Good investment?

14 Replies

I thinking about diving into a multi family rental with the profit I make from my first flip. Any thoughts on this deal it just came on the market?

http://www.realtor.com/realestateandhomes-detail/3484-N-100-E_Warsaw_IN_46582_M45619-06327?row=3

Estimated NOI (net Operating income) based on the 50% rule and the gross income says this is a lousy deal. The price is too high for the amount of the cash flow.

Of course this is a quick screening of the deal and there are many factors to consider. What is the condition? Are the rents below market? Is there an opportunity to reduce operating costs? Is this a hot market where rents and values are appreciating?

Originally posted by @Ned Carey :

Estimated NOI (net Operating income) based on the 50% rule and the gross income says this is a lousy deal. The price is too high for the amount of the cash flow.

Ned, can you elaborate your calculation for a newbie like me? 

I did my own calculation just for fun, and I was getting about $200 per month cash flow for 4 units assuming rent is $650 per unit with 30 months mortgage and 5% downpayment. Is this close to the number you were getting?

@Roy C.  

The 50% rule assumes your expenses (not including financing costs) will average about 50% of the income.  This means you have 50% of the rent to cover financing cost and what is left over is your net positive cash flow. 

Most new investors don't have a clue that expenses will run that much. Now a given property may do much better but over a portfolio of homes over time 50% is a pretty good estimation. There is a lot written about the 50% rule here on the site.  A search will bring up plenty of threads on the subject.

When I mentioned NOI, calculating that is the first step in figuring Cap Rate which is another way to value properties. That is a much longer and more complicated answer. I don't have time to go into that now but trust me, it has been well covered on the site. You might also search for "APOD" which is a form to calculate income and expenses.

Ned

@Ned Carey  O the result I was getting is after 50% rule, taxes, and other expenses. (I made a spreadsheet based on some of the example spreadsheet that was on the site) The reason why I am asking is I want to see what's your def lousy deal and compare with mine, because I am still learning how to distinguish good deal from bad one. Thanks Ned!

Roy,

I calculated a 6.15% Cap rate. I just don't want to buy at that low a rate. I don't have to I can do better.

I figured $15,990 NOI. At that number and today's low interest rates it might actually cash flow very nicely. Perhaps a lot better than your $200 a month.

The problem is you left out a lot of variables. You said 30 month mortgage. Did you mean 30 years? Where are you going to get a 95% mortgage? I can't get that. I am going to hold it in a LLC which in my market, for me, means I can't get it financed at all without a private lender. What interest rate are you figuring?

If you can get it under the terms you think you can, it could actually be a very good deal. Pending other due diligence, If I could get this with %5 down and a 5% rate I would jump on it. I know I can't get that.

@Ned Carey  Ah I see your point. Yup I meant 30 years, sorry I wasn't thinking when I was typing. I def see your point after looking at interest rate for mortgage. I was looking from a new buyer perspective. I assumed this b/c I figured it's Casey's 2nd or 3rd investment judging from his story, but in your situation with a high interest rate, I can def see it's not a good deal. Thank you very much for your detail explanation. I was just trying to get my math straight, and this was a valuable practice lesson. Thanks again!

Originally posted by @Ned Carey :

Roy,

I calculated a 6.15% Cap rate. I just don't want to buy at that low a rate. I don't have to I can do better.

 But @Ned Carey, the lower the cap rate the less risk AND more profit is perceived by the market.  You can buy a riskier and less profitable property at a higher cap rate but why would you?  Does your 50% only include operating expenses like you would use to calculate a cap rate?

Originally posted by @Bob Bowling:
You can buy a riskier and less profitable property at a higher cap rate but why would you?

Are you saying that every property with a higher cap rate is riskier and less profitable?

@Bob Bowling  You are once again making assumptions that I believe lead to mediocre investment results. 

1) that everything sells at the market price

2) that the  market knows how to accurately value an investment. 

The fact that the market goes through cycles is clear proof that the market is constantly under or  over valuing investments.

Fact: on any given property,  a higher cap rate (ie a lower price) reduces the risk and increases the profit. 

 

Wow even J. Scott chimed in! I just listened to your podcast. Thanks to everyone that's commented. So now that I've googled "cap rate" what kind of cap rate do you shoot for? For a bad, good or great deal? I'm sure this is market dependent but I am curious just to know what to shoot for? Thanks again!

Originally posted by @Ned Carey :

Roy,

I calculated a 6.15% Cap rate. I just don't want to buy at that low a rate. I don't have to I can do better.

I figured $15,990 NOI. At that number and today's low interest rates it might actually cash flow very nicely. Perhaps a lot better than your $200 a month.

The problem is you left out a lot of variables. You said 30 month mortgage. Did you mean 30 years? Where are you going to get a 95% mortgage? I can't get that. I am going to hold it in a LLC which in my market, for me, means I can't get it financed at all without a private lender. What interest rate are you figuring?

If you can get it under the terms you think you can, it could actually be a very good deal. Pending other due diligence, If I could get this with %5 down and a 5% rate I would jump on it. I know I can't get that.

 So if I could get that financing this would work well? (I only have one mortgage, good income and credit so I would speculate that I can?) also I realize I left out taxes they are 190/month

Originally posted by @Casey Young :

Wow even J. Scott chimed in! I just listened to your podcast. Thanks to everyone that's commented. So now that I've googled "cap rate" what kind of cap rate do you shoot for? For a bad, good or great deal? I'm sure this is market dependent but I am curious just to know what to shoot for? Thanks again!

 As @Bob Bowling points out Cap rate is in part affected by the perceived risk of a deal. People with lousy properties have to offer them at low prices which equates to a higher cap rate. They need to offer the higher cap rate, to attract buyers. Excellent properties attract lots of buyers and can be sold at high prices ie. low cap rates. 

So what is a good cap rate? That depends on your risk tolerance and your goals. Also is the property operating at it's optimum or is there opportunity to increase income and /or decrease expenses. Is the property in an area where there is high probability of increasing rental rates?

So cap rate is a combination of the right type of property for you needs, premium A class vs a D class property, for example. This will set a range of cap rates for the type of properties you want. Then the question becomes what is a "Good" cap rate for the specific property you are looking at, given it's risks and potential rewards?

Originally posted by @Casey Young :

 So if I could get that financing this would work well? (I only have one mortgage, good income and credit so I would speculate that I can?) also I realize I left out taxes they are 190/month

 Casey,

Based on a crude pro-forma it appears to. However you need to do appropriate due diligence to determine the actual numbers. You can't assume the numbers they give you are accurate. Keep in mind much of the due diligence can be done after being put under contract with appropriate out clauses.

If you buy the property in your own name financing will be much easier. As soon as you choose to put the property in an LLC or other entity all the financing rules change. Good luck - Ned

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