buy a bunch of properties at the market cap rate!

Mike

What would the Cap Rate be on this property?

What is a good Cap Rate for a property?

What type of ROI do you guys look for?

I am lost how did you come up with the NOI with just those numbers listed?

Originally posted by "MikeOH":
RIDICULOUS!

Cap rate is defined as NOI divided by the value (or sales price).

...

That's very simple. For residential rentals, which is what we're talking about, I do a cash flow analysis and determine the price that will allow me to have a positive cash flow of $100 per unit per month using the real world expense numbers and 100% financing (even if I'm putting something down). To get that monthly cash flow, you will ALWAYS have significant equity (at least 30% in almost all cases).

Mike

You appear to be doing the math and not paying full price. Hence you are getting a better CAP rate than the market average for your area. There is still a CAP rate. No one is arguing that bargaining or offering less than the seller might want is bad. Are you preaching to the choir?

All expenses numbers can be cooked. Obviously you believe your numbers so you can still calculate the cash flow and determine the price you will pay. The CAP rate calculation still works to produce an implied market value. You can also use the offer price to compute your CAP rate to see how it compares to the market. Buy at one CAP rate and sell at another is a way to explain it.

As you like to buy equity you must believe that the market will pay more than you did. Otherwise if everyone was paying the price you think is fair that price would be the market average and there would be no equity above your offer. Either the market values your property higher than you are paying (hence equity at close) or you are paying the market price (no equity at close). There must be a way to determine the value in the market for other income producing properties. Cash flow times some multiple?

CAP rate is used by people who are much more sophisticated than what you call novices. It is a calculation that is well accepted by professionals in the commercial sector. No one is saying you have to pay the value implied. Just that the value implied gives you the present market value for a property. If you buy for less (like you advocate) you have equity.

Why get all hot under the collar about the math? NOI is NOI. Bad data is leads to a bad result. Good data in leads to a better (good?) result. You compute NOI using what you call real world expense number. It still produces something that you and others call NOI. If all you are arguing is people do not know what real world expenses are then why are you going on about CAP rate. It would be the NOI that is off, not the rate.

You said CAP rate is the NOI divided by the value. Your process produces a CAP rate. Call it the MikeOH CAP rate in that it is the rate you expect given your requirements for income and value.

I see no dispute. You are pointing out that most investors fail to accurately understand the true expenses and otherwise end up overpaying. You are saying they can not get the NOI right.

John Corey

I see no dispute. You are pointing out that most investors fail to accurately understand the true expenses and otherwise end up overpaying. You are saying they can not get the NOI right.

That's right. Garbage in, garbage out. Therefore, if the majority of investors don't get the NOI right, then the cap rate is off. If those determining the market cap rate are using this data, then the market cap rate is also garbage. Garbage + garbage = garbage.

Instead of relying on a cap rate that is garbage, I simply calculate the cash flow (using real world expense numbers) and look at the equity from my experience of looking at hundreds of rentals in my area(which is essentially comps, except I'm not relying on someone else's opinion of the value).

Mike

I thought you were from the "50% of gross rents = NOI" crowd---I'm glad to read that we are using real numbers these days...

Regards,

Scott Miller

Originally posted by "MikeOH":
I see no dispute. You are pointing out that most investors fail to accurately understand the true expenses and otherwise end up overpaying. You are saying they can not get the NOI right.

That's right. Garbage in, garbage out. Therefore, if the majority of investors don't get the NOI right, then the cap rate is off. If those determining the market cap rate are using this data, then the market cap rate is also garbage. Garbage + garbage = garbage.

Instead of relying on a cap rate that is garbage, I simply calculate the cash flow (using real world expense numbers) and look at the equity from my experience of looking at hundreds of rentals in my area(which is essentially comps, except I'm not relying on someone else's opinion of the value).

Mike

I thought you were from the "50% of gross rents = NOI" crowd---I'm glad to read that we are using real numbers these days...

50% of the gross rents ARE THE REAL NUMBERS, or at least as close to reality as you're going to get in the real world. If you've got a better formula or method, I'd love to hear it!

Mike

This is something that we are just going to disagree on---Gross Rents x 50% provides an estimated NOI---using of REAL NUMBERS (like real numbers from tax returns, operating statements and historical data) yields a REAL NOI...

Regards,

Scott Miller

Originally posted by "MikeOH":
I thought you were from the "50% of gross rents = NOI" crowd---I'm glad to read that we are using real numbers these days...

50% of the gross rents ARE THE REAL NUMBERS, or at least as close to reality as you're going to get in the real world. If you've got a better formula or method, I'd love to hear it!

Mike

One final word from this respondent on cap rates. I think we all can agree that cap rates are one of many methods of evaluating a property. Different cap rates apply to dfferent types of properties and different situations. If cash flow is your gig then MikeOH has the right answer here. I would be willing to accept no cash flow if not negative if I have a property that will be re-developed in a few years or that I have leases rolling and I can push the rents. In the case of pushing the rents I am adding value and will be selling the property. I have no idea what interest rates will be when I finish stabilizing the cash flow of the property but cap rate is not affected by interest rates. Next buyer will most likely use cap rate to base heir purchase price and the banks appraiser will most likely use cap rates to determine values. If the buyer is looking at cash flow only he is not my best buyer b/c he is bottom fishing and in a solid real estate market the bottom fishers are normally buying properties in declining areas of town that have little to know chance for appreciation. The days of rising tide floating all boats is over so to make the real dollars you must create the value yourself. Cash flow is great but you are only a couple of unexpected capital improvements away from a mediocre if not negative return.

Typically the buyers that buy on cash flow alone and ignore cap rates are the same buyers that don't look at IRR either. Making $25,000 profit on a 5 year hold is not my idea of creating personal wealth which I believe to be all of the members of this forum's goal.

Originally posted by "EZLoanz":
This is something that we are just going to disagree on---Gross Rents x 50% provides an estimated NOI---using of REAL NUMBERS (like real numbers from tax returns, operating statements and historical data) yields a REAL NOI...

Sure. And I know a property with an excellent REAL APPRECIATION RATE (calculated by looking at appreciation rate of 50% between 1995 and 2006). Would you like to purchase it?

Scott, I don't mean to be harsh, but your post is hogwash. Your method might be okay to estimate fixed expenses, but 1) those expenses will need to be multiplied by some factor to project future expenses, in which case the accuracy is at the mercy of your factor, and 2) this ignores all variable costs (or, even worse, you assume that past variable costs are a good estimate for future variable costs... if so, I hope that sounds a little off when you actually hear it out loud).

As far as I can tell, the main beef people here have with the 50% number is that it seems too easy. Repeat after me:

There is no way to deterministically predict future costs.

All you can do is estimate, and just because your estimation method is more complicated sure doesn't mean it's more accurate. I have pointed out a couple times that the 50% number is mathematically flawed. There is no discernible dependency between gross rents (set by market) and expenses. However, there are a lot of models in economics (and statistics in general) that work even though one can't quite tease out the logic behind the numbers. (In fact, if you want to get technical, the entire scientific community is built upon these situations, with very few exceptions. But I digress...)

Originally posted by "SADEV":
Cash flow is great but you are only a couple of unexpected capital improvements away from a mediocre if not negative return.

Yes, if you have to purchase a new roof, you will likely have negative cash flow on that unit for that month. This is not the point of a cash flow analysis and this is why cash flow analysis for short-term holds is pretty pointless (unless you have a warranty, or the term is so short that you know exactly what expenses you'll have, or something along those lines).

If you purchased right, you will have an average of $100/unit/month cash flow. That means one month you will have $+325, and the next $-284, and the next...

50% of gross rents might work in some areas. That statement is the same as using a cap rate. Usually I find out that Realtors don't include some fees on properties such as landscaping, Snow removal, stuff like that. I never bought a multi unit apartment complex but if I was you could sure bet I will be doing more investigating on NOI than just a cap rate or 50% or gross rents. Sometimes when a city extends the city limits the current owner of a property does not pay the new city tax, but the new owner will. Just like taxes will get reevaluated for new taxes when the property changes names. HOA fees could eat you alive as well. Yes Cash flow is nice but I am more interested on my return of the money I put into it. I don't really want to give $100,000 and only get $4,000 back annually. Maybe $35,000 in and $8,000 back annually.

I love the fact that no one (That I seen) asked what the Laundry mat usually averages for a income, and other items that might be not known for the NOI. Yes I don't think I would get off my couch to look at this deal unless the seller is serous. I get about one call a week from someone telling me they have a deal. Usually I am the 50th person they talked to.DEALS ARE NOT FOUND, THEY ARE MADE. I read that somewhere.

Matt,

With all due respect, my opinions are not mine, but that of an industry called lending.

I don't know who everyone borrows money from, but these are the steadfast rules that are applied.

Multiplying gross rents by 50% is hardly constitutes due diligence, but we can pretend it is to conclude this thread (I think this will be the last time I speak up on this matter---I'm tired of fighting off the cronies and "experts" that have read a book).

I don't speculate in business or life and neither will any of my clients (if I have anything to say about it)...

Regards,

Scott Miller

Originally posted by "mwarden":
Originally posted by "EZLoanz":
This is something that we are just going to disagree on---Gross Rents x 50% provides an estimated NOI---using of REAL NUMBERS (like real numbers from tax returns, operating statements and historical data) yields a REAL NOI...

Sure. And I know a property with an excellent REAL APPRECIATION RATE (calculated by looking at appreciation rate of 50% between 1995 and 2006). Would you like to purchase it?

Scott, I don't mean to be harsh, but your post is hogwash. Your method might be okay to estimate fixed expenses, but 1) those expenses will need to be multiplied by some factor to project future expenses, in which case the accuracy is at the mercy of your factor, and 2) this ignores all variable costs (or, even worse, you assume that past variable costs are a good estimate for future variable costs... if so, I hope that sounds a little off when you actually hear it out loud).

As far as I can tell, the main beef people here have with the 50% number is that it seems too easy. Repeat after me:

There is no way to deterministically predict future costs.

All you can do is estimate, and just because your estimation method is more complicated sure doesn't mean it's more accurate. I have pointed out a couple times that the 50% number is mathematically flawed. There is no discernible dependency between gross rents (set by market) and expenses. However, there are a lot of models in economics (and statistics in general) that work even though one can't quite tease out the logic behind the numbers. (In fact, if you want to get technical, the entire scientific community is built upon these situations, with very few exceptions. But I digress...)

Originally posted by "EZLoanz":
Matt,

With all due respect, my opinions are not mine, but that of an industry called lending.

I don't know who everyone borrows money from, but these are the steadfast rules that are applied.

This does not change anything, and it certainly doesn't change the fact that your method produces estimates as well. Estimation methods are created for specific purposes. The 50% method is intended to have a certain balance between accuracy and speed of calculation, the latter of which is very important. No one has ever said that due diligence is not required.

Not to mention that no one here has been able to show that the more complex methods are more accurate.