Can You Pay MORE and Get a Better Deal?

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In my previous posts, I mentioned that I use Yield” as my metric of choice to compare various investment properties. When I have to choose from several different types of properties, such as Single Family House vs. a Duplex vs. a Four Plex vs. a small apartment building, “Yield” provides a simple method to prioritize investment options.

The following is how I calculate “Yield”:

Yield = (Expected Yearly Cash Flow) / (Down Payment + Closing Costs + Repairs)

The following example is my latest investment purchase:

Expected Yearly Cash Flow:   $6,000  (Net cash of $500 per month after all expenses)

Down Payment:      $20,000
Closing Costs:         $2,000
Repairs:                     $8,000
Total Costs:              $30,000

Yield = ($6,000 / $30,000) * 100% = 20%

Now for a brain tease – Can you pay more and get a better yield? What do you think?

The simple answer is YES. 

In fact, there are several ways to structure a deal to get a better yield by paying a higher price.  The following are just a couple of quick examples.  Get creative and let me know how many more creative ways you can think of.

Ideas for Increasing your Yield

What if you raise the purchase price by $10K, and reduce the down payment by $20K?  If you are willing to pay $10K more for the property, some of the sellers might be willing to finance the purchase with a below average interest rate.

Another example: Keep the down payment the same, but get the seller to provide a second mortgage for the amount of expected repairs costs at a nice interest rate.  In many of my deals, my repair costs will exceeded my down-payment.  So, if I can finance the repair costs, it will increase my yield.

Lastly, what if you raise the price by 10K, and you are able to get the seller to agree to no mortgage payments for 6 or 9 months. After 6 to 9 months, it is time to refinance the now seasoned property at a higher value. In this scenario, you will get most, if not all the repair costs back because the new bank loan will take into account the value you added to the property.

Overall . . .
In the end, the price of a property is only a single metric and by itself it means very little in calculating “Yield”.  In my opinion, the terms of the deal are far more important than the price.  If I find a flexible or a motivated seller, I will spend a lot more time coming up with creative terms than trying to grind them down on price.

Most new investors mistakenly focus on price and price alone.  Don’t make this mistake.  Learn to be creative and use terms to drive success of your business.

Remember, you can pay more for a property and actually create a better deal for your business.

Good Investing

Photo: LifeSupercharger

About Author

Michael Zuber is an active buy-and-hold real estate investor who still has a full-time job. Michael is not an agent or broker, and simply uses the internet and agent relationships to drive his business. He currently averages at least one deal a month and has developed laser focus on his 5 step process.

15 Comments

  1. Mike,

    I agree with you here. I think “yield” is the best way to discover the true value of a Buy and Hold deal.

    One quick question for you, how important is equity capture if you are planning on holding the property for 30 years at a rate of ~5% (I’m still under 10 fannie mae loans)? My last purchase was only 5K below market, but it only needed $1000 of rehab. I figured that was still good so long as I could hit a 20%+ yield. Do you agree?

    PS: We got to catch up soon!

    Arthur Garcia

  2. Chris Clothier

    Michael –

    Great article. That is a very creative strategy for structuring deals. Yield is a funny word because so many of us have focused on the yield equation without trying to be creative with how we structure the deals. Really great tips Michael, thank you.

    Chris

  3. Michael, I enjoyed your analytical article, however I’m not so sure yield is a silver bullet for prioritizing deals. Take a look at your “expected yearly cash flow” term. Comparing this term for a single family house (1 rent stream) against a small apartment building (multiple rent streams) doesn’t appear to adequate frame the inherent risk. The multifamily cash flow should be more “expected” or certain. Would you agree? Toss in a probability factor for cash flow and I’ll be more persuaded.

    • Chris Clothier

      Al –

      Over the last few days I’ve been thinking about this and even how it pertains to triple net leases on commercial deals and lease-purchases on single family homes. In those scenarios, all costs become fixed while the lease is in place eliminating (mostly) variable costs and allowing for an extremely accurate cash flow calculation. Besides these two scenarios, I don’t think there is a way to compare sfh to multi unless you have the same number of doors in each deal ( a package of sfh for instnce).

      Not sure that point came out correctly, but wen reading your posts you hit on the cash flow expectation and I thought of the fact that different investors use different calculations and different structured deals play a big role in the bottom line.

      • Hi Chris

        As you know it is tough to create a single metric that can be used to compare different asset classes.

        My main goal is to insure I am maximizing my return on capital deployed so that I can continue growing.

        Good Investing

    • Hi Al

      The key is to make sure you your expected monthly cash flow take into account vacancies and bad debts, etc. I own a bunch of both types and I can tell you houses don’t stay vacant long while apartments can have a lot higher turns and evictions.

      So at least in my market and with my experience I am not comfortable saying apartments offer more “expected cash flow”.

      That said you point about making sure to include vacancy, evictions and bad debt is right on and should be an expense that is extracted from monthly rent.

      Good Investing

  4. Good food for thought, but Al is correct that techniques to increase your leverage also increase risk. Your debt coverage ratio shrinks, and the investment is much more susceptible to becoming cash flow negative if adverse events occur. I like to impose a floor on the debt coverage ratio that I can tolerate, at 1.75, so this forces additional discipline into the leverage decision.

  5. Good discussion all. Sounds like we have more work to do on developing a silver bullet equation for evaluation.

    Mike, in my market (non-subsidized, affordable housing, SFH and apts) my experience is opposite of yours. But, I like the fact that you found analtyics that work for your market AND that you were gracious enough to share it with us. Thank you.

    I plan to share my equation for determining how much a MF landlord should invest in curb appeal with the group soon.

    • Lee

      Sorry but I will have to disagree. Cash Flow keeps you alive while you wait for appreciation. Without Cash Flow guess what. You either stop buying or you go broke.

      Cash flow is the big deal (my opinion anyways)

      Good Investing

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