Deal Analysis - Too conservative?

Question

I have been running the numbers on some deals, mostly 2-4 unit properties, and I am finding that nothing on the MLS is even coming close to cash flowing at the list price. I am sure part of it is just how the market is, but I want to check to see if the numbers I am using are right in the first place.

I use 8.33% for vacancy (1 month per year). 5% for maintenance. 5% for management, even though I self manage. 10% for Cap Ex. And then local tax rates and standard insurance amounts as well.

Do these make sense? Should any of these be adjusted at all based on your experience?

Aaron Zimmerman · Answer

Repairs and capex should be adjusted on age of property. I'd say up to 10% for each could make sense

Doug Smith · Answer

I am usually in the minority when I say stuff like this, but right now looks a lot like it did in 1998 and 2007. More $ flooding the market chasing less assets. Underwriting quality goes down and then boom...people lose money. They lost in those times because they didn't understand that they weren't being too conservative...others were being too aggressive. Advice from a guy that's managed through three major crashes? Stick to your models and don't follow the crowd by lowering your standards. Stick to the fundamentals and let others overpay and be too aggressive. After 1998 and 2007, there was a ton of opportunity for those that didn't go with the crowd and be too aggressive. We're seeing a lot of hedge funds flooding the market with capital, but they did that in 1998 and 2007 as well. Stick to your principles.

Evan Polaski · Answer

Almost every deal cashflows if you pay cash.  The assumptions you are using, if anything, are likely not conservative enough.  As others noted, you need to look at your average market rents for the property and know the cost of the repairs and maintenance, then back into your percentage to use.  But more seriously, for many people the issue is not necessarily your assumptions, per se, but might be your return expectations.  The market is more challenging than it used to be.  You need to work harder to find deals (not just passively on MLS), get creative with how you structure deals, or show some other creativity within the deal.  You have to remember you are in a highly desired market and niche.  When you invest there, you will get lower returns, typically.  When you do it passively, you will get lower returns.  The days of the 1% rule, which was the 2%-3% rule 15 yrs ago, are gone.  And unfortunately, if you are in a major market, there will almost always be a high income earner or other person who has money that is valuing the perceived low risk of real estate and are willing to accept a lower return because it fits in their portfolio due to its risk:reward profile, versus the "get rich quick" paradigm that a lot of people think real estate is.

Don Konipol · Answer

We just purchased a property for $2,600,000.  The asking price was $5,500,000.

Was it easy? No

Was it fast? No

Due to the availability of market knowledge, the legal obligations of listing brokers, and the relatively low interest rate / capital ROI requirements, you will not find any “deals” on MLS or its commercial property equivalent at LISTED price.

@Drew Sygit has it exactly right.  Good/Great deals are negotiated, not found at asking price.

Here’s another example from our private lending side.  A borrower with a special use property came to us and told us he would accept an interest rate no higher than 8% for a loan and pay no more than 1 point.  He “needed” 60% LTV.  The loan we offered (and he accepted was at 13% interest with 5 points, at 40% LTV.

If you know the max you want to pay it’s relatively easy - offer that or a little less.  Count on making at least 10 offers for every one deal that goes through to completion, or 5 offers for every one that’s accepted.  Two of the five will elicit no response or counter offer.  1 of the five will counter at or slightly below asking price.  1 will counter lower but not low enough. And 1 will counter low enough or show enough flexibility to make a deal.

Also, though this is rarely used anymore, a seller whose “stuck” on a price may be willing to accept almost any terms as long as they sell for their price.  I once bought a property paying the sellers price (about 10% above market) by putting 10% down and the seller carrying back a loan for the balance at 0% interest payable fully amortized over 10 years.

Drew Sygit · Answer

It's easier to MAKE deals than to FIND them!

Run the numbers backwards to determine the purchase price that makes your ROI work.

YES, you will have to make many offers to find a motivated seller willing to accept your price.

Investing is WORK!

Amir Twig · Answer

@Nate F. your percentages aren't crazy. 8.33 vacancy + 5 maint + 5 mgmt + 10 capex is roughly 28% before taxes and insurance, which is in the normal range. I wouldn't trim them to make a deal pencil. That's how people end up owning something that "cash flows" on paper and bleeds in real life.

A few things I'd tighten though:

• Capex as a % of rent works badly on small multis. A 4-unit with 4 water heaters, maybe 4 furnaces and one roof doesn't care what the rent is. Walk the big components, guess remaining life and cost, and turn that into a $/unit/month number
• Mgmt at 5% is light if you ever hand it off. Most small multi managers are 8-10% plus a leasing fee
• Look for owner-paid utilities. Water/sewer/trash and a house meter are really common in 2-4 units and they're the line people forget
• Use taxes AFTER your purchase (reassessed), not the seller's current bill, and get an actual insurance quote instead of a standard number

Capex as a % of rent works badly on small multis. A 4-unit with 4 water heaters, maybe 4 furnaces and one roof doesn't care what the rent is. Walk the big components, guess remaining life and cost, and turn that into a $/unit/month number

Mgmt at 5% is light if you ever hand it off. Most small multi managers are 8-10% plus a leasing fee

Look for owner-paid utilities. Water/sewer/trash and a house meter are really common in 2-4 units and they're the line people forget

Use taxes AFTER your purchase (reassessed), not the seller's current bill, and get an actual insurance quote instead of a standard number

Then flip the question around. Instead of asking whether the deal cash flows at list, solve for the price where it does with your real inputs. If that's 15-20% under ask, that's your offer, and on stale listings sellers sometimes take it.

What does one of the deals you ran look like? Price, rents, and what taxes and insurance came out to. Happy to sanity check it here.

Michael K Gallagher · Answer

@Nate F.  generally if you are looking for a house hack for me it has to meet two requirements:

1) can you generally handle the mortgage payment on your own? or in the case of a 4 unit at say 50% vacancy, basically making sure 1 missed month of rent ins't going to sink you type thing.

2) does is better your financial position in the short term and/or in the long term?

If its a "traditional rental"

Yes generally the deals on the MLS you are going to have to "make offers" and wheel and deal to an extent.  Unless something is agressivley priced there is usually a negation that is happening.

Deal Analysis - Too conservative?

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