Posted over 1 year ago

Worcester-Why you should buy LOW CAP RATE for your first Investment

With Mulit-Family investment I always hear all my clients looking for a 10 CAP or the 1% Rule.  They think this is the HOLY GRAIL

Solid Real Estate investment is based on long term growth through appreciation of a leveraged investment.

Don't get me wrong, Cash flow is great.  Cash flow gets you the ability to scale and move into real estate full time.

However, most people have other jobs and are looking for a solid annuity investment backed by real estate that they can see and show their friends.  Most people own a home that they live in and this is an investment.

We have lots of investment opportunities, but most are making the choice between the stock market and real estate.

If I put $100k in the stock market and do very well and get 10% i make $10k a year.  There are few transaction costs, and I am mostly liquid.

In real estate investments there are transaction costs, closing costs on the way in, and brokers costs on the way out.  And I am not as liquid.

That being said, the key is leverage.

When I take $100k and buy a $400k multifamily that covers my mtg costs, and pays me a decent return on my $100k investment I actually win in 3 ways.

Example, $400k purchase price, with the closing costs paid by seller

$5k taxes, $1500 insurance, $1800 Water and sewer , $250 for snow/maintenance/common electric and $3000 a month in rent which is low.  This works out to just about a 6.18 CAP Rate---KEEP IN MIND THERE IS NO MANAGEMENT HERE

But I win 3 ways

1. I get a cash flow return on my $100k,  $626/month or $7512/year (almost as good as the stock market)

2. I get to depreciate the property over 27.5 years or $14,545/ year  or another $5090/year in tax savings if you are at 35% tax bracket

3. I get leveraged appreciation.  If the property goes up 5% that is $20k in equity.

Typically the good places have lower cash flow, and lower CAP rates, but don't shy away from these properties if they provide any cash flow and will provide appreciation over the long run.

Why is there low cash flow?

1. Low Rents- those go up over time

2. High Price- it is better to overpay for a good place with good tenants then to underpay for junk with bad tenants

3. The property works so you don't have to spend $ fixing things.

If i take the same property and add $225/month or $75/door in property management I go to a 5.5% CAP rate


Moral of the story:  If you buy a good property that will appreciate over time that you can self manage, it may perform as well as a property with great cash flow that needs work and management