OLD property, long term renter is in place. IS this a deal and property Value at the end?

Question

Please advise.

2 factors that I thought would average out and therefore not include i calculation.

a.  No down payment.

b. Interest is not accounted.

Purchase price70000

Inspection Costs450

Lender fees and closing costs2000

Total IN72450

Monthly rent ( renter in place)850

Yearly collections10200

Subtract 10% vacancy  -1020High vacancy in the area

(Reserve)  -1000Old property so maintenance cost

Annual Tax  -2800

Annual Total expense.  -4820

Conservative annual gross  5380

Payoff property ( without accounting Interest on loan)13.5 years to pay off.

Considering if I pay off early 8 yrs ARM Would this be deal worth it?

and/OR

What would be Value of property by then?  Is this deal worth it?

Ned Carey · Answer

Capitalization rate is how fast an investment pays itself back. If is usually expressed as a percentage In this case it would be 7.4%~. In other words it pays itself back 7.4% a year or it pays itself back completely in 13.5 years.  It is just another way of expressing the same thing.

Why did Naveen choose not to include it. You would have to ask him.  My guess is he hasn't yet learned some of the more traditional ways of valuing properties.

@Naveen Desai  you wrote:

In commercial properties they estimate the value after a period of years, then calculate the Internal Rate of Return (IRR) Which takes into account the cash flow, and future value to calculate the total returns. It is always a guess what the future value will be. In commercial property it can be an educated guess becuase the value is based on the cash flow.

However the value of SFHs is much harder to predict because a homeowners desire to live in a particular area can drive the prices up well beyond what makes sense from a cash flow perspective.

My point is that yes you can use IRR to ehlp calculate the total return from both cahs flow and appreciation but it is as much an academic expercise as it is a practical too for SFHs.

Ned Carey · Answer

I would not consider this a deal. I want better cash on cash returns.

However there are other factors. Are you a high income earner that may benefit from the depreciation. Is the property in an area that is likely to appreciate.  Are rents likely to go up or possibly down? How would you asses the risk of this property? How does this compare to other deals in the area?

Naveen Desai · Answer

Agreed @Brandon Hall ,  7.4% annualized is not a deal considering the things one has to deal with being land lord and that is why I had to factor in "Value of the property" say after 5 yrs, 10 yrs, 15 yrs, if I am able to sell the property for atleast the same cost, if lucky.

Want to know if folks would consider that a deal?

Brandon Hall · Answer

@Naveen Desai It depends on whether or not you think a 7.4% (5380/72,450) is a good annualized return.

Naveen Desai · Answer

Hi,

Thanks for quick replies guys.   Yes, the interest not considered as no down payment and leverage factor that @Ned Carey  pointed out!.

However nobody answered if this is a deal.

Let me make it simpler. What if I put all down, is it worth it to get 850 monthly?

Thanks,

Ned Carey · Answer

@Naveen Desai  I suspect your expenses will be higher. You have only figured in vacancy but nothing else for turnover costs. When a property goes vacant you have cleaning costs, painting and minor repairs, cost of new locks, possibly leasing commissions, advertising etc.

You only have $1000 for maintenance and reserves. Especially if this is an old building that will likely be higher. All you need is for a furnace to go out and that is 2-4 years of repair budget right there.

You also haven't figured in anything for management. There is nothing wrong with managing yourself to increase cash flow. However the investment in the building is not generating that additional cash your effort managing the property is generating that cash.

Brandon Hall · Answer

@Ned Carey that makes sense, thank you for the explanation. Why wouldn't he account for it when estimating his pay-off period?

Ned Carey · Answer

When figuring capitalization rate you do not figure in financing costs. One reason is so you know how much the building is generating vs how much return is coming from leverage.

Brandon Hall · Answer

Can you clarify as to why you aren't accounting for interest?

Jason Eyerly · Answer

Never count on appreciation to determine whether a deal is worth it otherwise you are gambling..Just my two cents.