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?

Ian Bertsch · Answer

Depends entirely on the market. In my market, you'll see the same, hard to find/make a deal with those metrics due to the amount of people in the market.

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.

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.

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.

Aaron Zimmerman · Answer

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

Arman Ahmed · Answer

Your assumptions don’t sound crazy to me, especially if you want to underwrite conservatively. The bigger issue may just be that MLS pricing leaves very little room after realistic expenses. I’d keep your numbers honest and look for a better basis through off-market deals, direct-to-seller, or value-add opportunities. If you’re open to looking outside Louisville, parts of the Midwest market can also be worth comparing.

Ashish Acharya · Answer

Nate, I don’t think your assumptions are wildly conservative. If anything, they’re forcing you to answer the right question: does the deal still work after you account for the expenses that eventually show up anyway?

The one I’d look at most closely is vacancy. Using 8.33% means you’re assuming a full month vacant every year. That may be too conservative for a stabilized small multifamily in a strong rental area, but I’d rather start high and reduce it only if local turnover and occupancy data justify it.

Your 5% maintenance assumption is reasonable as a starting point, but I would not let that replace actual CapEx planning. A newer property with updated systems may need less near-term maintenance than an older 4-unit with aging roofs, plumbing, HVAC, or electrical.

I also like that you’re including management even though you self-manage. That gives you a truer picture of whether the property works as an investment without depending on your free labor forever.

The 10% CapEx reserve may be conservative depending on the property, but I’d rather size CapEx around the actual age and remaining life of the major systems instead of using one percentage for every deal.

The bigger point is that if nothing on the MLS works under realistic assumptions, that does not necessarily mean your underwriting is wrong. It may simply mean the current asking prices do not support the returns you want.

From the tax side, I’d also compare the after-tax return, not just monthly cash flow. Depreciation can improve the economics of a rental, but I would never use tax benefits to justify a deal that is already weak before tax.

Feel free to DM me, I’d be happy to send over a few resources that might help with small-multifamily underwriting and pressure-testing your assumptions.

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.

Alex S. · Answer

Paying cash just removes debt service, so "it cash flows" stops being a useful screen - the real test is unlevered yield on cost (year-one NOI divided by all-in basis) versus what that capital earns elsewhere. If that number lands under roughly 6-7%, the deal isn't good, it's just unlevered. And the conservatism worth arguing about is on the expense side anyway: vacancy, 8-10% management even if you self-manage, and a real per-unit capex reserve, none of which change when you drop the loan.

Jorge Guerrero · Answer

This is pretty normal in the current market — with rates where they are, very few MLS listings are going to close with strong cash flow using conventional financing at 20-25% down. A couple of things worth checking before writing off the market entirely: 1) Are you running numbers with actual market rent (comps from Rentometer or similar) or with what the listing is asking for? Sometimes there's room there. 2) Try different financing structures — an ARM, seller financing, or a bigger down payment (30-35%) can change the cash flow significantly even if it lowers your cash-on-cash. 3) On 2-4 units, the real upside is often not day-one cash flow but forcing value through below-market rent or a value-add angle — if you're only underwriting for immediate cash flow, you'll miss deals that actually make sense over a 3-5 year hold.

Deal Analysis - Too conservative?

Deal Analysis - Too conservative?

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