FL Condo Deal, Would You Take it?

25 Replies

I have a verbal contract for a 2 br 1 bath condo. This is my first investment property purchase so I am analyzing the heck out of it and looking for advice from the experienced community.

Purchase Price: 65,500

Income: currently at $750 lease through Oct. Rentometer and research suggests that this is low. I can get 800-850 for this unit.

Expenses: Taxes:850; Assoc Fee: 840/yr; self managed.

Repairs: The property looks good, but I have yet to do an inspection. It looks to have had tile floors and paint and appliances not too long ago. I am assuming only regular maintenance costs 5-10%/year.

Financing: The seller is offering financing. I am looking at a 25% down, 6% interest, 40 year amortizing loan for a payment of $270/mo.


Thanks in advance for your input.

Nate

With 25% down you would be better off using conventional financing. There is a mcc lower interest rate associated!

I also would stay away from using only rent I meter. This calculator doesn't work for any of my houses or my parents. Are properties are located over 3 different states?

I am also weary of rentometer, but this condo is in a dense rental area so the rental comps are numerous. I feel comfortable about 800+/mo.

I also considered conventional financing, but the numbers are so close that I'd rather not deal with a bank. What are interest rates for investment properties now 5.5%?

Personally I'm not a fan of condos because you don't have control of some of the maintenance costs like you do with a single family home. With a SFR home you can choose which landscaper to hire or if to hire one at all while the property manager at a Condo or HOA hires their drunk brother-in-law who does a terrible job and charges way to much (I'm joking but I have seen HOA boards make really bad financial decisions on behalf of everyone).

It also seems like the dues are constantly rising. I don't know how many short sale sellers I talked to who told me how much the dues went up in X amount of years. You also have to worry about special assessments, an unexpected expense to the complex that everyone must pay for (i.e. elevator breaks, roof top pool leaks, building needs painting, lawsuit, etc.).

The associations can also change the bylaws and rules limiting the amount of units that can be rentals (this happened to me in a residential subdivision with an HOA) or require owners to live in properties for at least a year before renting them out, even if the tenant already lives there and an investor buys it.

They also have the power to nitpick you about little maintenance items. I'm constantly getting letters, "trim the bushes, power wash the driveway or roof, your grass died." I've found a lot of the people serving on the boards are retired and have nothing better to do than nitpick your property. I prefer homes that aren't in deed restricted communities and try to avoid any kind of community association. They have an incredible amount of power under Florida statute and can even garnish rent from your tenants and evict them. I got into a dispute with a HOA when they tried to charge me $5K for "Fines" for the sins of the previous property owner. It was extortion and I refused to pay them and they served my tenant trying to collect the rent, my tenant ended up moving because I threatened to evict them if they paid them and not me, it was bad.

If you do condos or single-family homes don't forget to put away reserves for items like air conditioners, hot water heaters and appliances. Take the average life of each and divide by the cost and you should be subtracting that from your net income every month (i.e. roof cost / useful life = reserves for roof, $7000 / 20 yrs = $350/yr for roof reserves).

Also, in evaluating a deal you should account for property management even if you are doing it yourself. Your time has value and if you ever went to sell to another investor they would evaluate it assuming they would be paying property management. 10% of gross rent and 1/2 months leasing commission is the norm where I am.

@Josh D.

Thank you for the detailed advice! I get that I might not be conservative enough with the unknowns. I'm interested in your take on including management fees in the calculation of metrics. I'm looking for at least 10% cash on cash, but this is not accounting for my management time. Am I selling myself short?

To me this is an ok to not-so-great deal only. Around 11% cash on cash without management, less with. What returns do you guys look for in Tampa?

Thanks!

Nate

10% cap rate (net income / purchase price) is good, cash-on-cash measures your return on your cash or money you put down in the property so if you're using leverage (@ say 6%) a 10% cap rate would have a higher than 10% cash-on-cash return because you're only putting down 25%. IMO 10% cap is good for a property in a blue collar to middle income neighborhood but make sure its a true 10%, taking into account reserves, maintenance, vacancy and management. I would agree with you that its a so-so deal, the fact its a condo woudl make me not want to do it.

Now that I have been thinking about it, It makes a lot of sense to include management expenses in the cap rate calc. I am willing to manage for better returns, but the underlying deal has to be able to support its self.

Here you see the cap rate at 7.5%, a little low it seems. If anybody has any input on the expenses, let me know. With 10% for management, 5% for maintenance, another 5% for reserves, HOA fees etc. The expense ratio comes to 60%!

Nathan. There is no such thing as a "good" cap rate. Also cap rates are not appropriate for small residential properties because where would you get reliable cap rate comps? Cap rates are only to see what the market is doing. It does not predict profitability.

@Bob Bowling Yes, correct. Cap rate is set by the market, not calculated. Thank you for the correction.

I'm calculating NOI/purchase price. Similar to cap rate, but I'm not sure what this would be called. It seems like a useful metric nonetheless for comparing deals before any financing is considered.

Originally posted by @Nathan E. :

@Bob Bowling Yes, correct. Cap rate is set by the market, not calculated. Thank you for the correction.

I'm calculating NOI/purchase price. Similar to cap rate, but I'm not sure what this would be called. It seems like a useful metric nonetheless for comparing deals before any financing is considered.

 You could call it a cap rate.  Maybe this will help. 

http://www.propex.com/C_g_capvs.yld.htm

@Bob Bowling

Not sure what you mean by there isn't a "good" cap rate. I guess you're assuming the real estate market is perfectly efficient and if you receive a higher cap rate you are taking additional risk. If that were the case there wouldn't be such a thing as a "good deal." Cap rate is NOI / Purchase Price and you can back into it either way. If the going sales cap rate for a NNN Starbucks is 6%, a developer can sell their Starbucks for NOI / 6%. If a doctor is looking for a NNN investment his cap rate will be his NOI / Purchase Price. If this works for commercial real estate why does it not apply to residential? Whats the difference? You're probably making a complicated assumption about the credit risk of the tenant. I'm just looking for the unleveraged return on my investment. He's not trying to appraise a property he's looking for a metric to measure his investment and everyone I know uses cap rate. Thanks

Originally posted by @Josh D. :

@Bob Bowling

      I'm just looking for the unleveraged return on my investment. He's not trying to appraise a property he's looking for a metric to measure his investment and everyone I know uses cap rate. Thanks

And when you divide your NOI by your purchase price and get a "return", how do you conclude that you have a "good" cap rate of a "good" deal? You have to know what the MARKET CAP RATE RANGE is for your particular property type, market, and timeframe. THEN, you can determine if you are buying AT market, ABOVE market, or BELOW market. You could possibly say below market was a "good" cap rate but you'd want to compare each component of your NOI against each component of your cap rate comps to determine if your below market cap rate purchase was a "deal".

The reason you can't use a cap rate on small residential properties is that THERE ARE NO RELIABLE CAP RATE COMPS!! Anybody that you know that uses cap rates on small residential properties to "measure his investment" is ignorant. Thanks.

@Josh D.  

ANYONE that is using a cap rate on ANY property type to measure profitability is ignorant.  It is ONLY used to compare to what the market is doing for that property type at that particular time in that particular market.

The new format is not giving me time to edit.  Above I meant that most would consider a higher number as a better or good cap rate but it actually means nothing without being compared to the actual market cap rate and yes if you the market cap is 6% and you can buy at 8% and there is comparability with the market/property and time then sure that is a better "deal".

@Bob Bowling said:
And when you divide your NOI by your purchase price and get a "return", how do you conclude that you have a "good" cap rate of a "good" deal?

Well, its actually quite simple Bob. I evaluate the relative quality of a neighborhood, its potential to appreciate and then decide if the CAP RATE or YIELD is good enough for me. Which depending on the neighborhood is typically around 10%.

You have to know what the MARKET CAP RATE RANGE is for your particular property type, market, and timeframe. THEN, you can determine if you are buying AT market, ABOVE market, or BELOW market. You could possibly say below market was a "good" cap rate but you'd want to compare each component of your NOI against each component of your cap rate comps to determine if your below market cap rate purchase was a "deal".

All I have to know is if the house is block, what will my approximate total cost after I repair it, what is my approximate rent and after using conservative assumptions if the return is attractive enough for the area (I like working class neighborhoods) its a go.

The reason you can't use a cap rate on small residential properties is that THERE ARE NO RELIABLE CAP RATE COMPS!! Anybody that you know that uses cap rates on small residential properties to "measure his investment" is ignorant. Thanks.

I don't typically pull comps on rental properties. I don't have to, I know my market. I'm not an appraiser, I buy houses to buy and hold. Anyone who thinks they can nail down any type of investing, real estate or otherwise to exact an science is truly ignorant. I prefer to be conservative and estimate a range of possibilties and if the lower end looks good, I do it. Thanks

Originally posted by @Josh D. :

  

Well, its actually quite simple Bob. I evaluate the relative quality of a neighborhood, its potential to appreciate and then decide if the CAP RATE or YIELD is good enough for me. Which depending on the neighborhood is typically around 10%.

   

Maybe good enough for you but if you don't know what the market is doing you don't know how you are doing.  Did you even read the link I provided?  What you are doing is just picking some arbitrary number and measuring your "deals" against your made up number.  Hey, if it works for you fine but IT IS NOT how a cap rate is used professionally and it is ridiculous to tell an investor that "10%" is the universal "good". 

Originally posted by @Bob Bowling:
Originally posted by @Josh D.:

Well, its actually quite simple Bob. I evaluate the relative quality of a neighborhood, its potential to appreciate and then decide if the CAP RATE or YIELD is good enough for me. Which depending on the neighborhood is typically around 10%.

Maybe good enough for you but if you don't know what the market is doing you don't know how you are doing. Did you even read the link I provided? What you are doing is just picking some arbitrary number and measuring your "deals" against your made up number. Hey, if it works for you fine but IT IS NOT how a cap rate is used professionally and it is ridiculous to tell an investor that "10%" is the universal "good".

I know what the market is doing because I'm constantly looking for houses. I know what my investment alternatives are and I know what my cost of capital is. So what else do I need to know? What the exact cap rate is for a Walgreen's that just sold down the street? I know its a lot lower than 10% and frankly I don't care because that's not what I do. I don't measure my investments by what others are getting so I can feel good about myself, if I think its good I'll do it, if not I'll wait for other opportunities.

I didn't say 10% is the universal good, for quality SFR its good for me and in today's RE investment market in Florida it is good which is what the OP was asking about. How do I know? Because I'm looking for deals all the time and I know the market here. Garbage C- apartments are trading between 8-9 caps. Trailer parks are selling at 7 caps. So 10% on quality SFR works for me. I'm sure you have better deals in Hawaii and California but geographically that doesn't work for me or the OP.

Originally posted by @Josh D. :
 

I didn't say 10% is the universal good, for quality SFR its good for me and in today's RE investment market in Florida it is good which is what the OP was asking about. How do I know? Because I'm looking for deals all the time and I know the market here. Garbage C- apartments are trading between 8-9 caps. Trailer parks are selling at 7 caps. So 10% on quality SFR works for me. I'm sure you have better deals in Hawaii and California but geographically that doesn't work for me or the OP.

But you wouldn't know that "

Garbage C- apartments are trading between 8-9 caps. Trailer parks are selling at 7 caps." UNLESS you had ACTUAL cap rate comps! BUT for SFR's you don't have reliable comps. You are just using some made up "cap rate" based ONLY on the properties you are looking at. Why not just use a GRM? That is an acceptable and professional way to compare properties.

@Nathan E.  

Here's some more reading about cap rates for commercial property. 

http://incomepropertyanalytics.com/direct-capitalization-vs-yield-capitalization/

You do not want to start your investing career with wrong information.  If you have someone giving you cap rates for SFR's they are either trying to sell you something or are posers.

@Nathan Earle

I would advise you to go to a local REIC meeting and talk to people in your local market who are actually doing deals and know what is going on in the market there.

I don't know the Orlando market but would be happy to answer any other questions you have if you want to PM me.

"It is better to be approximately right than precisely wrong." -Warren Buffett

@Josh D. The local REIA, here in Orlando has been great, an invaluable resource. And thank you for the offer to answer questions. I may take you up on it!

@Bob Bowling Great article. To quote the conclusion:

"Direct Capitalization is convenient, but then so is the microwave. Take some advice and use it as a way to measure how expensive a property is in relation to similar properties currently, not whether it’s a good long term investment. For this, we look to Yield Capitalization."

I do however question with your suggestion to use GRM over cap rate, since it doesn't take into account expenses. I think that most investors want to look at as many metrics as possible, GRM, Cap Rate, and IRR to name a few, to really understand the nature of the deal. As long as you understand what the numbers mean, dont put garbage into your calcs, and understand the market in which you are operating, life is good.

Just to close the loop, I did not end up investing in this property. I dont believe it would have been a terrible decision, but I saw a few risks, namely in the property condition, rent increase, and HOA.

Best Regards,

Nate

Originally posted by @Nathan E. :

@Josh D. The local REIA, here in Orlando has been great, an invaluable resource. And thank you for the offer to answer questions. I may take you up on it!

@Bob Bowling Great article. To quote the conclusion:

"Direct Capitalization is convenient, but then so is the microwave. Take some advice and use it as a way to measure how expensive a property is in relation to similar properties currently, not whether it’s a good long term investment. For this, we look to Yield Capitalization."

I do however question with your suggestion to use GRM over cap rate, since it doesn't take into account expenses.

@Nathan Earle GRM vs, CAP RATE.... Go ask 10 neighbors what cap rate they bought their house at,.....I'll wait, I have a cocktail. .... Good, you're back. Now I'm sure all ten neighbors gave you a weird look. They bought based on sales comps! Now go ask 10 investors of SFR's. Refreshing my drink....... OK, one person gave you a "crap rate". Go ask 90 more investors. So maybe you actually now have ten "investors" out of one hundred that "use" a cap rate to buy SFR's. Now ask how they derived it and what cap rate comps they used to make their purchase decision. I'll bet you have ten different computations and not one can come up with a cap rate comp. THAT"S why you don't use cap rates to determine what the market is doing with SFR's.

Now to use a GRM all you need are sales prices and rents for COMPARABLE properties just like you would do with cap rates IF there was a reliable source of market cap rates. So you go to a target neighborhood and say rents for a 3/2 are about $1,500 a month and they are selling for about $200,000. That's a GRM of 11.11. There will be a range that should be pretty tight. so if you have a comparable property that has rents of $1450 you'd be comfortable paying $193,000 less any conditions that were not typical. How easy is that to use an income approach that doesn't rely on made up calculations by investors that don't know what they are doing. Now you could even take this to another neighborhood of similar properties and say "hey, If the market is paying 11.11 times the gross rents in a good neighborhood why would I pay more in a neighborhood that I think is inferior?" even if you don't have sales comps in that neighborhood. See what a great tool GRM is?

Originally posted by @Josh D. :

Yeah I'd probably use cap rate.

GRM doesn't account for expenses which can vary because of taxes, Insurance, property age, landlord paid utilities, vacancy rates, etc. This is a good explanation of the two.

http://en.m.wikipedia.org/wiki/Gross_Rent_Multiplier

So @Josh D What are you using cap rate for and where are you getting reliable cap rate comps? 

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