High COC Returns - Should I Buy?

Question

So I've been running some numbers in a nearby market (Evansville Indiana) on some multi family properties I'm seeing, we don't currently have any in my local market. Evansville is about an hour away from me so I would likely hire property management. Below are the cash on cash returns I came up with for each:

Deal 1: 24%Deal 2: 26%Deal 3: 29%Deal 4: 22%Deal 5: 32%

Each deal is a duplex except deal 5 actually includes 2 duplexes (they offered to sell a 2nd on top of the listed duplex for 40% the price). In my calculations I budgeted 10% for management, 10% for R&M, 5% for Capex, and 5% for Vacancies for a total of 30%.

They've all been on the market for less than a month. They're obviously not the nicest properties or in the best area but the numbers pencil. Interior wise they're all updated and look good and they stay rented. Occupancy rates for the city are at 93%-95%.

As long as the structures, electrical, and plumbing are in good shape should I be jumping on these deals? Anything I'm overlooking here?

Nicholas L. · Answer

@Logan Weber

yes - you're likely overlooking that this is spreadsheet math that doesn't reflect the experience of actually owning these, and you won't make anything like the returns you're showing here.

i don't know a thing about the Evansville market, but I'm assuming these properties are in a more challenging area which you alluded to.

so for example - what does a $2-4K turnover every year do to the return? takes it to zero. and 5% a month for capex is utterly nothing on a big ticket item like a roof, furnace, porch, retaining wall... each property needs what it needs. maybe some have new roofs and others have roofs with no life left.

especially if these properties are sitting on the MLS and no one has purchased them... that means everyone else has passed on them.

hope this helps

market is challenging right now

no one is offering properties for new investors to swoop in and make easy money on

Logan Weber · Answer

@Nicholas L. Yeah that's definitely true, thanks for your feedback! I had been skeptical myself but the numbers looked so good that I figured I'd get a 2nd opinion to see what I was missing. Think I'll pass on them and wait for an opportunity I feel more comfortable about

Richard I. · Answer

@Logan Weber — agree with Nicholas L., and the math quantifies exactly why: your deals pencil at 13–16% cap on paper, which is screaming relative to the region, and that premium is the market pricing in what Nicholas described.

Running your numbers (annual rent × 70% after your 30% expense budget):

Deal 1: $20,400 × .70 = $14,280 NOI → 13.6% cap

Deal 2: $19,200 × .70 = $13,440 NOI → 15.8% cap

Deal 3: $19,740 × .70 = $13,818 NOI → 13.2% cap

Deal 4: $21,900 × .70 = $15,330 NOI → 13.9% cap

Deal 5: $33,600 × .70 = $23,520 NOI → 13.4% cap

Two stress tests before you touch this price band again:

1) Expenses. 30% is thin for C-class duplexes with a property manager. Add landlord insurance on an older duplex ($150–250/mo in Indiana), reassessment, lawn/snow, unmetered utilities, turnover/cleaning, eviction/legal, and the PM lease-up fee. At 45% expenses the same deals look like: D1 10.7%, D2 12.4%, D3 10.3%, D4 11.0%, D5 10.6% — still decent on paper, but your 22–32% COC roughly halves, and COC is what you actually pocket.

2) The "$50k duplex at $1,200/mo" inside deal 5 is the one I'd interrogate hardest — that's a 28.8% gross yield. Either the rents are overstated for that block, or the price is low for a reason (deferred maintenance, area, flood zone — Evansville sits on the Ohio River; check FEMA maps before any offer).

Also: city-wide 93–95% occupancy is not these units' occupancy, and when everything in a price band pencils above 13% cap in a market an hour away, ask why the sellers are selling. Cap rates that far above the regional norm are pricing in something.

My rule: underwrite at 45% expenses, assume first-year vacancy and a capex hit, and still require your target COC after that. If the numbers survive, walk the units and talk to the actual tenants before writing an offer. (Not financial advice — just the math.)

Vijay Friedman · Answer

@Logan WeberThose returns would definitely get my attention, but I’d pressure-test the inputs before jumping in. On older duplexes I’d verify actual leases/rents, taxes, insurance, owner-paid utilities and any deferred CapEx, then rerun the numbers using the financing you’d realistically get today. If the deals still produce strong cash flow after actual debt service and a more conservative expense case, that tells you a lot more than the headline CoC return.

Henry Lazerow · Answer

I just sold a building that rented $4000 a month with $265k cash out refi done, as the cashflow was fake on paper only it pretty much just broke even in real life. Low class tenants cost you a ton every time move out and do not even stay long before not paying rent. It doubled in value as so many desperate investors now paying top dollar for low credit areas so I still made out great from equity. Those areas properties used to be almost viewed as worthless prices post GFC years.

Drew Sygit · Answer

The biggest mistake we see newer investors making, over and over again, is not fully understanding Neighborhood/Property/Tenant Classes and how they impact your probability of success!

They all run their ROI numbers assuming Class A results – when buying Class B, C & even D rentals.

Then they’re shocked when their performance expectations aren't met😞

If you choose to invest OOS, and have little to no landlord experience, we highly recommend targeting Class B Neighborhoods/Properties/Tenants. If you target Class C, you better be prepared emotionally & financially for plenty of challenges.

You can find Class B properties in the Midwest to BRRRR, but it will take more digging and YOU will need to understand how to analyze & identify them - because a lot of agents, wholesalers, PMCs, etc. will try to sell you Class C or D misrepresented as Class B:

• Many of them don't know/care what Class the properties are, so they're incompetent.
• Others know exactly what they are doing, so should be labeled as crooks! EITHER WAY YOU LOSE!

Why is Property Class so important for investors to understand and apply in their investing strategies?

Because the Property Class dictates the Class of the tenant pool that the property will attract.

The Tenant Class greatly impacts rental income stability and property maintenance/damage by tenants.

Both Property Class and Tenant Class will affect what type of contractors, handymen and property management companies you should target and be willing to deal with a property.

The Property Class will also impact the maintenance & renovations you do to, “Maintain to the Neighborhood/Market”.

Why is that important?

Well, if you buy & renovate a property in Class D area to Class A standards, what Tenant Class will actually rent it?

Or, if you put several Class D tenants in a Class A four-plex, what do you think will happen to the property?

What do you think will happen if you rehab a Class D rental to Class A standards?

So, if you fail to apply the correct assumptions to a property, your expectations won’t be met, and it may even be a financial disaster.

We use the following to rank Property Classes, in order of importance:

• Property Tenant Pool: closely linked to location, but not always.
• Property Location: closely linked to tenant pool, but not always.
• Property Condition & Amenities: it’s important to, “Maintain to the Neighborhood/Market.”

Key metrics for each Property Class:

Class A Properties: Tenant Pool: Majority of FICO scores 680+, no convictions/evictions in last 7 years. Tenant Default: 0-5% probability of eviction or early lease termination. Section 8: Class A rents are too high and won’t be approved. Vacancies: 5-10%, depending on market conditions. Cashflow vs Appreciation: Typically, 3-5 years for positive cashflow, but you get highest relative rent & value appreciation.

Class B Properties: Tenant Pool: Majority of FICO scores 620-680, some blemishes, no convictions/evictions in last 5 years. Tenant Default: 5-10% probability of eviction or early lease termination. Vacancies: 10-15%, depending on market conditions. Cashflow vs Appreciation: Typically, 1-3 years for positive cashflow, balanced amounts of relative rent & value appreciation. Section 8: Class B rents are usually too high for the Section 8 program.

Class C Properties: Tenant Pool: Majority of FICO scores 560-620, many blemishes, but should have no convictions/evictions in last 3 years. Verifying recent 2-years of rental history very important! Same for 2-years of job/income stability. Tenant Default: 10-20% probability of eviction or early lease termination. Section 8: Class C rents usually meet program requirements, proper screening still recommended. Vacancies: 10-20%, depending on market conditions and tenant screening. Cashflow vs Appreciation: Should cashflow immediately, at the lower end of relative rent & value appreciation. Class D Properties: Tenant Pool: Majority of FICO scores under 560, little to no good tradelines, lots of collections & chargeoffs, but should have no convictions/evictions in last 12 months. Verifying last 2-years of rental history and income/employment extremely important to find the “best of the worst”. Tenant Default: 20-30% probability of eviction or early lease termination. Section 8: Class D rents meet program requirements, often challenges to pass Section 8 inspection. Vacancies: 20%+, depending on market conditions and tenant screening. Cashflow vs Appreciation: Typically, all cashflow with little, maybe even negative, relative rent & value appreciation.

Where did we get our FICO credit score information from?

Check out this chart:

FICO Score

Pct of Population

Default Probability

800 or more

13.00%

1.00%

750-799

27.00%

1.00%

700-749

18.00%

4.40%

650-699

15.00%

8.90%

600-649

12.00%

15.80%

550-599

8.00%

22.50%

500-549

5.00%

28.40%

Less than 499

2.00%

41.00%

Source: Fair Isaac Company

Make sure you understand the Class of properties you are looking at and the corresponding results to expect.

For example, Metro Detroit has 132 cities and the City of Detroit 183 Neighborhoods, which we’re analyzing and classifying to make better investing decisions.

Horror Stories from those that did NOT Understand What they were Buying:

https://www.biggerpockets.com/forums/48/topics/1137397-baltimore-a-path-to-never-ending-pain

https://www.biggerpockets.com/forums/432/topics/1231840-sell-at-a-loss-or-rent-at-a-loss

https://www.biggerpockets.com/forums/311/topics/840134-memphis-turnkey-tenant-turnover-costs

https://www.biggerpockets.com/forums/963/topics/1195280-experience-of-oos-investing-in-cleveland-after-15-years

Samuel Diouf · Answer

Anything over 15% coc seems too good to be true and you're either running numbers wrong or buying a very high risk asset.

G. Brian Davis · Answer

Those are great returns if the numbers hold up, but I’d want to understand why they’re that high before jumping in. I’d verify the rents and actual expenses, but I’d also spend some time getting to know those neighborhoods. High turnover, trouble collecting rent, or more repairs than you expected can change those numbers pretty quickly. Since you’re an hour away, I’d definitely talk to a couple of property managers who already manage rentals in those areas and see what they think.

High COC Returns - Should I Buy?

High COC Returns - Should I Buy?

Most Popular Reply

9 Replies

FICO Score	Pct of Population	Default Probability
800 or more	13.00%	1.00%
750-799	27.00%	1.00%
700-749	18.00%	4.40%
650-699	15.00%	8.90%
600-649	12.00%	15.80%
550-599	8.00%	22.50%
500-549	5.00%	28.40%
Less than 499	2.00%	41.00%