All Forum Posts by: Wes Brand

@Edward Peugh Not factoring in appreciation is a huge mistake. I made the same mistake. If you ignore appreciation you're giving up the biggest boost to your profits you can get, anywhere. Cashflow is pretty minimal compared to what you get from appreciation...if you take your 100k for 10k purchase, you'll end up spending 100k of your own money (ignoring financing for a moment), just to get it back over 10 years. And that's best-case; no unexpected vacancies, no unexpected damages, etc. After 10 years you'll start making a profit, but it's still pretty minimal, and, importantly, linear. You'll still be getting the same 10k/year in 30 years (remember, no appreciation). You'll actually be losing money due to inflation. When you sell, you get back your 100k.

Ok, so let's take the safe appreciation of "inflation" at 2%/year into account. Now at least you'll have inflation adjusted dollars coming in (but you're anticipating appreciation, there are markets where you can't even assume you'll continue getting inflation adjusted rent increases). So you've spent 100k to get 10k+2%/year (so in 10 years you're looking at 12k/year), but that's still pretty minor. 

Now, let's look at appreciation. The "worst house in the best neighborhood" or "market where everything is going up" or "the fixer": 

You paid in 100k, to make 10k/year. But if you look at market data for your neighborhood and saw that it's gaining 5% / yr instead of inflation adjusted 2% / year, and further you see that the house you're looking at is undervalued by 20% because it has a dated kitchen...well, now you're looking at 10k on a kitchen remodel (so you spent 110k, for a value of 120k, yes I'm rounding), but in 10 years your investment is worth: 

10k + 2%/yr rent (110k)

120k + 5%/yr appreciation (66k)

for a total of 185k over those 10 years, or an extra 18.5k / year...you're making 28.5k every year instead of 10k. Could you get lucky and buy into this situation from the start? Definitely. Should you be aware of it and design your investments to take advantage of it? I'd say so. Why do you think people say to buy the worst house in the best neighborhood? Let me give you a hint: It's not because they think appreciation is a myth.

Something else to consider in MFH...what happens when one tenant's negligence causes damage to another tenant's unit? If I turn off the heat in my unit and it causes a pipe to burst in the winter, for example, or if I start a fire unintentionally...in one case you have an easy target to tell everyone else: Go talk to the renter's insurance company (since almost every renter's policy carries some liability insurance). In the other case...well, good luck getting anything out of the renter.

Less of a deal in SFH, but multifamily I would absolutely require it.

@Robert P. I get XXXX+/mo from a roommate here, I'm slightly under market rents, and it rents within a week after showing it to 10-15 people total. Another property I have rents in hours and is significantly under market rent. I left it under market because this way I get my pick of qualified applicants and I don't need to think about it -- the purchase price was such that the rent is still an ok return. 

The roommate situation could be in the XXXX+100-200/mo range, if I wanted to bother with an extra couple hundred dollars/mo and show it for longer (it's a headache because of reasons that I won't get into on a public forum). I know people who are doing roommates in the XXXX+500-600/mo range. It takes them longer to fill a vacancy, but they still get their asking price. 

I totally get asking under market as a valid strategy...but realize that's what you're doing. Especially if you had 20 people interested in your property and of those 10 applied. If you had 5 people interested and only 1 applied that's still a win for you if the person who applied was qualified and was paying more rent. And if you *didn't* get enough interest...drop the rent. There's no harm in it the way there might be for a home sale.

You had 10 applications from 19 families. That's roughly 50% of the people who saw it applied. If you raised the rent by 25/50/100/mo(depending on what rents are now), you would have gotten some percent of them to apply anyway -- there aren't an unlimited number of rentals, and the best time to show it is when everything is new. Further, you would have had a smaller open house. Also, it's pretty easy to pull a listing for a couple days and drop the rent because you didn't get the response you wanted. Maximizing profit isn't everything, but the market here was telling you, and is still telling you, that the rent is too low.

@Mike Hanneman Not in SF. If the property is not subject to rent control you can just raise the rents a ridiculous amount subject to the proper notification period (60 days for > 10% increase), but if it is subject to rent control you're stuck with a tenant for life. This is why you want to make sure you buy crappy units and ask more money than they're worth. Top of market for a studio (currently 2600ish) that's in an ok location will get people moving out all the time -- "I can pay 2600 for a studio in a prime location, or I can get a 1 bed in a not-so-prime area for 3000 and split the rent with an SO..." so you can continually adjust to market as people move. A 3 bed subject to rent control is the kiss of death here -- people are never going to move, and in fact they can't move and get anything even remotely close to their current rent after a few years. 

One thing to beware of @DG A. is what happens to the unit after you evict. In SF a no-fault eviction means the unit could be subject to rent control in the future even if it is not currently. I haven't done the research for Oakland, but there could be similar rules on the books there.

@Brent Coombs - You have it backwards. If the market cap is 4%, then the NOI on a 250k house is 10k. If the market cap is 1%, then the NOI on a million dollar house is 10k. This is important, because what's changing is not the market cap rate. You need to compare the cap rate on your purchase against the market. In my example it's the same market, same market cap, but one seller is using a 1% cap rate to value their property, and the other seller is using a 4% cap rate. This is similar to one seller selling at $250/sqft and another at $1000/sqft. They can both exist, in the same market even, but there's a typical $/sqft for the market that you need to compare against. If the number is too high or low you need to ask why. You're hung up on thinking NOI is your profitability on a deal...it's not. The same way $/sqft is not a measure of profitability. You want to look at your total return INCLUDING appreciation and rent growth when you figure out how profitable something is.

If we take the previous thought experiment and we add "the 1% cap rate property will appreciate at a rate of 20% / year" with market data to back that up (or reason to believe that it will continue to happen) due to, say, average rent growth (no speculating on property values going up at this time), while the 4% cap rate property will only appreciate at 2%/year (tracking inflation), well, we have a very different picture of which property will be more profitable over the long term. I realize this example is somewhat contrived, but I'm using it to illustrate a point, not that I think anyone can actually find something that matches it exactly.

If you can't afford the cost of the debt then this discussion is moot, but at that point you're not making the best investment decision you can...you're compromising on potential because you need $ today. The same as saying "those <whatever> stocks are too volatile, I'm going to invest all my money in treasury bonds". You have a "safer" return on treasure bonds, but your returns are vastly lower due to the safety.

So, if I'm hearing you right, @Brent Coombs you'd turn down a property with the following features:

Cap rate: 4%

Market cap: 1%

Reason for the discounted cap rate: the seller just wants out. No problems with the property, they're just tired.

I would certainly consider it, assuming I was buying commercial properties. That's buying a $1m property for $250k...

You'll want to look up zoning laws in your area. 

One lot might not be worth much of anything, but if you could buy up the entire street and combine the lots to make something bigger (commercial or residential apartment)...now you have a real play in the works. Further, why are the properties worth so little and why are none of them maintained? Well, more specifically, why isn't that area desirable? If it's because the area is run down you can fix it and make an investment for appreciation in the entire area. If it's because there's a ton of crime and it's actually dangerous/you're likely to have any repairs you do undone, you'll want to start talking to the local police and politicians -- you want them to step up patrols in that area to kill the crime element. Once the crime is gone you can start improving the properties and putting solid tenants in place.

How well do you know the city? Every city official is going to say they're going to go up in population / rental demand / etc. 

2nd: Why are you looking at cashflow per door on a commercial deal? 

What's market cap for apartment buildings in that area? If market cap is 15% you're overpaying by buying at 13.7% cap. If market is 10% you're getting a decent deal for the market, though you'll have to estimate if the discount on cap rate is worth buying the worst property around.

@Mike Hanneman It goes beyond that, but yes. This is why it's critical to know the landlord/tenant laws in your investment area. 

As an example, and scoping this to only rent controlled property in SF: 

If you offer a "same" (so same timeframe, allowed rent increase, etc, but you can't change the terms) lease and the tenant refuses to sign it you can evict them for not signing, otherwise they convert to month to month under the terms of the old lease. You can also evict for breaking the terms of the lease and failing to correct after written notice, but the terms that are broken need to be legally allowed. For example: Subtenants are allowed by law so if your tenant is subletting you can't use that as a reason to evict, even if your lease explicitly bans it(you can require approval, but there are only a few reasons you can deny approval, and credit score isn't one of them). 

There's far more that could be written, but the short answer is just because it seems like something should work a certain way doesn't mean it actually does everywhere in the country.