I’m just now trying to figure out Cap Rates, etc. I own a house with an NOI of $1010. My Cap Rate comes out to be 6.73%. My COCR is .59%. So my cap rate is acceptable I think but the cash I’m getting out of it each month is quite minimal. I’m just wondering why the Cap Rate seems to be more important in these forums.
scottpull - where did you get the idea that cap rate is more important in these forums? Maybe in the Commercial forum…
When I first start reading I was surprised to see how much emphasis is placed on positive cash flow. Actually my feeling is that we hardly ever talk about cap rate. And after thinking about this, it make sense to me… in the end of the day if you get a property that puts money in your pocket every month, you have a good deal…
And based on your post it seems that you are reaching the same conclusion…
And on a side note - I don’t think 6.75% is a good cap rate. I am getting 6.01% on my checking account right now. I wouldn’t take the risk of owning investment properties to get less than 1% more… Just my 2 cents.
Good luck!
Cap rates are meaningless in the world of single family rentals. Just worry about collecting your rents, managing your expenses and having positive cash flow after ALL expenses are accounted for. Cap rates are useful in the world of commercial income producing properties as a yardstick for valuation.
Please let us know where you are getting 6+% on your checking. Thats the best rate I’ve heard of for a long long time.
jmd_forest
A
jmd_forest - Arizona Bank & Trust - 6.01% on checking accounts with balance up to $20k. :O) The only inconvenience is that they have only 6 branches and none is really close to me… whenever I need to go there I have to drive 15 miles… :O(
To get the rate you need to:
- do 12 no-PIN card purchases per month (you have to sign, not key your PIN).
- sign for electronic statements
I have been with them for 5 months now. So far so good.
Good luck!
6.73% CAP? That sucks. Sorry, but an investor should get paid more than that to take a risk. I believe a person should get no less than a 20% APY on a long-term fixed asset (aka real estate). On a shorter term fixed asset (say one with a life cycle of less 7 years or less) I expect far, far higher APYs. And I get them every time, otherwise I don’t make the investment.
Do you mind sharing all your numbers on the deal?
Scotpull,
Forget the cap rates! “Investors” of SFHs and small multis who talk about cap rate are simply trying to impress you with the lingo.
A cap rate of 6.73% is a TERRIBLE deal that will bleed cash over time. Using a big downpayment to buy cash flow does not change the quality of the deal. A truly good deal would have a cap rate of at least 12%. However, as I said, cap rate is just a big joke for SFHs and small multis.
What you need is CASH FLOW! Cash flow is the money that is left over after ALL the real world expenses AND the debt are paid. Personally, I won’t buy a property unless it has at least $100 per unit per month of positive cash flow after ALL real world expenses are accounted for and considering 100% financing (whether I’m using 100% financing or not).
Good Luck,
Mike
Mike,
I usually buy all cash with no intention to refi and I use the cap rate to compare what I would get from the property against the current return of my money. My goals for purchase are 10% Cash on Cash and 30% equity. However, in this area it is almost impossible to achieve. Prices are still high and rents are still quite reasonable. The type of properties I try to collect are generally FMV between $190K and $255K and rents are about $1500/month with taxes around $3600. Other expenses can run from $2K to $4K/year depending upon association fees and other variables.
Even when I buy at around 65% of FMV its still very tough to get better than 8% return. Maybe I’m too limited in what I will buy or the areas I will buy in, but I know the market in these areas well and since I am a hands on rehabber and manager, I don’t to be traveling more than 30 minutes to a property.
jmd_forest
These numbers tell me that you have expensive financing on this $15K property and/or your rent is too low. Perhaps you made an error in your calculations.
A COCR less than 1% is just above break even. Your numbers suggest that your debt service is eating up nearly all of your NOI. You are not putting any money in your pocket with this property. Future appreciation at this price point really needs to be dramatic for you to want to hold on to this property.
If you had taken the same cash that you invested in this property and put it in six month CDs instead, your COCR would be right around 3% in today’s market – just over 5 times greater than you are getting now.
What is the interest rate on your financing? Is it higher than your cap rate?
If your numbers are accurate, my suggestion is to dump this property and invest elsewhere for a better return.
Well thanks for all the input. I’m trying to figure all this out. I bought the house for around 175K three years ago and financed it for 5.5%. I forget exactly what I put down on it but it’s worth about 180K now and has about 56K equity in it. The monthly payments are 869. The rent is 1050/month. Whoops! I just realized an error of mine. I forgot the taxes were included in the payments. I was adding them to my expenses. Correcting this I come up with a COCR of 3% and a Cap Rate of 6.73%.
I own 4 houses total. Bought all of them 3-5 years ago. 3 are paid off. The one above is the only one I have a mortgage on. I have about $780K equity built into all of them. The tenants have been very good thus far and houses have appreciated well on average. Actually this varies a lot from house to house. I am financially independent although I just make ends meet. I’m in the process of trying to really invest and go into multi-family units. So far it’s really confusing. Trying to understand the numbers and so forth. I’m getting better at it though. I live in Albuquerque and haven’t seen much that I’d want to buy. Lots of low end stuff that might make sense financially but I don’t want all the headaches of low end tenants. Mid range tenants and above is what I’m aiming for.
scottpull,
Two weeks ago I spent a whole weekend in Albuquerque looking for student housing for my son, a 2nd year student at UNM. Students were lined up 3 and 4 deep inside every house with a “For Rent” sign on it near the University. Landlords were saying, “You’re third in line, do you want an application?”
So It seems like everything within a mile of the hospital and UNM is in great demand. There are some charming neighborhoods there with unique architecture. We finally found a house for $1500, about $500 more than we had wanted to pay, but so close that no parking permit is needed. Three students will share the rental, a fair deal all around.
If I were in Albuquerque I would be looking to buy right in that high-demand area. I would be furnishing those houses/ apartments too, and getting more rent. This would make parents really happy! I would be using sturdy, indestructible dorm-type furniture bought in yard sales and thrift stores.
Instead I’ve got to rent a truck and drive a bunch of furniture there for 3 and 1/2 hours one way, as my son’s roommates are from South America and Chicago, have no cars and yes, I do have six garages full of furniture.
What a great market the student rentals could be!
Furnishedowner
If you bought the house for $175K and have a cap rate of 6.73%, then your NOI calculates to $11777.50 – quite a lot more than $1010. Since your monthly rent is just $1050, I think you are mistaken on your numbers.
How much do you pay in property taxes, hazard insurance, flood insurance, earthquake insurance, legal fees, license fees, cleaning, maintenance, repairs, leasing fees, advertising, HOA fees, utilities, and management fees throughout the year?
Starting with a gross scheduled annual rental income of $12600, I am guessing that your costs of ownership and rental operation take about half of your rental income. This reduces your net operating income to $6300 per year. Dividing by your purchase price, this gives you a cap rate of 3.6% provided you have 100% occupancy and 100% rent collection. The cap rate is even lower if you have a vacancy during the year.
Now I am assuming that you only have $6300 to cover your debt service. You don’t tell us whether your $869 monthly payment is PITI or just principal and interest. I am going to guess that it is PITI. Since you say your equity is about $56K, and only $5K of that is due to appreciation, then $51K of your equity came from your intitial downpayment and the principal payments you made each month. In three years, you probably paid down your loan balance about $5K, so you probably put about $45K down. (As an aside, how did you calculate your COCR if you don’t remember how much you put down?)
This means that you financed $130K, which at 5.5%, gives you a monthly principal and interest payment of about $738 or $8856 in annual debt service (assuming a 30 year loan). By my calculations, you are $2556 in the red each year.
Your cash on cash return is a negative 5.6%. Your cumulative negative cash flow of $7668 after three years is offset by only $5K appreciation. You are losing money on this property before taxes.
Let’s assume that you are in the 25% tax bracket and your modified adjusted gross income is at or below $100K so you have the full $25K passive loss allowance available to you.
A negative cash flow of $2556 probably gives you a rental loss of $785 because the principal payments on your loan are not deductible. Add to this a depreciation expense of about $4500, you have a Schedule E loss of $5285 for this property which gives you a $1321 tax benefit.
So, even after taxes, you are still $1235 in the hole at the end of the year.
Unless you have a compelling reason to hold onto this property, perhaps you should consider selling and investing in more profitable properties.
Just how I see it.
If you’ve been reading past posts in the forums, you’ve seen people talk about getting about 2% of your total purchase price as your monthly rent. If you’re getting $1050/mo, that’s not good for the amount you probably financed (assuming around $130K as Dave T listed). You don’t need a bunch of financial calculations to tell you that. It sounds like money from the other paid off properties you have may be subsidizing this one.
Really? That seems high to me.
With the duplex I’m looking at right now, I calculate my Principal + Interest payment to be $731/mo, and based on rents in this area I’m pretty confident each unit will rent for $750/mo. I figured that was pretty good. According to the 2% rule you mentioned though, that would mean I’d have to collect $1,100/mo per unit based on the $110,000 borrow price, or I’d have to negotiate a $139,000 listing down to $55,000. Either way that seems like overkill yeah?
Either way that seems like overkill yeah?
Overkill? Not hardly. Throughout the Unites States, operating expenses run 45% to 50% of the gross rents. You didn’t even mention operating expenses. Here is how I see your deal:
Gross rents: $1,500
Operating Expenses: $750
NOI: $750
Mortgage Payment: $731
Cash flow: $19 per month or $9.50 per unit per month.
Personally, I think like $100 per unit per month and I wouldn’t buy a property with a cash flow of only $9.50 per unit per month.
Good Luck,
Mike
Lol, yeah overkill probably wasn’t the best word. Nothing’s really overkill when you’re talking about cash flow.
I see what you’re saying here though. I was not as conservative with my operating expenses, and put them at 30%, which would have given me a cash flow of $300 /mo. That was probably a mistake on my part. I got that number from a book called “The complete real-estate investing guidebook” from David Crook of the Wall Street Journal. He said operating expenses COULD run as much as 25%-45% on larger units. I guess since I figured it was an owner occupied duplex which is also an REO from a failed flip with all new amenities, I took the low road with only 30% operating expenses. I would listen though if you thought that was not conservative enough.
Living in one half of the duplex does not change the character of the deal unless you are going to live there forever. There is NO WAY that operating expenses run 30% for rentals over time.
Why not list the expenses that you know for this property and we’ll take a look?
Mike
I’ve been preaching student housing for a while on here, finally someone else sees the light. Great thing about student housing—it’s not driven by the external economic factors such as employment, etc. It is a demographic driven industry and if you do any sort of quick research you will see the business is thriving but it hasn’t attracted the attention of many people outside of the business. The first publicly traded student housing company only came about in 2004.
I’m already looking into UNM–thanks for the heads up!!
I don’t really know all of the operating expenses. This is my first endeavor into real estate, so just used the 25%-45% operating cost rule of thumb from an investing book, but best I can figure at this point:
Mortgage Insurance: $135/mo
Trash: $20/mo
Snow/Lawn Care: $100/mo
Total: $255/mo
That’s only 17% so I’m sure I’m missing stuff like attorney’s fees, and license fees, but I just don’t have enough experience to know those at this point. Beyond operating expenses though,
Mortgage: $732
Insurance: $50
Total: $782
Aside from that, based on rents in the area both units should go for $750/mo
Gross Income: $1,500
This is as far as I’ve gotten, thanks for looking though. :dance
You’re missing a bunch of stuff. You didn’t list taxes, advertising costs, vacancy allowance, maintenance, repairs, tenant damage, gas/mileage for showings & repairs, business supplies, etc.
Some things you’re not going to know (i.e. how many evictions will you have, how much tenant damage, how much you’ll spend for maintenance/repairs, length of vacancies). That’s why it’s generally accepted here that we evaluate properties based off 50% operating expenses. You build in that extra buffer. You may not need it now, but in the future something may come up.
So you start your evaluation with this process. It will help you arrive at a purchase price where you should still make money. You still need to evaluate the items that will be known expenses (property tax, insurance, any utilities you might pay, HOA fees, lawn care if you hire it out, etc) and see how much money is left over after that. If you just barely have enough money to pay the mortgage at that point, you should negotiate a lower price or move on. If you don’t have much money after the mortgage is paid, the other “unknown” costs above will eat away at your finances over time.