Rookie crunching data for possible 1st buy

106 Replies

Hey all. My wife and I are considering making an offer on the following SFH:

3/1 with 1340sq.ft listed at $64,900. Built in 1954. Its an estate sale by the only child of the deceased homeowner. Vacant for over a year; on and off the market since June of 2013. Decent neighborhood. Lots of seniors, blue collar folks and some college kids.

$4500 in DIY renovations estimated: drywall repairs for small mold & water spots; painting interior; ripping up carpet & installing hardwood laminate; ripping up vinyl & installing tile; replacing oven/stove, refrigerator, & dishwasher. Can live with roof and HVAC but will probably need attention w/in 5yrs. We plan on living in it the first year and then renting it out.

20% down for 30yr fixed at 4.3%

Estimate $850/mo. in rent. Median rent in area estimated at $750/mo. Upper end is around $1000/mo.

Estimated cap rate: 7%

Estimated annual cash flow with 10% PM factored in: $3263

What do the BPers think? Thanks!

Forgot to include our max purchase price of $60k.

Calculations of cap rate and cash flow are based off of J. Scott's 2010 spreadsheet.

For that kind of rent I would not buy for under 10% cap rate (assuming 50% expenses). The smallest things can turn your cash flow negative and vacancy costs are always higher than you expect. Since its been vacant for a year, its clear that its not an appreciating property.

@Matt McLeod Why would anyone care about a cap rate on a SFR?

Originally posted by @Anish Tolia :
For that kind of rent I would not buy for under 10% cap rate (assuming 50% expenses). The smallest things can turn your cash flow negative and vacancy costs are always higher than you expect. Since its been vacant for a year, its clear that its not an appreciating property.

Seriously Anish Tolia what does occupancy status have to do with appreciation?

Anish, thanks for the comment. Property values have been stagnant in this area for a while, so I think I might be hard pressed to find one that's appreciated over the past year or two. I will keep my eyes peeled though. Thanks for the advice!

Bob, thanks for your comment as well. Since I'm new, perhaps you wouldn't mind explaining why cap rate doesn't matter for a SFR. I included it in my estimate for just this kind of feedback, and because the BP recommended reading for new investors calls it the single most important number when evaluating a rental property. See http://www.biggerpockets.com/renewsblog/2010/06/30/introduction-to-real-estate-analysis-investing/ . I appreciate you pointing out that it might not matter, but if you could explain further I'd be glad to hear your reasoning. Thanks Bob.

Newbie here but average deal. Get it for 49k max all in and it is more reasonable as far as business is concerned. If it's been on the market that long I would be tempted to offer 40k especially with 5 years left on the most expensive maintenance items. A wise bper once said " if you are not embarrassed by your offer you paid too much" and he is right. You make your money when you buy.

Thanks,

Matt

Matt Rosas - Maybe you make your money when you buy, however it's not always on the front end.

If the property could be purchased using selling financing, the cash flow and terms can be structured in an almost endless number of ways, both to make the deal cash flow positively quickly and some great back end profits, without necessarily requiring appreciation.

For example, a first trust deed for half the financing, whereby the payments don't start until a tenant is in place, and a second that doesn't require payments until the 1st is paid off, etc., etc. this is where it gets fun!

The point is to structure a deal with both the present and the future in mind. Expecting that the seller (or their heirs) will eventually return to the well and ask to be paid off early to pull more cash later is your opportunity to renegotiate yet another time.

Learn some great strategies by studying John Schaub, Jay Decima and Bill Tan. The real money is made in the back end.

Thanks for the great ideas. What do you think about presenting 3 offers:

1) 50k, bank financing. (Seller nets 50k minus realtor fees)

2) 50k, seller financing: 15k down, 35 at 4% for 20. (Seller nets 65k minus fees)

3) 50k, seller financing: 15k down, 35 at 6% for 10. (Seller nets 61k minus fees)

Thoughts? Any tips for presenting multiple offers?

I'll let better minds weigh in on the financing options, but my initial hit was that your $4500 seems low for the rehab you outlined. I guess it depends to some extent on how DIY you want to be, but still - this isn't that different than what I did (very much by myself) to my own modest 1950's house, and it sure cost more than $4500... just don't want you to be unpleasantly surprised!

Originally posted by @Matt McLeod :

What do the BPers think? Thanks!

I don't see where you posted a market value for this property & you have people telling you whether it's a good deal or not. You've even got @Anish Tolia telling you a vacant house can't appreciate. Does any of that sound wise to you? Don't make an offer on something you don't know the market value.

I believe it is Ben L something that had a pretty informative discussion on what cap rates are. I'll keep looking & maybe someone can help find it.

@Matt McLeod

I never assume my rentals are going to appreciate, so it is a great bonus when they do.

This property passes my 1% rule test, so I'd look further at it as a rental.

I would find out exactly how much the following expense are going to cost you each month. "The tenant pays" is a good answer as well. Put those numbers up here and I'll tell you what I would pay for the place.

Taxes

Sewer and Water

Trash

Heat/Utilities

HOA

Cap Ex and Ops

Insurance

Mgmt Fee - as a % (general consensus here on BP is 10%. include it even if you think you are going to self manage)

Vacancy- as a %. (8% represents 1 vacant month/unit/year)

Taxes: $63/mo.

Water, trash, electric: Tenant pays

HOA: none

Cap Ex and ops: Assuming $4500 for initial improvements. Budgeting $400-450/mo. based on 50% of expected monthly rents.

Insurance: $50/mo.

Mgmt: $80-90

Vacancy: 8%

.

Originally posted by @Matt McLeod :
Anish, thanks for the comment. Property values have been stagnant in this area for a while, so I think I might be hard pressed to find one that's appreciated over the past year or two. I will keep my eyes peeled though. Thanks for the advice!

Bob, thanks for your comment as well. Since I'm new, perhaps you wouldn't mind explaining why cap rate doesn't matter for a SFR. I included it in my estimate for just this kind of feedback, and because the BP recommended reading for new investors calls it the single most important number when evaluating a rental property. See http://www.biggerpockets.com/renewsblog/2010/06/30/introduction-to-real-estate-analysis-investing/ . I appreciate you pointing out that it might not matter, but if you could explain further I'd be glad to hear your reasoning. Thanks Bob.

Here you go! This was in response to arebelspy at MMM that was trying to argue FOR cap rates for SFR's and using @ali boones blog to support that when in fact it did the opposite! Oops. No disrespect to Ali Boone and she did agree to the corrections when it was pointed out to her and I do see in later posts she has a better grasp of cap rates but I've been doing this for 20 times longer.

Are you talking about the Ali Boone post? She's a 2 year expert!? And here are the comments correcting her post that she agrees to and are pretty much what I've been saying all along,
Ben Leybovich March 31, 2013 at 4:30 pm
CAP rate metric is used to peg a value to a piece of income-producing real estate based on its' income as represented in the NOI. It is used exclusively in the multi-family commercial and industrial spaces. The value-setting mechanism in the SFR space is a function of the comparative market approach and not the income. Trying to utilize CAP rate analysis in the single family space is highly misleading and impractical. Hope this helps
Frank Gallinelli March 31, 2013 at 3:53 pm
@Ben Leybovich raises a very good point here, and explained it very well. Cap rates are essentially a market-driven metric — a market cap rate represents the rate of return that investors in a particular location are actually achieving with a certain property type (office retail, etc.). As such, you really can’t describe a rate as being high or low universally. A 9% cap rate on a particular property might seem very high to an investor in midtown Manhattan, while the same rate could seem very low to someone in Upper Dry-Rot County.
I don’t want to invent any new terminology (we have enough already) but perhaps a way to wrap your mind around this is to start by recognizing that the market cap rate is, as I said, the rate of return other investors are actually achieving for a given property type in this location. Then, when looking at a particular property, calculate its cap rate and ask, “Is this property yielding a market cap rate, an above-market rate or a below-market rate?” I think describing a property as being above or below the market rate will tell you more than describing it as having a high or a low rate.

Well I definitely use cap rates on SFRs and I think @Anish Tolia gave good feedback. I don't think his point was to argue appreciation or not but rather to say that there is always a trade-off when buying rental properties. That trade-off being: buy really nice new properties in nice areas, get a lower cash rate. If you want a higher cap rate, you have to get less 'nice'. Whether it be the area, the property, whatever. What he was saying is what I agree with too, I'm not sure a 7% cap rate on this is high enough considering the age of the house and price range (cheaper properties usually warrant higher caps). But it's not a deal-breaker either. I would confirm however exactly what numbers you used to calculate that 7% and I would also get more concrete numbers to use just so you are sure. I wouldn't go lower than 7% by any stretch, so make sure that is a strong estimate.

Is this around Knoxville?

Originally posted by @Ali Boone :
Well I definitely use cap rates on SFRs and I think @Anish Tolia gave good feedback. I don't think his point was to argue appreciation or not but rather to say that there is always a trade-off when buying rental properties. That trade-off being: buy really nice new properties in nice areas, get a lower cash rate. If you want a higher cap rate, you have to get less 'nice'. Whether it be the area, the property, whatever. What he was saying is what I agree with too, I'm not sure a 7% cap rate on this is high enough considering the age of the house and price range (cheaper properties usually warrant higher caps). But it's not a deal-breaker either. I would confirm however exactly what numbers you used to calculate that 7% and I would also get more concrete numbers to use just so you are sure. I wouldn't go lower than 7% by any stretch, so make sure that is a strong estimate.
Is this around Knoxville?

I guess I was wrong. @Ali Boone

can you explain exactly what a cap rate on a SFR tells you? Are you now back tracking on your statements to @Ben Leybovich and @Frank Gallinelli?

@Bob Bowling

I'm not sure I know what statements you are referring to?

Cap rates are just a basic calculation that compares the net income to the purchase price you are buying for. It's not an end-all calculation by any means, but it gives a good gauge to know whether you are buying an investment property for a decent price or not. Doesn't really matter if it's SFR, MFR, or commercial. More of the difference just comes in when the property is being priced. Residential has to be priced more by market and commercial is priced more based on cap rate. So the cap rate determines nothing for a SFR but it gives an idea as to the wroth of the purchase price.

Originally posted by @Ali Boone :
@Bob Bowling

I'm not sure I know what statements you are referring to?

but it gives a good gauge to know whether you are buying an investment property for a decent price or not. So the cap rate determines nothing for a SFR but it gives an idea as to the wroth of the purchase price.

The statements I was referring to were in my previous post that included comments from Ben and Frank to your blog post. Please read and comment.

1. How does the cap rate GAUGE whether it is a decent price or not?

2. How does it give an idea as to the "worth" of the purchase price?

Please be detailed as the OP is a new investor and should not start off his investing career with a bunch of incorrect information.

Sorry, I'm lost... the only link to an article I see is one written by J. Scott. I didn't write that article and have never seen or read any of those comments?

Bob,

I don't see what's ambiguous or incorrect about anything Anish and Ali are posting. It seems you are being pedantic and petty, or easily confused, I'm not sure which.

And for a guy who brags about doing 40 billion in business and flying first class to Hawaii you seem very uncomfortable with basic math.

Originally posted by @Ali Boone :
Sorry, I'm lost... the only link to an article I see is one written by J. Scott. I didn't write that article and have never seen or read any of those comments?

I did not post a link. I copy and pasted comments from an article/blog that was attributed to an Ali Boone. If that wasn't you then still please kindly comment on the information of cap rates by Ben and Frank, specifically how you think they are wrong.

@Bob Bowling

I'm not sure what 'attributed to' me is even referring to or how I have anything to do with that article.

If you want to post a thread to debate the use of cap rates on SFR vs MFR, I'd be happy to give my thoughts there. I don't think this thread is the place to do it because it is not the point of the initial question asked.

Originally posted by @Steve B. B. B.:
Bob,
I don't see what's ambiguous or incorrect about anything Anish and Ali are posting. It seems you are being pedantic and petty, or easily confused, I'm not sure which. And for a guy who brags about doing 40 billion in business and flying first class to Hawaii you seem very uncomfortable with basic math.

@Steve B. I don't see you adding anything with your posts other than to make unsubstantiated attacks. Step up and do the explaining for @Ali Boone & @Anish Tolia I notice you are absent from the 3%-6% appreciation thread. Com'n Stevie, learn us yer math.

Start first how occupancy affects appreciation.

Originally posted by @Ali Boone :
@Bob Bowling

I'm not sure what 'attributed to' me is even referring to or how I have anything to do with that article.

If you want to post a thread to debate the use of cap rates on SFR vs MFR, I'd be happy to give my thoughts there. I don't think this thread is the place to do it because it is not the point of the initial question asked.

The OP asked about this in his third post. He wants to know. I explained and you contradicted me, @Ben Leybovich and @Frank Gallinelli. I think the OP would like your explanation here.

@Ali Boone Are you saying that you are NOT the Ali Boone that wrote about cap rates around March 31, 2013 that had comments from Ben and Frank?

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