Multifamily property value.Please respond.

General Real Estate Investing
21

ok guys obviously I understand the fact that 4 months is not a whole year. And I also am not so naive as to think that a big expense will never happen out of the blue i.e. heating/cooling, roof, plumbing, electric, or whatever. I have enough properties and have replaced enough furnaces, toilets, decks, etc to know that.

To respond to what tatertot said about a $1,000 property costing $50,000. He’s 100% right, those numbers don’t work.

$50,000 @ 7% over 30 yrs. is $332.65, but you expect someone to pay you $1,000. No matter what state you’re in you’re not going to find a property bringing in $1,000 that you paid $50,000 for. And if you use you’re 2% rule, $50,000 is the most you’re willing to pay for it, so it’s safe to assume that you would pay less making this scenario even more unrealistic.

Let’s look at this from a cap rate point of view using $1,000/mth on a $50,000 price. That means you’re buying at a 24 cap. Those deals don’t exist, and if they did, well nevermind they don’t. The national average cap rate is 8.8 according to Moody’s. And you guys say you’re running around buying at a 24 cap or higher. What you’re saying is that you’re investments are performing about 275% better than the national average. I believe that you’re all good investors but noone is that good. Another thing working against the 2% method is that the public in general is way more savvy about real estate than say 10 years ago and are more aware of the value of their property and that makes it harder to get a real gem, not to say it can’t be done, but it certainly makes it harder.

22
ok guys obviously I understand the fact that 4 months is not a whole year. And I also am not so naive as to think that a big expense will never happen out of the blue i.e. heating/cooling, roof, plumbing, electric, or whatever. I have enough properties and have replaced enough furnaces, toilets, decks, etc to know that.

Obviously not. Otherwise you would have not made the ridiculous statement that your maintenance expenses are $7 per month. If you had the experience that you claim to have, you would understand the real operating expenses. You might want to do some research. All of the large apartment associations have extensive data showing that throughout the United States, operating expenses run 45% to 50% of gross rents.

I had a cracked manifold on a gas furnace about a week ago. The furnace needed to be replaced and the quote was $1,600 for the cheapest furnace they had. Think of what that would have done to your maintenance cost. Instead of 7 per month, you’re expenses would have been $407 per month. That’s only one maintenance item. You just don’t seem to have a clue about the reality of the situation.

The mistake you have made is a common one for new investors: that is to equate what happens in one month (or a short period of time) to the average that you will experience over time. Your average over time is what will determine whether your business will survive or not.

$50,000 @ 7% over 30 yrs. is $332.65, but you expect someone to pay you $1,000. No matter what state you're in you're not going to find a property bringing in $1,000 that you paid $50,000 for.

Again, this illustrates that you don’t understand this business. We’re not buying a $50,000 house and renting it for $1,000 per month. We’re buying a $100,000 house for $50,000 and then renting it for $1,000 per month. It is ALWAYS more expensive to rent a property than to buy the same property if the landlord is making money. Think about it. A landlord not only needs to make the payments, but he also needs to pay the operating expenses and make a profit. When you see properties renting for less than the equivalent mortgage payment, the landlord is subsidizing the tenant or has owned the property for many years and bought it much cheaper than the current value.

What you're saying is that you're investments are performing about 275% better than the national average.

The fact is that the vast majority of newbies fail in a short period of time. That is why there is such a huge turnover in rental properties. Therefore, if you don’t do better than the national average, you will certainly be out of business. Look at your deal, if I had several dozen of those, I would be out of business.

Forget the cap rate! You clearly don’t understand the cap rate and how meaningless it is. The cap rate is only as good as the numbers you plug in. When you are plugging in your artifically low expense numbers, your cap rate is garbage. Garbage in - garbage out. Regardless of that, the best that the cap rate does is compare your property with that of others. It doesn’t tell you ANYTHING about your profit or loss.

There are places where if you try to use the 2% rule, you will never ever be able to purchase anything.

So…? I guess you are saying that if you can’t find a property that will cash flow, you should just buy one anyway. Then what, pray for appreciation?

Clearly, we aren’t going to change your mind. It will all become apparent soon enough. Just remember these four little words: I TOLD YOU SO!

Mike

23

Do this for me, find me somewhere that says operating expenses are 45-50% of gross rents. I searched and searched for it thinking maybe I was missing something here and couldn’t find it. So if you could point me in the right direction that would be great.

By the way that furnace quote that you got for $1600 for a cracked manifold, I’m laughing at. I could have installed a whole new furnace for $800 because I do it myself. So actually I paid myself $800, which I think means I’m not working for free.

Tell me this, if we both walked into a big time bank and you started telling them that you buy based on 2% of the gross rents and I started quoting local cap rates, national cap rates, and how I only buy at a 12 cap and so forth who would look like they know what they’re talking about. That’s the last thing I’m saying about this, but I do appreciate the dialogue I learn a little bit from each of our conversations.

24
Tell me this, if we both walked into a big time bank and you started telling them that you buy based on 2% of the gross rents and I started quoting local cap rates, national cap rates, and how I only buy at a 12 cap and so forth who would look like they know what they're talking about. That's the last thing I'm saying about this, but I do appreciate the dialogue I learn a little bit from each of our conversations

That’s my point. You are TRYING to sound like a big time investor by quoting cap rates. Unfortunately, the cap rate is telling you nothing about the profitability of the deal. I have several dozen rentals and a ton of equity, so the banks will loan money to me and they certainly don’t expect me to spout nonsense to them. I have never had a banker ask for the cap rate for a SFH or small apartment building, because they know it’s bogus. Don’t be fooled, a smart banker will understand the rental business and will understand when he’s seeing bogus numbers. If you’re spouting meaningless and bogus numbers, they’ll just know that you’re a newbie.

You can find the expense data at the National Apartment Association or any of a number of other large apartment associations.

Mike

25

OK, guys, don’t fight.

Real estate is local and buying with the 2% rule works in some parts of the country, because some people are doing it.

Buying with the 2% rule is impossible in other parts of the country and those of us who live there can’t use that rule. We use other tricks.

No one is going to be much of a success in real estate if they don’t know what the expenses are going to be and they don’t have any way to come up with that money.

On every real estate cycle, locally there are outsiders who come in and speculate and a lot of them lose. But that doesn’t mean the locals and the incomers who study the market and how it is played locally aren’t making any money.

$50,000? You know what I can buy for $50,000? A recreational lot. That is a “building” site that has been turned down for a septic permit so it can’t be built on. People set them up as private RV sites to use when they come to vacation. Yes, they sell for that much, and yes, they sell relatively quickly. And no, I am not going to get $1000 a month rent for one of them.

A really cheap rental would cost a little over $200,000 and it would be hard to find tenants for it at $900. $800 would be a lot easier. The local tenants really do not like those houses, and I wouldn’t even consider buying one of those. They were built for the incoming speculators. You know, the guys who didn’t learn the local market.

A decent small investment house is about $350,000 and rents for about $1,000-$1200. Yet here I am, and I’ve been here for 30 years. I am supporting myself entirely with my real estate. There’s plenty of money here if you play by the local game plan.

On the other hand, I would never try doing what I am doing in Indiana. In Indiana, you find out what the successful local investors do, and that’s what you do.

26
Buying with the 2% rule is impossible in other parts of the country and those of us who live there can't use that rule. We use other tricks.

C’mon Tatertot, there ARE NO TRICKS! This is a business, not a magic act. Either a property has a positive cash flow or it doesn’t. The math does NOT change with where you live. You can make almost any property cash flow if you put down enough money, but you still have the opportunity cost of that downpayment.

So, exactly what are you talking about? What TRICK do you do to make a bad deal become a good deal? Or are you talking about speculating on appreciation?

Mike

27

I will tell you the 2% rate is another tool to use. After reading this column and having property manager reply to one of my questions it changed my strategy. I found 3 properties out of 15 that my realtor sent me that fall into the 2% formula. The properties are out their. I have my realtor doing a walk through before I look at them.

Thanks for the education

Mark

28

For those of you thinking about or currently using the 2% rule for multi family projects try something. Google phrases such as “2% rule” or “2% rule multi family” and see how many returns you get, 0. Next Google “cap rate”, “capitalization rate”, “cap rate multi family” something along those line and notice the unlimited amount of information you can look at. If you don’t believe me that the cap is the most widely used and accepted formula for evaluating properties the simple fact that there are millions of hits for ‘cap rate’ but not a single one for ‘2% rule’ or anything else along those lines should maybe carry some weight.

29

I am sure you are right about that, however my understanding is that the cap rate formula may not accurately determine the expenses you will incur as an investor. I too looked at cap rate until I read this post. Using the 2% rule gives you much more leverage and you are buying at a deeper discount.

30

Around here I buy for equity, not cash flow. You can’t buy cash flow here; you haven’t been able to buy cash flow for the entire 30 years I’ve invested in this area.

I put more money in, carry more equity. I don’t expect every property to stand independently; older properties help carry new purchases.

Yes, we get appreciation. Sometimes we get a lot of appreciation. It runs in cycles. When prices are going up, investors can flip and build spec houses. When prices are going down, I do buy and hold. I see other people are starting to do lease options (I don’t know how that is working for them, I don’t know anyone who is doing it, I just see the ads)

People who know the local market expect the price cycles and they expect to ride them out.

There are lots of ways to make money besides cash flow. Build spec houses, subdivide land, buy out in front of development and wait for it to catch up to you. Buy without cash flow and wait for rents to catch up. Buy timber. Buy apartments and convert them to condos. Buy property that can have value added. Do equity splits.

It doesn’t matter what math you use. There is nothing in this area that can be bought for $50,000 and rented out for $1,000. Anyone who insists that they can only buy real estate with the 2% rule is going to be investing in the stock market, because they won’t be buying any real estate in my area.

31
If you don't believe me that the cap is the most widely used and accepted formula for evaluating properties the simple fact that there are millions of hits for 'cap rate' but not a single one for '2% rule' or anything else along those lines should maybe carry some weight.

JBaldwin,

OK, since you’ve done extensive reading on cap rate, here are a couple of questions for you?

Where are you getting the market cap rate for your area? How did that person or entity get accurate expense data (who did they get it from) so that they could determine NOI?

Even if you could get a market cap rate, what does that tell you when YOU don’t know what the actual expenses are for YOUR property and are using ridiculous expense numbers like maintenance of $7 per month? You see, even though you supposedly knew all the cap rate nonsense, it didn’t do YOU any good because you compared a ficticious cap rate for your property to an inaccurate (imaginary) market cap rate.

Why do you think the vast majority of newbies fail in a short period of time?

You can't buy cash flow here; you haven't been able to buy cash flow for the entire 30 years I've invested in this area.... I don't expect every property to stand independently; older properties help carry new purchases.

That’s my point exactly. You can either follow the 2% rule (which is nothing more than a simple math equation) or the property will not cash flow properly. Where you live has absolutely nothing to do with the math. If you can’t buy properties that are very close to the 2% rule, you don’t have adequate cash flow. It’s that simple. That’s the mistake Jbaldwin made.

There are lots of ways to make money besides cash flow. Build spec houses, subdivide land, buy out in front of development and wait for it to catch up to you. Buy without cash flow and wait for rents to catch up. Buy timber. Buy apartments and convert them to condos. Buy property that can have value added. Do equity splits.

In other words, if rentals won’t work in your area, do something else!!! Again, my point exactly!

Mike

32

Am I missing something here?..Following the 50% and 2% rules equate to a 12% cap rate and a 50 Gross Rent Multiplier for those of you into using the GRM rule…Sounds like you guys are talking about the same thing…

JB - If you’re looking for 12% cap rates, then you’re following Mike’s 2% rule, but just calling it a different animal…

33
Am I missing something here?.....Following the 50% and 2% rules equate to a 12% cap rate and a 50 Gross Rent Multiplier for those of you into using the GRM rule...Sounds like you guys are talking about the same thing...

JB - If you’re looking for 12% cap rates, then you’re following Mike’s 2% rule, but just calling it a different animal…

Buffinvestor,

What you’re missing is that they he’s not using the 50% rule for expenses or the 2% rule for maximum puchase price, not even close. What he’s doing is using an imaginary expense figure with no management expense; $2 per month per unit maintenance expense; no tenant related expenses (evictions, legal fees, etc); no capital expenses (although not technically an operating expense), no advertising expense, no office supplies, etc, etc, etc, etc.

So, obviously what happens when you put garbage into an equation is that you get garbage out of the equation. When the expenses are garbage, the NOI is garbage. When the NOI is garbage, the Cap Rate is garbage.

For the property he purchased, the gross rents are $1,750 with a purchase price of $135,000.

So, here is how the cap rate really looks.

Gross rents: $1,750
Operating Expenses: $875
NOI: $875
Purchase Price: $135,000

Cap Rate: 7.7% (not 12%), which means that in this case there is a negative cash flow of $69 per month.

You are correct, IF he had used the proper expense numbers (50% rule) and IF he had bought using the 2% rule, that would have been the same as a real 12% cap rate. However, since he didn’t do that, he has a property that will lose money over the long term.

Moreover, another important distinction is that he is basing his purchase price on a mythical market cap rate that he is apparently getting from a realtor. Most rental properties are purchased by newbies. Most newbies fail in a short period of time. When you base your purchase (of SFHs and small multis) on the market cap (which is a garbage number to start with), then all you have done is pay what the losers paid for their property.

Mike

34

This is my experience with CAP rates:

The figure that the realtor puts into the listing is totally worhtless. In order to get a Cap rate attractive enought to get investors to take a look, the agent leaves out all sorts of expenses. (and that is in 100% of the commercial properties I’ve looked at)

Anyone who wants to use cap rate to decide whether or not to make a purchase, had better be doing their own figuring to come up with the cap rate. And that means hunting down the real costs: you have to call your insurance agent; you have to call the power company; you have to refigure the property taxes, because they are going up when the property changes hands.

Then, in addition to the cap rate, you have to look at the area, you have to look at repiars needed, and you have to go and find out what sort of new develpment and changes are on the schedule for the surrounding area.

I don’t do cap rate and I don’t so the 2% rule. This is how I figure it. First, I decide if the property is something that I would like to own. If not, we are done. If I want it, I add up all the income. Then I add up all the expenses. Subtract the expenses from the income and if what is left over is enough to make me happy, then we start negotiating to try to purchase.

35

I’ll say this again. Cap rates are important but are not neccesary to evaluate a deal. Do your cashflow analysis. If you feel comfortable with determining the cap rate % to make sure it’s inline/above/below market rates, fine. But the bottom line is your bottom line i.e. cashflow.
COCR is crucial.

Cap rates are still a very important part of understanding your market/submarket and making future projection. If your plan is to buy and hold, well you need to have a formula to project the outcome. Cap rates(past and present) and certain market trends will help predict future value.

I really don’t like to generalize anything. Your evaluation needs to be specific. Verify and confirm all expenses. In my market, I know what the typical expenses are per unit per asset class.

Investors using Cap rates only presented to you by brokers and sellers is a recipe for disaster. On the other hand, Brokers love to use cap rates, or should I say inflate Cap rates. They know a high listed cap rate regardless of actual performance will draw attention. That is a common mistake by newbies. They focus on Cap rates and what the interest rate on the debt service is/can be, and mathmatically trick themselves into the deal. But the truth is, in the end, most of, if not all of the spread, will get eaten up by the actual expenses.

36

Hello. I am looking into doing some multi-unit investing in about 8 months, so i am trying to learn what I can now. Although the following 8 unit apartment complex does not appear to be a good deal I want to be sure that I am doing all of the calculations correctly.This is simply an example I found in the local paper

$55,600 annual income (Does not give rents, so i am going to assume 55600/12 = 4633 (total rent) / 8 = 579 a month per unit rent

4633 / 2
2317 for expenses
2317 Net Income - mortgage

Building cost $624,000 * 7.5 = $4680 mortgage payment.

Did I do this right? Obviously, this building is way over priced when using the rules that have been set forth.

Now what if I was able to offer $231,670 = $4366 / .02
So monthly rents $4633 / 2
2317 expenses
2317 Net income - mortgage
Building cost $231,670 * 7.5% = $1738 mortgage
$2317 - $1738
= $579 total profit / 8(# of units)
Equals a profit of $72.38 per unit, per month, which fits in with what you guys are saying.

If any of this is incorrect please let me know…

37

roostking,

You used the formulas correctly, however I didn’t come up with the same mortgage payment that you did. For example, a $231,670 mortgage for 30 years at 7.5% interest gives a payment of $1,619. I didn’t get $1,738 for 20 or 25 year terms either.

Mike

38

Once again, the 2% rule will steer you towards unrealistic goals and subsequently unrealistic offers. You go around offering $231,670 for buildings that are priced at $624,000 and see how long your reputation lasts. The problem once again with the 2% assumption is that you are using a GRM of 50, again unrealistic. Read over this story and you may reevaluate your usage of the 2% and GRM valuation methods.

http://ezinearticles.com/?Say-Goodbye-To-The-Gross-Rent-Multiplier&id=303508

happy holidays!

39

jbaldwin,

Once again, all one has to do to judge the viability of your argument is to look at YOUR DEAL! YOU bought a rental that will LOSE money over the long term because you paid too much using your imaginary cap rate and ridiculously low expenses (claiming $2 per unit per month in maintenance, for example).

Once again, let me clarify that it DOES NOT MATTER what the asking price of a property is. It also doesn’t matter if 99.999% of the properties in a given area won’t cash flow. If you want to have an acceptable cash flow from a property, the rent needs to be a minimum of about 2% of the acquisition cost. This is simple math. The article is right, if you are paying very high interest or there are unusual factors, you may need to pay EVEN LESS for the property, meaning that the rents need to be MORE than 2% of the acquisition cost. That is why the 2% rule is a screening tool and you still need to do a cash flow analysis WITH REAL WORLD EXPENSES.

Mike

40

Thanks for the help guys, I dont know if im doing my math wrong but I get the point. I am concerned with my ability to find a deal that is suitable given the market of the last few years, unless of course they are in foreclosure, but I will certaiinly try!

Rk