Am I missing something here?

General Real Estate Investing
1

http://listing.loopnet.com/15033533

Scheduled Gross Income: $226,260
Vacancy 10%: $(22,626)
Laundry: $800
Effective Gross Income: $204,434
RE Taxes: $17,660
Other Expenses: $84,389
Total Expenses: $102,049
Net Operating Income: $102,385

Seller is asking $875,000 for 45 units.

@ $375/unit income would be $202,500
50%rule says NOI would be $101,250

Debt service with zero down would be $68,100

Cash flow should be $33,150/year and $61/unit monthly cashflow.

AND

http://listing.loopnet.com/15241584

Bank owned

Asking $780,000 @ 365 per unit (low ball) and 48 units

Gross income could be $210,240
50% rule would make NOI $105,120

Debt service $60,708 with close to zero down.

Wouldn’t this place cashflow $44,412/year. $77/unit monthly. To get it to $100/unit it would only need a (relatively) small downpayment.

Why havent they been purchased?

What’s the “SECRET”?

2

There are obviously reasons why bldgs are selling so low at such a high cap rate, like I stated in my thread.

Here’s a few:

Market, location, downswing, current tenent mix/demographics, unit mix, year built, asset class, turn over etc etc, the list can go on and on. This isn’t just a numbers game which many believe.

I’m not too familiar with Cincy, but it’s known that it has it’s rough areas. I know for a fact that this building has been on and off the market for the past couple of years. I think someone bought it in 2006 and now that bank owns it so that speaks for itself.

Don’t quote me but I also believe that Toledo, OH is in a downswing. It’s typical to see bldgs in that market to be listed over 10 caps. I noticed that population has decreased dramatically over the past few years, which obviously isn’t a good sign.

I know there are opportunities in every market but to start you career in a market like this could be a disaster.

Jordan

3

I thought real estate investing was all about the numbers.

I figure the reason the bank owns it is because it was purchased for to much, and the former owner couldn’t cashflow. All that could be checked through due dilligence.

4

I thought real estate investing was all about the numbers.

ofcourse it’s not, as I previously illustrated. My approach to investing is finding the market first, then the properties, then finally evaluating and verifying the numbers. Understanding the market is extremely important.

I figure the reason the bank owns it is because it was purchased for to much, and the former owner couldn’t cashflow. All that could be checked through due dilligence.

Sure, that is always a possibility amoung others. I know that it was on the market for a while so chances are the buyer did buy at a discount, but you never know. I’m not even sure it was even purchased. It was in and out of contract a few times.

5

If I offered $700,000 on the second deal, and put $90,000 down, the debt service would be $46,484.

Subtract that from NOI of $105,120 and you get cashflow of $58636/year or $101/unit monthly cashflow. Sounds like a good deal to me. What am I missing? It does seem to need rehab work.

6

OK, let me put it into number perspective for you. It

In bad areas I would definitely up the expenses, instead of 50% use 60%, expect more turn over, more maintenence, more evictions etc.

The Gross income you are using 210,240 take out atleast 15% for vacancies/concessions/loss2lease (31,536). although I suspect it’s alot more then this.

Net Income = 178,704
less expenses at 60% 107,222 - (which is still low, only $2233/unit/yr.)

Net Operating Income = 71,482

Now let’s do a cashflow analysis with a purchase price of 700k 20% dp

140,000 plus closing costs = $160k

560,000 @ 8.5% 30 yr am = 51,672/yr

Cashflow=$19810/yr

COCR = 12.3%

Expect the high interest rate due to the class of asset, age, area, that it needs to be repositioned and doesn’t have strong financials in the past couple of years. The riskier the deal the higher price you will pay.

Not bad, you made 12% on your money year one. But what happens in year two if rental rates drop by 4% and occupancy falls 5% and turnover increases. In a declining market you need to account for this.

Year 2
Gross Income is now $201,831
Vacancy 20% = 40,366 (which may very well be currently)
Net Income = $161,465
Less expenses = 107,222 (which typically would increase)

NOI = $54,243

Debt service 51,672/yr

Cashflow = $2,571/yr

COCR = 1.6%

You can make more on your money in a savings account. Prepare for year 3 to be worse.

You get my point. I’m not saying that this will be the case, I’m just pointing out that if infact this is a declining market in a bad area, that you must anticipate your numbers to reflect this.

That’s why I stress the importance of understanding your market.

7

One more thing.

Moreover, what does this do to your value?

If bldgs in the same asset class are trading at a 10 cap in the same submarket?

NOI = 54,243/.10 = $542,430

You purchased this asset for $700k

total capital loss = ($157,570)

8

I am interested in cashflow and cashflow alone. I have little to no intention of selling investment properties I may purchase. In fact I look foward to them being paid off as it would increase my cashflow quite a bit.

Seems to me that the issues you pointed out could be lessened by proper management of the property and proper tenant screenings.

9

Hi Anthony91,

Here is the way I see these deals:

Deal 1:

Gross Rent: $202,500
Operating Expenses: $101,250
NOI: $101,250

Commercial Mortgage: ($875K, 20 yr, 8%) $87,816
Cash flow: $13,434 per year, or $1,120 per month, or $25 per unit per month

That is a very low cash flow for the trouble!!!

Deal 2:

Gross Rent: $210,240
Operating Expenses: $105, 120
NOI: $105,120

Commercial Mortgage ($780K, 20 yr, 8%): $78,288

Cash flow: $26,832 per year, or $2,236 per month, or $47 per unit per month

This is still not a good deal in my estimation.

That’s why these deals haven’t sold. They are priced too high. Commercial loans normally have a term of 20 years max, which raises the mortgage compared to a 30 yr loan. If I were looking at them, I would insist on buying cheap enough to get $100/unit/month. For deal #2, that would mean buying it at no more than $473,000.

Ohio is poised to offer great deals (as is much of the rest of the U.S.). I would buy DIRT CHEAP and insist on strong cash flow.

Good Luck,

Mike

10

Thank you very much for the response.

11

Hi Mike,
Would your formula hold true for duplexes or smaller commercial properties?
In other words…
Gross Rent X .5 - debt service or mortgage payment = cash flow

Is this a quick way to analyze any deal?

12

[b]I am interested in cashflow and cashflow alone. I have little to no intention of selling investment properties I may purchase. In fact I look foward to them being paid off as it would increase my cashflow quite a bit.

Seems to me that the issues you pointed out could be lessened by proper management of the property and proper tenant screenings.
[/b]

We are all interested in cashflow. However, declining markets can affect your cashflow from year to year, and that needs to be taken into account.

Also, you do not want to see your property value decrease regardless. You may not think you want to sell now, but it’s possible, almost probable you will change your mind if another opportunity came your way down the road.

Sure property management companies will help but they can only play what is in their hand. Property management companies have no control of downswings.

The point I am making to everybody is please realize that it is not just a numbers game. Don’t buy a 10 cap because it’s a 10 cap. Examine the reasons why it’s a 10 cap. Understand the market conditions you are buying in.

13

propertymanager,

The 50% EGI rule is inflating your numbers. That’s why I don’t like using it. You’ll see at 50% that the expenses per unit are way too low. Even Marcus & Millichap is marketing this with a 62% EGI.

It’s a quick way to analyze a deal but be aware of the typical expense per unit in your area to do a comparison. This deal for example, is way off.

Commercial loans normally have a term of 20 years max, which raises the mortgage compared to a 30 yr loan.

Probably if you go to a local bank you’ll see 20-25 yr am but I typically see 30 yr ams on Conduit loans, Even Hud has some 35 yr am programs.

14

Isn’t this downswing a good thing all things considered. With the housing market crashing, wouldn’t more people become RENTERS instead of buyers? (ie. tenants)

15

Isn’t this downswing a good thing all things considered. With the housing market crashing, wouldn’t more people become RENTERS instead of buyers? (ie. tenants)

I’m referring to a micro downswing specific to this asset and submarket. Meaning a decrease in rents, decrease in population, decrease is occupancy, decrease in job growth etc.

Typically, yes, when the housing market is doing bad there will be more renters.

16

So disregarding cap rates and purchasing at a big enough discount or using a large enough discount will still satisfy my goals or 100/unit cashflow?

17

Yes, all of that is good. buy at a discount, Equity, $100/unit cashflow rule etc. I’m trying to impress the importance of understanding your market you are investing in. $100/unit today could mean $50/unit tomorrow, in a declining market.

18

Anthony,

Yes, you should buy at a big enough discount to ensure that you will receive at least $100 per unit per month in positive cash flow. Lightbeing is absolutely right that you should consider the market in your local area. For example, if the biggest employer in town is shutting their doors, then you might expect vacancies to go way up and you profit to go way down. On a more subtle level, people may slowly be leaving your area which would indicate a bleak outlook in the longer term. As I frequently say, you need to become an EXPERT in your local area.

The 50% EGI rule is inflating your numbers. That's why I don't like using it. You'll see at 50% that the expenses per unit are way too low. Even Marcus & Millichap is marketing this with a 62% EGI.

There is no 50% EGI rule that I know of. The “50% Rule” does not use EGI, it uses gross rents (or gross potential rents, if you prefer that term). So, when you say that the expenses are way too low, we/re talking apples and oranges. If you add the vacancies back into the EGI to get gross rents, we’re essentially at the same number. I’ve never heard of Marcus and Millichap.

Mike

19

Thanks Mike, good conversations we are having lately :beer

Right, the 50% rule is on the gross rents, my mistake.

Marcus and Millichap is one of the nations biggest brokerage firms. They handle Investment sales, Finance, Reseach and Advisory. They are the ones marketing this property.

M&M has the Gross potential rents listed at $230k and expenses per unit $2,784k(which is closer to the local average). It works out to be 62.9% of the Effective Gross Income.

However if you use the 50% rule on 230k = expenses at 115,000. That would be $2395/unit. In our examples, it’s even less because we are being conservative on the rents per unit. You see why they 50% rule doesn’t work, it bring the expenses down closer to $2000/unit when they should be closer to $3000/unit or $250/unit/mth.

20

Man 100/unit is harder to come by or needs rediculous downpayments. Would 80/unit be ok then I could work to lower expenses to get to 100/unit?