how do I calculate an offer price on a rental property
Investor · orlando florida · Member since 2016 · 26 posts · 7 votes
Just wonder how do i caculate a right price to offer on a rental property
Well Joe, mentioning ROI isn't really worth 10 votes, IMO, LOL, especially after mentioning "rules of thumb" like 30% below an ARV as that limits the room to profit.
As Assaf mentioned, what's the goal, why are you buying?
You said it's a rental property, first question is what is the highest and best use for the place? Can't assume the owner used it at its highest functional use.
The CAP rate is an economic aspect of valuation, compared to like properties in that market, and before you buy, the CAP rate will help you reach an expected ROI, but it is the ROI that your price should be based on, not the guess of a CAP rate.
An appraiser will use the CAP rate in the income analysis, what investors generally obtain for similar properties in that market, but they will also look at a more important factor of highest and best use which takes them to the market value approach.
The "Cost or Replacement" approach is also important as it looks to condition, depreciating the property to it's current condition. You need to take in to consideration if the place has a 20 year old HVAC system, if it will need a roof in 3 years!
With a single family residence, the market approach is and should be the most weighted approach to value, who wants a rental property that can't sell in the open market? Unless you're looking at a commercial property, lenders base their loan to value on the market approach, I've never seen a lender base financing on another approach and can't think of a good reason to do that for collateral.
If you only look at an estimated ROI, and that value is higher than market, you'll be paying too much on a house. Most likely you're also in a poor area, declining neighborhood, which carries limitations as to improvements, potential future profits and limitations on rents.
A more important aspect to investing is your cash on cash return, your capital costs and return on cash invested is a better guide.
Before you leap you should have a good idea as to your COC and ROI after taxes will be, that's what you really get.
Now, I've seen investors advertise CAP rates, that's totally useless as a new owner's CAP rate will never be the same as the prior owner's (if the seller even gives the correct rate). Your cost of capital will be different, your vacancy will be different, repairs will be different, your economic and actual costs of management will be different so there is no reason to even look at what a seller claims.
Folks, this isn't complicated stuff to learn, anyone with average intelligence can grasp this and use it in developing a good and justified offer!
Justify your offer, I hate to see these amateur investors blast out low ball offers based on X% of an asking price and hope to snag a deal. Begin by selecting the properties you think will have the best potential for your business and then do some homework. With practice you can get through this valuation fairly quickly, knowing your market very well, you can come to an offer after a walk through inspection! And it is not just a % off the asking price! :)
@Kerwin Montilla I'll start by saying that "right price" is very individual and depends on what you expect from this property; do you want it to generate cashflow? appreciation? a little bit of both? I know investors that would buy a property with negative cashflow just for the tax benefits and potential appreciation.
Now, let's assume you want cashflow and you have a certain cap rate in mind. What you now have to do is to analyze properties in your target area to figure out the expenses, and then work backwards to derive the maximum purchase price.
Work out your desired Return On Investment (ROI), [not cap rate]. Provided that the subject property will meet your ROI once it's rent-ready, your Offer price (plus its rehab cost) should aim for a 30% discount off ARV, so that you're on target to be able to refi to get all your deposit back - for your NEXT one! (Look up "BRRRR": Buy, Rehab, Rent, Refi, Repeat). Cheers...
Work out your desired Return On Investment (ROI), [not cap rate]. Provided that the subject property will meet your ROI once it's rent-ready, your Offer price (plus its rehab cost) should aim for a 30% discount off ARV, so that you're on target to be able to refi to get all your deposit back - for your NEXT one! (Look up "BRRRR": Buy, Rehab, Rent, Refi, Repeat). Cheers...
I want to vote 10 times for this...but one will have to do...especially the "not CAP Rate".
Thank you guys for the information
Well Joe, mentioning ROI isn't really worth 10 votes, IMO, LOL, especially after mentioning "rules of thumb" like 30% below an ARV as that limits the room to profit.
As Assaf mentioned, what's the goal, why are you buying?
You said it's a rental property, first question is what is the highest and best use for the place? Can't assume the owner used it at its highest functional use.
The CAP rate is an economic aspect of valuation, compared to like properties in that market, and before you buy, the CAP rate will help you reach an expected ROI, but it is the ROI that your price should be based on, not the guess of a CAP rate.
An appraiser will use the CAP rate in the income analysis, what investors generally obtain for similar properties in that market, but they will also look at a more important factor of highest and best use which takes them to the market value approach.
The "Cost or Replacement" approach is also important as it looks to condition, depreciating the property to it's current condition. You need to take in to consideration if the place has a 20 year old HVAC system, if it will need a roof in 3 years!
With a single family residence, the market approach is and should be the most weighted approach to value, who wants a rental property that can't sell in the open market? Unless you're looking at a commercial property, lenders base their loan to value on the market approach, I've never seen a lender base financing on another approach and can't think of a good reason to do that for collateral.
If you only look at an estimated ROI, and that value is higher than market, you'll be paying too much on a house. Most likely you're also in a poor area, declining neighborhood, which carries limitations as to improvements, potential future profits and limitations on rents.
A more important aspect to investing is your cash on cash return, your capital costs and return on cash invested is a better guide.
Before you leap you should have a good idea as to your COC and ROI after taxes will be, that's what you really get.
Now, I've seen investors advertise CAP rates, that's totally useless as a new owner's CAP rate will never be the same as the prior owner's (if the seller even gives the correct rate). Your cost of capital will be different, your vacancy will be different, repairs will be different, your economic and actual costs of management will be different so there is no reason to even look at what a seller claims.
Folks, this isn't complicated stuff to learn, anyone with average intelligence can grasp this and use it in developing a good and justified offer!
Justify your offer, I hate to see these amateur investors blast out low ball offers based on X% of an asking price and hope to snag a deal. Begin by selecting the properties you think will have the best potential for your business and then do some homework. With practice you can get through this valuation fairly quickly, knowing your market very well, you can come to an offer after a walk through inspection! And it is not just a % off the asking price! :)
I've done a decent amount of reading about CAP rates and how they really shouldn't even have any attention paid to when you're only dealing with a few units in a building (1 to 3 or 4?). In order to come up with a good offer, I'd take a few things into consideration:
How much you're monthly payment will be (if any) including mortgage, taxes, insurance, expenses, etc.
How much the rent is currently, is there any room for improvement?
From here, you can figure out how much you'd like to receive each month after expenses etc. If you're okay with breaking even, cool. If you require $500/mo, youll have to try and make that work. Another really quick way and complete rule of thumb is the 2% rule. You should aim to have your monthly rent be 2% of the purchase price. If you pay $100,000 for a house, you should get $2,000 in rent each month. It seems that this 2% can be really difficult to get, but that's your goal to shoot for I guess.
I have one at 2.1% but with higher expenses and one I'm developing that will be 1.6% hopefully.
Your question is similar to asking...How do I pick a winning horse at the race track
It is very easy for others to answer your question and give advice but the reality is that until you educate yourself on all aspects of income investment properties snippets of advice are useless to you.
The only answer to your question that will even come close to what you need is ....spend the next 6 month to a year educating yourself on investing and with a little hard work and dedication you will learn the answer. Fully educating your self on every aspect of real estate investing is the only answer of any value to your question.
@Bill Gulley, the main reason I mentioned the 30% below an ARV "rule of thumb" wasn't that anything less "limits the room to profit", but rather, limits your ability to "get all your deposit back" when you refinance! If you want your BRRRR machine to be perpetual - try for 30% off ARV!
@Brent
@Brent Coombsundefined
BRRRR is not perpetual or infinite as portrayed on BP, as the number of properties held go up, lenders begin to reduce the LTV to be met on additional properties, then you hit the lending wall if conventional financing was used and commercial loans will also come to an end due to loan concentrations, effecting 3 areas, to one borrower, to the type of loan and to additional reserves required on loans held. This is reality and investors should be aware that when some system sounds to be good to be true, it is as a rule.
It's easier to translate costs and profits to a %, I may need 30% to break even, 200K -30% = 140K - 5 in closing costs and 30 in rehab cost I need to buy at 105K or less.
Taking 30% of 200 off the top is 160, -35 as well, you're still buying at 105K, you're right.
But what happens when the appraisal doesn't come in at 200K? An investor's guess of value is rarely the same as the appraisal.
Buy at 105K, have 35 in costs, I need 140K to break even, say my appraisal comes in at 192,500, at 70% I'm at 134,750 or at 75%, I get 144, 375, either way I'm short.
This is another big assumption of BRRR, that your appraisal will be at the expected ARV or more.
You can work from the top down or bottom up, same animal, but assuming you work off an ARV will be a gamble. That can limit profits.
So how do you cure that?
Put it under contract, subject to your financing requirements. Then have plans and specs, take it to your lender, appraise off the plans and specs, all you will need for the loan is a final walk through by the appraiser and you close the loan after seasoning the transaction.
Now, the OP didn't ask about BRRR, but how to value for an offer, the BRRR can leave you out in the cold, I also assumed above there is no fixing, just buying a ready to rent place and that would be as outlined. You can find many threads on the BRRR concept blowing up in financing when it's too late, the method I just ran over reduces those blow ups, try it that way and don't try to work off your ARV so much :)
@Bill Gulley, you wrote: "Buy at 105K, have 35 in costs, I need 140K to break even, say my appraisal comes in at 192,500, at 70% I'm at 134,750 or at 75%, I get 144, 375".
Did you think I wouldn't notice you're wrong to conclude: "either way I'm short"?
ie. If I do have a "75% of appraisal" Lender, I CAN refi all of my own money back! Cheers!
[But of course, you do make some good points around: matching expectations with reality]...
@Bill Gulley, you wrote: "Buy at 105K, have 35 in costs, I need 140K to break even, say my appraisal comes in at 192,500, at 70% I'm at 134,750 or at 75%, I get 144, 375".
Did you think I wouldn't notice you're wrong to conclude: "either way I'm short"?
ie. If I do have a "75% of appraisal" Lender, I CAN refi all of my own money back! Cheers!
[But of course, you do make some good points around: matching expectations with reality]...
Brent, I did that as I typed, LOL, I didn't notice it, Thanks, that was my point even if the arrow wasn't straioght, LOL. My suggestion above avoids the risk. Good luck :)