All Forum Posts by: Immanuel Sibero

@Rob Gervais

It's probably fairly common to see low, real low cap rate on residential properties (1 to 4 unit), especially in a hot, low supply, high demand market. Within residential properties which are 1 to 4 unit properties, not only are you competing with other investors you're also  competing with owner occupants (i.e. for these buyers success/failure calculation is not the same as that of investors). A 2% cap duplex in an excellent school district is a success to an owner occupant but not so much to an investor (i.e. 2% cap is tough to finance and still cash flow).

Cap rate is more commonly used in analysis and valuation of 5+ unit properties. Within this market segment, you're typically competing with investors only so the success/failure calculation is the same for all potential buyers (i.e. everyone is all on the same level of playing field, everyone is looking for cash flow).

To answer your question - is it the metrics? or are people setting themselves up for failure? It's more likely the metrics you are using. Cap rate has little relevance in the analysis of 1 to 4 residential properties, it is particularly irrelevant in valuation of those properties (i.e. "comps" are used instead)

So cap rate is definitely commonly used in analyzing 5+ units but other metrics such as CoC and/or IRR are typically more useful in analyzing 1 to 4 units. Better yet why not use CoC and IRR on all types of real estate properties? ...... Or bonds, or stocks, or bitcoin, or crude oil.... you name it.

Cheers... Immanuel

@Mendel Deitsch

As you pointed out cap rate is a metric to measure some kind of return (ROI). Cap rate uses the cost/value of the entire property because it is a property specific metric. This is why cap rate is commonly used to compare one property against another to determine which is a better investment.

When you measure ROI specific to you (i.e. the investor), then yes it makes more sense to use your down payment. But there is already a metric for that, it's Cash on Cash (CoC).

Another way to answer your question is:

It does not make sense to calculate ROI by taking NOI and divide it by your down payment because NOI is generated by the whole property which is acquired with your down payment AND the loan from the bank. You would be overstating ROI when you take all the NOI and divide it by your down payment only, wouldn't you?

Cheers... Immanuel

@Stanley A.

This is probably a good summary:

Note: all other posters please correct if any the classification below is incorrect.

Cheers... Immanuel

@Sheldon Peart

Good luck! You can always stop by BP, it's a great resource.

Cheers... Immanuel

@Sheldon Peart

... My thoughts are that anything above the down payment is paid by tenants, so why would you base your NOI on total purchase price?...

It is correct that tenants pay for the property beyond your DP (i.e. the 80% portion that is financed). But how do tenants pay for the property? They use NOI, don't they? If so, then you shouldn't take 100% of the NOI in calculating your Net Return because some portion of NOI goes to pay for the property (i.e. it doesn't go to you). So your Net Return should be Your portion of NOI / Down Payment. I should also add that you will find that as an owner "Your portion of NOI" is really what is left of NOI after all obligations are satisfied (i.e. "residual"). And incidentally, under this definition your Net Return is essentially Cash On Cash metric (i.e. CoC) which is also very commonly used by investors.

What is a good cap rate? There are many posts asking this question, you will find that the answers are almost always "it depends". Depends on the market, the local economy, the type of property that you're considering (i.e. A, B, C, D). I would say a good cap rate would be a cap rate that is higher than the prevailing market cap rate for the type of properties comparable to the one you're considering to purchase. In you example, if the property you're considering is 6 CAP, and if the recent sales of comparable properties in the area have been trading at 5 CAP, then I'd say 6 CAP is a good cap rate for the property you're considering to purchase. The point is, a good cap rate is relative.

Cheers... Immanuel 

@Sheldon Peart

Congratulations on paying off the large student loan. I'm sure it's a huge relief. Now that you're financially more flexible, I applaud you to turn your attention into investing.

First, I'm assuming you are referring to 5 or more unit properties, since income based valuation is largely irrelevant when it comes to 4 or less unit properties. Properties with 1 to 4 units are normally valued using recent sales of comparable properties. If you were to apply income based valuation on 1 to 4 unit properties, you would likely get the wild swing that you have observed.

Second, the formula of "Net Return" as you defined it (i.e never seen it used before) is essentially Cap Rate * 5 (i.e. using your assumption of 20% down). So why not just use Cap Rate?

Third, there are many metrics that we deal with in real estate - NOI, Cap Rate, CoC, ROI, IRR, Down Payment, etc. It helps to understand them by separating them according to their purposes. For example, NOI and Cap Rate are metrics that are property specific whereas CoC, ROI, IRR, Down Payment are metrics that are investor specific. To calculate "Net Return" as NOI/DP is IMO mixing apples and oranges. You can certainly use this metric across different properties, but Cap Rate already does that. Your Net Return is always going to be Cap Rate * 5.

Cheers... Immanuel

@Peter Bui

There really is not enough information to answer your question. From a high level perspective, evaluating investments is not all about return. There is another aspect of investments that is rarely discussed because it's not quantifiable so it's difficult to measure. I'm referring to RISK. Investment is about balancing return vs risk. For example, in my market I would be fine with 8% ROI in high growth, good school, path of progress areas. However, 30 miles south of me is borderline war zone, shrinking demographics, high crime areas, ROI is 20% but I wouldn't invest there.

So, would I invest in a property with 8% ROI? Well, tell me more about the risks...

Also, it might be helpful to join your local investor group and meetups. You would be able to get an idea what kind of returns local investors are expecting.

Cheers... Immanuel

@Johann Jells

For a minute I too thought you were seeking a higher assessment. Maybe you can point out that 25% expenses are just way too low.

Cheers... Immanuel

@Johann Jells

I'm assuming this is a true commercial multi since you indicated >4U (i.e. larger than 4 units). You can find more info at  https://www.propertymetrics.com/blog/2016/03/10/ho...

A couple of comments:

- Cap rate is a property specific metric and is commonly used to compare one property against another. Financing the property does not negate or render useless the use of cap rate.

- I would question the use of rent roll in calculating the assessed value. Why did they not use NOI?

Cheers... Immanuel

@Lewis Christman

Sometimes it's like pulling teeth to get an answer to a specific question, isn't it? LOL

Let me give this a try... so this is IMO. The cap rate formula calls for NOI divided by "Purchase Price" but note that sometimes people use "Cost" or "Value" in place of "Purchase Price". Regardless of what it's called, IMO cap rate calls for all costs associated with 1. acquiring the property and 2. placing the property in service as a normally operating business.

- Do you include closing costs - survey, title, recording fees? Yes. Why? Because you wouldn't be able to acquire the property without paying these costs.

- I'm assuming initial repairs are known repairs that need to be made to get the property to operate normally . Do you include these costs? Yes. Why? Because you wouldn't be acquiring a normally operating business without paying these costs.

The term "Purchase Price" is probably the source of confusion here because it is ambiguous. If you think of it as "Acquisition" price in a sense that you are acquiring a functioning business then you would probably have a better idea of what costs to include and what not to include in the "Cost" or "Purchase Price" of your "Acquiring" the property . Hope this helps.

Cheers... Immanuel