All Forum Posts by: Dory Peters

It happens all of the time in commercial--even on a group of SFHs (at least when evaluated together as a portfolio). You can confirm this with a commercial lender or appraiser--especially when evaluating the portfolio of SFHs for consideration of a blanket mortgage.

Yes, it does, and I'll give you a real world example from commercial RE. Keep in mind that the valuation of a commercial property--whether it's an apt, strip mall, medical office, single-box tenant retail location (like a Best Buy), etc--is determined by its income and not comps. For example, a buyer purchases a 100-unit apt with a NOI of 120K at a cap rate of 10%. (Using the 50% rule, one can figure that the gross rent is 240K [or $200/unit/month]. Although I'd prefer better numbers, I cherry picked these ones to simply the math.) It should be clear that the property is worth 1.2M, and a 3% increase in rent will increase the NOI to 123.6K. If that new owner were to resale that apt also at a 10% cap rate, then s/he will get a gain of 36K. However, if instead of selling the new owner were to re-appraise the apt after having raised the rents, then the appraisal will also reflect the 36K gain, and unfortunately so will the next tax assessment. :wink:

The point is appreciation can produce cash-flow, and vice versa.

Some habaneros and a healthy appetite. :mrgreen:

Integrity, creativity, number crunching, experience, and my network.

I analyze my deals using a linear combination of cash-flow, upside (instant equity and repositioning--any future appreciation is gravy), and interest rate spread (in that order).

I think Jim nailed it: this discussion actually should be more of a discussion on the strategy of timing one's RE investments. All three factors can be optimized mathematically to generate the best and highest yield for an appropriate strategy.

Mike's repeatedly stated he's in the buy-and-hold business, so maximizing cash-flow is the obvious play. Yet, for someone who's primarily into rehabs/flips, maximizing upside is the obvious play.

Earlier in the thread, I think someone stated it's not possible to buy at retail and get a positive cash-flow, and I don't entirely agree. As long as one finances the purchase of a property with a loan interest rate that's at least 2% less than the cap rate, that property will yield a positive cash-flow--the larger the spread the higher the yield.

Nevertheless, I'm cheap and greedy--just like my mentors taught me to be. For me, it's not a matter of choosing between the three; rather, it's all about optimizing all of my exit strategies to deliver me the most cash-flow, upside, and interest rate spread. I want to have my cake, eat it too, and still have some more left for tomorrow and the next day. :cool:

Dean,

I'm also in IT (software engineer and sysadmin), and I can relate somewhat with some of your comments.

Have you considered treating your RE business the way you'd treat one of your system deployments? If you've done any large scale deployments (on several hundreds of machines), then you'll know that it requires some planning. After all, you might not want to provision a system, that you intended to be your authentication server, as one of your file servers. Similarly, you plan your REI business activities, so that you can execute those plans effectively.

Although it's possible for one sysadmin to do every job during a large-scale deployment, the tasks are usually divided between several team members, and sometimes some of the work (or subsequent maintenance) is outsourced. Have you designed and refactored your REI plans to the point where you can subdivide all of the tasks into neat, discrete subtasks/subsystems? If so, then have you considered outsourcing the subtasks that least interest you, or that aren't your main line of business?

Ultimately, this is what I plan to do. Nevertheless, I admit that I initially found a lot of the business of REI to be full of business, until I dug a little deeper. The money and lifestyle are nice benefits, but that's not what attracted me back into REI. I was already comfortable with what I earned in IT. The things I like most about REI is negotiating deals (another form of problem solving). I LOVE to haggle--even on something as insignificant as a paperclip. For me, it's less about being competitive, because I enjoy the art of negotiation--of course, I'm in it to win it though. :mrgreen:

Stated another way, you need to determine--if you haven't already--what drives you. There's absolutely nothing wrong with you wanting to do nothing but collect checks passively. Show me the money, and I'll help you to put your deals together--for a price. After having closed a deal or two, I'll come on by and woop you up in some Tekken (my favorite--or any other game) too if you'd like. :D

I'm sure there are plenty of others here willing to make you a similar offer.

I used to think the same thing about CA and cash-flow, and I've actually seen some deals (on SFHs, and 2-/3-/4-plexes) in LA, Oakland/SF, and Stockton that actually will yield positive cash-flow. Believe it or not, I've seen properties that one could acquire for 8% to 10% cap rates in those areas. :D Nevertheless, I don't know how much longer this will last.

RIP

I like to use 2 months rent (122K in this case) as the amount set aside for reserves for repairs, etc. Since Daniel already mentioned that the apt was auctioned with initial bid of 300K, and there are at least 350K in repairs (more than twice the amount of my reserves), I suspect that apt is (nearly) 100% vacant. Nevertheless, it appears that the break-even point is 44 units (please see the calculations below), and it's pretty clear that at least 45 of the 153 units were vacant or under-performing (29.4% vacancy/collections)--otherwise the foreclosure would have never happened. I'd still want to verify the vacancy rate before I did anything else.

(153 units)($366K-$151689)/((12 months)($61K/month)) = 44 units (truncate the integer part)

(where NOI=$366K and debt-service=$151689 [assumed 7% APR for that $1.9M])

If the property is 100% vacant, then I wouldn't offer more than 30% to 40% of its market value ($2.614M [14% cap] to $3.66 [10% cap]) for an all cash offer, and I wouldn't offer more than 60% to 70% of its market value for an offer with 100% seller financing--even in that case I'd also insist on abating or at least deferring the first 6-12 months of payments.

Besides the all cash offer and the offer with 100% seller financing, I'd also present at least another hybrid option (with part cash and seller carry-back) with split funding, and I'd require that the property at least appraises for a certain target figure before the second payment is made (and I'd also include a conservative end-date by which time all of my repositioning efforts would have increased the value of the property minimally to that target figure).

KB,

I'm a numbers person; I enjoyed David Collins' explanation (and Will's additional commentary on David's comment). If you're like me, then perhaps seeing an example of how to work the numbers will help to add more teeth to all of the other great information already provided in this post.

ptcf = NOI-DS = DS(DCR-1) = dp(ROI)
cap rate = NOI/pp
(where ptcf is the pre-tax cash-flow, DS is the debt-service [or 12 months of mortgage payments], DCR is the debt-coverage ratio [or NOI/DS], dp is the down-payment, NOI is the net operating income, ROI is the return on investment, and pp is the purchase price)

NOTE: I'm going to make a few statements using the form A is B, and I'm using is in the mathematical sense--but not equating A and B as terms.

First, if one were to purchase a property with all cash, then the following are true: 1) the purchase price is the down-payment, 2) the ptcf is the NOI, and 3) the ROI is the cap rate. For example, let's say one purchases a property with the following characteristics: pp=120K, NOI=12K, and DS=0 (due to an all cash purchase).

cap rate = 12K/120K = .1
ptcf = 12K-0 = 12K
ROI = ptcf/dp = 12K/120K = .1

Second, if one were to purchase a property correctly with positive leverage, then ROI is greater than or equal to the cap rate. For example, let's say one purchases a property with the following characteristics: pp=120K, NOI=12K, DS=10K, and dp=12K (which implies a loan at 90% LTV).

cap rate = 12K/120K = .1
DCR = 12K/10K = 1.2
ptcf = 12K-10K = 2K
ROI = ptcf/dp = 2K/12K = .167

Notice how the purchase price, NOI, and cap rate are the same in both examples; yet, the ROI differs. I'll show three more leveraged examples to help drive the points home.

Following is an example of positive leverage misapplied (ie the ROI is less than the cap rate). Let's say one purchases a property with the following characteristics: pp=120K, NOI=12K, DS=10K, and dp=24K (which implies a loan at 80% LTV).

cap rate = 12K/120K = .1
DCR = 12K/10K = 1.2
ptcf = 12K-10K = 2K
ROI = ptcf/dp = 2K/24K = .083

Let's say one purchases a property with the following characteristics: pp=120K, NOI=12K, DS=9.6K, and dp=24K (which implies a loan at 80% LTV).

cap rate = 12K/120K = .1
DCR = 12K/9.6K = 1.25
ptcf = 12K-9.6K = 2.4K
ROI = ptcf/dp = 2.4K/24K = .1

Let's say one purchases a property with the following characteristics: pp=100K, NOI=12K, DS=8K, and dp=20K (which implies a loan at 80% LTV).

cap rate = 12K/100K = .12
DCR = 12K/8K = 1.5
ptcf = 12K-8K = 4K
ROI = ptcf/dp = 4K/20K = .2

By the way, it's OK if you don't understand how all of these numbers work together right now. You can learn that over time. For now, it's important for you to understand that there really is a method to the madness, and that there is a way to use real numbers to quantify how leverage can work for/against you. And it's ultimately up to you to structure your deals henceforth, so that the numbers will work for you--whether or not you opt to use leverage.

I use a Mac (and other stuff). Although I haven't tested the BP spreadsheet personally, I believe another poster mentioned that he accessed the spreadsheet using OpenOffice.org--and the software worked just fine.

I personally hack together my own stuff (in python), and it works fine for me.