SFH Deal Analysis

19 Replies

Hi all, was wondering if anyone can chime in on some thoughts I have on a nicely rehabbed turnkey opportunity I am considering.

Great suburb neighborhood, strong rental demand, low crime.

Purchase Price: $90k (recent comps put it's value around $105k)
Monthly Rent: $1200/mo
2012 Property Taxes: $2848 (very high, cleveland OH area)
Rental Registration with City: $150/year
Insurance: $700/year
Maintenance, PM, and Vacancy = 10% Each
Debt Service with 20% down($18k) = $72k @ 4% = $344/mo

I'm getting:
NOI ($544) - Debt Service ($344) = $200 cash flow
With these pretty conservative and realistic expenses the cap rate is 7.25%

Falls short of the 2% rule
1200/90,000 = 1.3333%

50% rule
1200 / 2 = $600 - $344 = $256

What do you think?
I've heard people say that cap rates under 9% never cash flow. But it SEEMS like this does? Am I missing something?

Any advice and wisdom would be appreciated. Thanks in advance

Updated almost 6 years ago

Income left over after expenses = $544 NOI = $544 x 12 = $6528 CAP = $6528/$90,000 = 7.25% Is that correct?

Hi @Mehran K. ,

Correction on your calculation. The Capitalization Rate should not be calculated using your debt service. The formula is:

Capitalization Rate = Net Operating Income / Value (or Price)

This will increase your cap rate - which is in line with many Cleveland property.

Also, don't get hung up on this "2% rule". It is a very general guideline and is not always correct. In fact, if you look back a few years there were "gurus" preaching a 1% rule. Stick to your pro-forma as it will be the best guide.

Good luck!

Did you check the auditor's valuation? If it's more than $90k, you should challenge the valuation and get it reduced to your purchase price. There's a tax calculator on the Cuyahoga Auditor's website if you want to check it out--lower taxes makes a huge difference in the deal. You can unfortunately only apply for a revaluation between 1/1 and 3/31 of every year (state law). If you're in one of those notoriously vicious boroughs, the school board might challenge your case.

It's my feeling that a 7.25% cap rate (calculated at $544x12 NOI / $90k purchase) is far too low for a SFH in this area, especially given an approximately zero percent chance of property appreciation. Commercial cap rates for multi-unit buildings are a solid 10%, so one ought to expect a premium for SFH rentals.

@Marco Santarelli I didn't include the debt service in my cap rate calculation. I just organized my post a little awkard! Thanks for the info on the 2% rule.

Chris C. How do you mean by check the valuation? The only thing I did was pull up the bill on the City web site for the last bill on 2012. If they re-evaluate it. I read there is some balancing law in effect with property taxes in OH that prevents them from fluctuating. It reads:

"The HB 920 reduction factor, mandated by Ohio law, is designed to keep tax revenues stable when property values increase or decrease. The factor that prevented your taxes from dramatically increasing when property values were on the rise will now keep your taxes from significantly decreasing despite declining property values. This reduction factor will keep the revenue to our schools, cities, libraries, etc. at nearly the same level as originally approved by the voters. A portion of your tax rate is not affected by the tax reduction factor and will result in a slight decrease in your tax bill."

Also, regarding the 7.25% cap rate, this is with all the expenses included. Most other "deal information sheets" I've seen on properties leave out a lot of stuff, making the cap rates appear higher. I don't know the area too well though.

Do areas like cleveland and university heights also experience 0% chance for appreciation? It seems like they would?

I was under the impression that cap rate was a tool better suited for multi unit properties. Would like to hear some feed back on this.

For SFH's I go with the 1% rule to start, if you can get 1% of the purchase price in rent then definitely look into the deal further.

For me now, my bottom line is will it meet my personal cash flow objectives after PITI, property management, vacancy\maint reserves.

I know this sounds redundant and kind of basic "duh!" information, but I have two rentals now that both cash flow a little, I've decided to find better deals. On a SFH I want a free and clear cash flow of at least $150-$200, but this is a personal objective, some say if you cash flow $50 bucks do it.

To me if you know what costs to count, and you are honest about those costs and if it cash flows what you want after those costs are calculated then do it.

Personally there's a lot of formulas and percentages and analysis that can paralyze you as a beginner, some times you just have to jump in and start learning. Some times I thing numbers, formulas and percentages can and will always talk you out of your first investment...Had I done all this with my first rental, then I probably wouldn't have it, which means I probably wouldn't have my second one...etc. Each property has taught me something, which I then incorporate into my thinking process. I wouldn't have the experience I do now had I not just done it on my first property. To me that's worth more than any cash flow.

I agree with not getting hung up on the 2% rule. It's nice if you find one, but I find that most homes that gives you 2% are much older and in less desirable areas.

I also have doubts on the 50% rule as well, especially if you do the work yourself like I do for most of my repairs.

As for Cap rate, I have it in my calculations, but I pay more attention to Cash on Cash Return, which is

Cash-on-Cash Return = Annual before-tax cashflow / total cash invested

CoCr = 10.58%

Although I feel this property does have potential appreciation to be factored in as well.

So as far as the deal itself. What do you guys think? Would you bite?

I very much appreciate everyone weighing in by the way!

@Mehran K. -

You say the property is in the Cleveland, Ohio area. Have you invested there before? How is the economy in the area and not just Cleveland but the surrounding area as well. Are you planning on holding this property for longer than 5-7 years? What is the areas economic forecast going forward and beyond that time period?

I can tell you from looking at the numbers that the property looks fine, but that is all we are looking at. I am a long-term buy & hold investor and I buy in 4 cities today so I don't mind buying away from home. It does not appear that you mind buying away from home either. So, my answer is, if you have done your homework on the area and you are very comfortable with your partners in the Cleveland area who will be assisting you with the operation of your property, then go for it. If you do not have a good feel for the questions above, do a little more due diligence on the area and team. For me, the property itself is always the last thing I look at in an area before I buy. I like to answer other economic and team oriented questions first.

@Mehran K. : You want to start with the Cuyahoga County Fiscal Officer's search to find the market valuation. Start here: http://fiscalofficer.cuyahogacounty.us/AuditorApps/real-property/REPI/default.asp

Go to "address," type in your address (no direction unless you're on a numbered street like East 185th) and go to the "Taxes" tab. Under "Market Valuation" you will find your number. If it's higher than your purchase price, you can challenge the valuation notwithstanding HB 920 at the Board of Revision: http://fiscalofficer.cuyahogacounty.us/AuditorApps/real-property/REPI/default.asp . HB 920 only really affects the triennial revaluation that the auditor has to perform on everyone's property, and the BOR challenge is the way around it.

My feelings on University: it's a solid city, and will always have a strong rental market from John Carroll University (about 4000 students). There are no bad parts. However, many of its residents are seriously underwater due to the bubble. Other suburbs within a couple miles have rebounded from their bottoms and are now competing for the same types of buyer.

As to appreciation: Appreciation is above all driven by population growth. New suburban sprawl pushing into the exurbs actually steals residents from the inner-ring suburbs since the Cleve-area metropolitan population growth is flat. In no case am I banking on appreciation ahead of inflation unless it's a $5,000 house in a gentrifying ghetto neighborhood.

Forgot to mention: University Heights has a point-of-sale inspection requirement and escrow requirements for violation repairs. The city inspector gives you a list of violations and you have to obtain a contractor estimate for the repairs before depositing that amount as escrow. If it's $90k, it had better be offered violation-free. If they haven't passed the POS inspection yet, be aware it could take months to remedy.

@P.J. Hankins Thanks for the input. And so far I agree. The problem is since it's my first deal, I am not precise on how much cash flow I require yet lol. I also have to worry about opportunity cost. As this deal might seem alright, there could always be a better deal that I just haven't researched yet!.

@Chris Clothier Thank you very much for your well seasoned perspective. I do feel comfortable about what I have researched about Clevelands future. I am unsure how to actually research the individual forecast future of micromarkets (suburbs). I do plan on holding the property longer than 5 years as long as the rental demand stays strong and it cash flows like I hope.

Chris C. Guaranteed PoS violation free. And thanks for your outlook on the appreciation and population direction in the area. Only a local could provide this!

Hi Mehran, good analysis.

I wouldn't focus on the 2% rule either because those are extremely hard to find, therefore focusing only on those would hinder how many you can buy. I do feel confident about the 1% rule and this property hits it. I don't use the 50% rule myself so can't comment there. I've usually fairly against % rules. Even the 1% rule, I use that as basis for thought but never a definer.

This property is cash flowing, but only $200/month. I know of plenty more properties that cash flow for substantially higher than that even after debt service. $200/month would be something I'd consider for a really strong higher price-to-rent ratio market, but not for Cleveland. If I was investing there I better be getting a lot more than that. Parts of Cleveland are good, others not. I'm not an expert out there, but that's what I hear. I keep hearing Cleveland in my head as being the next Detroit, at which point I wouldn't invest personally. But I could be wrong on that one.

$200/month isn't enough for me unless it's a better market, personally.

As I look at the numbers provided I really do not think this is an overall great deal. The surrounding cities especially in that area are less desirable then it may appear. Have you considered looking in other cities in the Cleveland area. For instance, if you go 20 miles east of downtown Cleveland in Lake County you could see better numbers and appreciation. Cities like Eastlake, Willowick, Mentor, Mentor on the Lake and Willoughby are great cities to buy in for two reasons: Great Great Schools and manageable homes (1200-1500 square feet) I currently work with an investor on buy and holds. In the past 4 months we have bought and held four homes bought and rehabbed between 50,000-80,000 each renting for above $1100 in addition taxes are lower and the homes are appreciating. I do not think that deal is as desirable as the numbers say. I have a rental in Cleveland Heights (the next city over) and bought and rehabbed for 32000 that currently rents for 800.00. You might be better off doing a couple of those if that is the area you desire.

i come up with a 12.6% cash-on-cash return. but keep in mind, you don't include your closing costs & holding costs. these are minimal but increase your initial cost.

12.6% is better than the stock market but you could do better, however, you're 2500 miles away. gonna be difficult to manage a rehab from that far away. it can be done though with the right person.

Originally posted by @Ali Boone :
I keep hearing Cleveland in my head as being the next Detroit, at which point I wouldn't invest personally. But I could be wrong on that one.

Ali Boone, most of the time, the best opportunity is found where the masses fear to tread. Detroit lived and died on the auto industry, which is what we're seeing in the news today. The contrast: Cleveland has the dubious historical honor of being one of the first financial and medical epicenters of the country outside of NYC, which is a tradition that it holds onto today with headquarters of several major banks, Big Four accounting (E&Y), insurance (Progressive), and medical (Cleveland Clinic), among others. Two local real estate companies are responsible for developing many recent NYC skyscrapers (FCR & DDR). These are conditions that don't evaporate overnight (and in fact are fast on the up-and-up today). Lots of major deals are made here, for reasons I won't get into in this post.

I'm writing this poolside in Palm Springs right now--I understand why west coasters don't see the draw, but for the average middle-aged professional, Cleveland offers nearly every amenity of east coast living without the cost and headache. Of course, it isn't in the same league as California living :)

@John Ellis : Lake County is a great suggestion. I am seeing a lot of Willoughby and Mentor-on-the-Lake foreclosures popping up on my MLS and I kind of want to buy one just for fun.

Chris C. I am currently doing five buy and flips in Lake County and have finished two already. I am hoping I can do more. The opportunity out here is awesome and I am glad you are seeing the value of Cleveland. I hope the secrete doesn't get out! Anyway let me know if you need any help with areas inside Lake County would be happy to help. I live in Mentor moved from the city of Cleveland three years ago. Love the area. There is a great demand for quality homes both rentals and flips.

Chris Carson Thanks for the information about Cleveland, I'll keep it in my thoughts as a potential market now (and not as a Detroit). And actually it's the opposite- Cleveland is far from where the masses are fearing to tread. Investors are flocking to Cleveland. I'm also far from opposed to investing in any market just because I'm a west coaster. I'm from the east coast for one, but I don't only focus on sexy markets. I focus on the markets where the numbers and the opportunity makes sense.

Happy Palm Springs-ing it! No shortage of sunshine out there and since it's been 70-80 degrees where I am in Venice, it must be nice and toasty out there!

@Ali Boone I don't know about you but It's about to rain just a few miles north of Venice here in the Valley! Thanks for your advice on expecting more from a deal in this area. I need to be weary of jumping into a deal too quick just because the numbers kinda make sense. I should be looking for a great deal to start off my rei career.

John Ellis Thanks for the info about the other nearby markets. I'll have to check it out when I have more time today.

Hey @Mehran K. ! I'm actually in Atlanta right now until the weekend so I totally missed the rain. Which, as odd as it sounds, I'm totally bummed about! Since I moved to LA, I have realized how much I really enjoy rain occasionally since it never rains there. Even last night in Atlanta there was a huge storm blowing through and I parked myself on a friend's porch just to watch and enjoy the storm, and then it blew right past us and never hit. I whined that, yet again, I missed the rain and my friend said, "It's always sunny in Ali-world!". Ha.

Sorry for the rain rant. If you like Cleveland, definitely keep looking into it and don't let me deter you. It may be a great market, who knows. Plus, lower returns don't always mean a lower return. If that makes any sense. I'm learning quickly that the lower cap rate houses often tend to produce better returns in the long-run because they often have better tenants and quality, so less vacancy and repairs expenses which make a drastic difference. As in, kill a deal.

Good luck!

@Ali Boone Don't be sorry about the rain rant. What a bummer! I'd have to vent too If that happened to me LOL.

I'm actually glad I decided against this property because today I hit the research hard and found a great deal with MUCH better cash flow in a different state. I do feel I really learned some valuable information in this post though. Seems to really hit home when its a deal I'm working on personally.

I'm going to make another analysis post on it once I get all right info. I'm hoping everyone can be as nice and offer insight as well on that deal.

Thanks everyone.

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