Investing in a low CoC ROI - Bad idea?

Question

HI all,

Want to start with thank you to everyone in the bigger pockets community taking the time to read this and provide input...

I'm looking at a property in Oklahoma City in what looks to be a very desirable up & coming neighborhood. Its a 4plex, gut renovated in 2021, A class. Im 29 years old and have 2 other properties where I've typically only invested based on cash flow. As we all know, strong cash flow is hard to find right now. I've shifted my approach to be long term appreciation focused, which lead me to this property. I have the property under contract. Right now, its a 6.51% cap, but only a 1.32% CoC ROI (this is with a very conservative formula: vacancy reserve, property management (although I'll likely self manage to start), maintenance reserve, etc.

Historically, I would hate this deal on paper. But with my appreciation mindset, I like it because I'm buying a great asset in a great neighborhood that will see both rent and property value growth. I believe I can slightly raise rents at lease renewals and get this to a 7.33% cap, 5.09% ROI in the near future.

Also should note that I am looking for turnkey properties only as my W2 job does not give me much time for renovation projects.

Am I making a mistake moving forward with a property that will not see strong cash flow for the next few years? Or is this a good approach as I'm not looking to be financially free immediately, but want to set myself up for that by age 40-45.

I'd really appreciated either the validation to go through with it, or the "wait for a better deal" take so I can weigh my options. Thanks everyone!!

TLDR: Is it worth it to invest in a property producing low cash flow that has strong appreciation upside?

Basit Siddiqi · Answer

Some prosThe property is A-Class which should in theory require less work.Interest rates may fall which gives you an opportunity to refinance and cash-flow better.No one can tell the future, people may have mentioned that Oklahoma City is not an appreciating city(historically), it may be in the future.Best of luck to you and this investment.

Marcus Auerbach · Answer

CoC by itself is a poor metric. Look at total risk adjusted ROI.

Long term, quality assets do better and you won't find anyone on BP complaining about that they bought a too nice property 10 years ago. Cashflow is always the worst in year one and is bound to grow.

You can't always predict appreciation, but inflation (the steady devaluation of the dollar) is pretty dependable. And it is not looking like the future will bring lower inflation, probably just the opposite. And that will move asset prices as well as rents - and with some delay also income.

Some people say the name of the game is to acquire as much (self-eliminating) debt as you can as fast as possible.

When I look back at properties that I have bought 10, 15 years ago most of them were not great deals at the time. I always felt I was paying too much. But long term, the higher quality neighborhood properties did so much better.

I would zoom out a bit: would your life change over a few hundred dollars in cash flow? You ran conservative numbers and you are predicting to break even. Can your W2 afford to kick in a few hundred if you have to? How do you think you'll look back at this purchase 10 years from now?

Drew Sygit · Answer

Why is the seller - selling?

Always good to know and don't believe the first answer you get.

In our opinion/experience, a Class A rental will typically take 3-5 years to really cashflow.

Nothing wrong with that, investors in high-price states deal with it all the time.

Jeremy Horton · Answer

Interesting - why do you think that the others sold for so much higher $/sqft? That's not even a small difference. It makes me think there's an error or a problem somewhere

What are the total rents? What are the comps renting for? How "comparable" are the comps? Reason why I'm asking is because there is a big discrepancy in the cost

Are you putting 20% down? What's would the loan term look like?

As @Henry Clark would say - It's your money, you're right, even if you're wrong. And make your big mistakes early. Two pieces of advice I think apply here

Rick Albert · Answer

What do you anticipate the appreciation to be? Oklahoma isn't actually known for appreciation. Here are a few questions that might help:

1. What's being developed as far as apartments in the area? If more apartments are being built, then you have more competition, which means you have to compete on price. That lowers your ROI and with a fourplex slows your appreciation.

2. Another factor to consider is loan buy down. Each month you make a mortgage payment, you are creating equity just by virtue of less debt. Is that factored into your calculations?

3. What is the unit mix? For example I recently bought a fourplex where each unit is 3 bedrooms. Rents are low now but overtime I believe I will become the house alternative, which will raise rents quickly.

4. With low cash flow, how does this hold you back from scaling?

5. Are there other options? Base hits work better over the long term than a few home runs once and a while.

Bruce Woodruff · Answer

I always looked for properties that would have high appreciation. Didn't care so much about cash flow (as long as it made enough money to cover itself...)

But....and this is a HUGE BUT....how do you know that it will have great appreciation? In order for me to pursue this strategy, I would want the property to gain 50% in less than 5 years. You do not have to be so aggressive, that's just me, but you need a large expected appreciation.

I looked for areas that were getting ready to gentrify - esp older historic areas....look for breweries, that is always a telltale sign that they're about to take off.....

Ben Scott · Answer

While a Class A property won't cash flow like a C or D, you'll have more stable tenants and less maintenance issues. The low income houses look great on a spreadsheet but you're subject to repairs, vacancy, evictions, etc. I'd move forward for the appreciation opportunity and the tax benefits.

Daniel Kelly · Answer

Thanks Ben, I'd be interested in discussing property management with you if you want to set up a call!

Jeremy Horton · Answer

1.32% CoC is extremely low

What kind of tax savings would you get? What % are you using for vacancy reserve/maintenance? What would the loan paydown be? What's the purchase price?

I personally wouldn't do it. It sounds a bit like you're justifying buying the property based on possible appreciation and that you just like it.

My advice: Never force a deal to happen. Run the numbers where the purchase price makes sense for you or where the financing makes sense for you. Then offer what your number is. Who cares what the list price is? That's what I would do anyway

Cashflow is essential - that is the life of the business unless you are a multimillionaire and can remain solvent until you get the appreciation you estimated and sell for a profit. I personally am not in that position. Nor do I have the knowledge to predict appreciation with the accuracy necessary for me to risk a major investment.

Investing in a low CoC ROI - Bad idea?

Investing in a low CoC ROI - Bad idea?

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