CAP rate and COC Question

7 Replies

Im revamping my spreadsheet and I want to get this right.

My model involves me buying distressed SFR properties, I rehab them and then rent them, out or flip.

If I hold the property as a rental I get a mtg that will give me back 100% of my hard cost for the purchase and rehab.

If I hold the property as a SFR, should I calculate Cap Rate based on the ARV of the property or my actual investment amount. My thought here is that by holding the property as a rental, I am deciding to leave all of my potential flip profits in the property. Therefore I should base my Cap Rate on the ARV, and use the unrealized net profit to calculate COC.

Should the unrealized net profit from the sale be pre tax or after tax?

Cap rates are inappropriate to use for SFH's.

If I have to make the decision whether to flip or rent I will use the ARV less the selling cost. That is the amount I am giving up currently to have a rental.

I like to decide before rehabbing what I am going to do with the property. The amount of rehab may be different if I am selling than if I am renting.

Good Luck.

Bill

Chris, what is cap rate? It's nothing more than your Cash-on-cash return had you paid cash for the property (no financing).

Under that definition, cap rate should be your NOI divided by your investment not the ARV.

Why do you care about cap rate after you get financing? As Wendell pointed out, cap rate is just your COC should you not finance...but once you finance, cap rate is completely irrelevant other than as a tool to compare it to alternative investments (which doesn't matter anymore, as you've already made the investment).

Is there a reason you care about cap rate in this scenario?

Chris -

I concur with @wendelldeguzman and echoed by @jscott, once your cash is out, cap rate has no relevance. Perhaps you are tryin to determine something else or we are not fully understanding the scenario or what what you are asking.

@J Scott Honestly I don't know if I care or not. I am trying to come up with system to compare which house I should flip and which house I should keep in my SFR portfolio. And I am driving my self a bit crazy.

I am measuring every possible metric to help justify a decision. So even tho I agree these are irrelevant after I refi, I may use this as a metric to help make a decision.

Someone mentioned using NPV also, I may work on that tonight.

@Chris Adams What to measure is dependent on what you're trying to achieve. What is your overall investment objective for your real estate holdings? Are flips a method to grow your capital for acquiring a portfolio of rentals? Are flips funding your living expenses?

If building a portfolio of rentals is the objective it sounds like you're hitting it out of the park when you get all your cash out at refi. If that's the case then it may be best to measure the returns by whether or not revenue is growing year over year as rents rise (or not) and vacancy falls (hopefully). If revenue is growing then you're doing infinitely well and getting better all the time!

Another measure to consider for the rentals is Return On Equity, the equity being what you would net after selling at a market price every year. If market prices remain steady and the tenants pay down the mortgage to the point where ROE falls below an acceptable level then it would be time to refi again or sell.

Good hunting-