What metrics are typically stuck to when determining a "good deal" for buy and hold?

Question

Hey Everyone,

New to BP and I'm excited to get started.

I'm reading through the Beginners Guide right now and am curious to know the thought process behind determining a "good deal" within a buy and hold strategy? For example, within my area do I want to be in the ball park of the comps for dollar per square foot? Is there a general table to stick to when considering the cash flow? Total repair work needed? Asking price? ROI?

I guess I'm confused on whether or not it becomes a gut feeling or if there are facts to stick to.

Thanks for the advice in advance and if I need to clarify my question further please let me know!

Lumi Ispas · Answer

Hi Kyle,

Everyone has different guidelines for what a good deal is.

Usually, if you can buy a property at a discount including the repairs and the cash flow makes you happy, you can call that a good deal.  Most people are looking for a minimum of a 10% discount. If let's say a home is worth 100K, and you can buy it for 80K, and make repairs valued at 10K, you own the home for 90K. That's a 10% discount from market price.

If the home can be rented for $1200 per month and property tax and insurance are $200/month, than your cash flow is $1000. ( I am assuming there is no mortgage and the tenant pays all the utilities for the sake of the example).

In this case, over 12 months, your cash flow is 12 months x $1000 = $12,000.

In this case, your cash flow is 13.3%, and the way you calculate it is $12,000/ $90,000. This is in case you purchased it all cash.

If let's say you got a mortgage on this property and all the cash you used was 25% on the $80,000 purchase price and then you made the $10,000 repairs with cash, you have only $30,000 in the deal.

Let's further assume you got a 6% principle and interest, fix loan, your mortgage payment will be $360 per month.  Now your cash flow is reduced by this amount:

$1000 -$360=$640.

$640 x 12 months =$7680 - Your cash flow for the year.

Going back and looking at the fact that you invested only $30,000 cash, we will calculate the cap rate using only the cash involved:

$7680 divided by $30,000= 25%

You can see now that using cash only versus a high interest mortgage for this market is significantly increasing your cap rate. 25% vs 13.3%.

Using the same scenario, you can use buy 3 homes with the same $90,000 and have a total cash flow of $7680 x 3 = $23,040 versus using all the cash in one home and getting $12,000 per year cash flow.

There are other factors to consider of course... This is just simple math.

Good luck and let me know if you have other questions.

Lumi

Bill Jacobsen · Answer

Your total return will be the net operating income divided by the value of the property + the appreciation rate.  On average, I would only count on 2-3% per year.  Thus, if you are looking for a total return of 10% then your cap rate(noi/value) must be 7-8%.

I try to determine value by looking at comps or by what is called the income method.  Comps are simply what other houses(similar configuration, age, square footage, geographical area) have sold for.  The income method involves valuing properties by looking at the average cap rate in your area.

I don't specifically look at cash flow.  How much cash flow you get is more a function of your financing.  If my cost of money is 5% then I want a cap rate of 8%.  I want 3 percentage points above my cost of money.  My cash flow will take care of itself.

Most houses need some repair.  If they don't, you won't get them at a bargain.  I have bought houses where the repairs were twice the cost of the house.  I guess I don't have a limit but I don't want to have a home built from scratch.  The more repairs you think are needed the greater the probability you will find something during the process that you didn't know before.  It will not be positive.

My offering price will be based on my assessment of the numbers.  It will not be based on the owners asking price.  If my gut feeling is that we are too far apart I will not make an offer.

I have probably gone on long enough and may not be even answering your questions.  Also, this is how I do it.  Don't assume that anyone else does it my way.  There may be my way and the right way.

Good Luck.

Bill