RBallard,
Where in NE Penn r u talking about? Oh, FYI, my entire family is from Scranton/Dunmore/WikesBarre…I am very familiar with that area…
Sunny,
Cap rate is a ratio of income to value. More precisely Cap rate = Net Operating Income (NOI) divided by Purchase Price. Net Operating Income (NOI) is gross rent minus all expenses EXCEPT the mortgage (P & I).
For example, if the yearly net operating income for a property is $10,000 and the property cost $100,000, then the cap rate is 10%.
Many investors use this formula to decide what to pay for a property. They do this by dividing their expected NOI by the cap rate they desire to get the expected purchase price of the property.
A higher cap rate gives you a higher rate of return.
Here’s a real life example (I rounded to make it simpler).
I have a 6 unit apartment building that I paid $88,000 for. The NOI is $19,000. This gives a cap rate of 22%. GREAT - right? Answer - no, it’s pretty good but not great. I borrow all my loans with a 20 year term and the mortgage payment per year is 8,000. This leaves an annual positive cash flow of $11,000. Great - right? Again no, it’s pretty good but not great. How much is that per unit per month - only $152!!! This is with me managing the building myself.
If I paid a 10% (of gross rent) management fee, that would take about $2,500 off my profit (gross rents are $25,000). Throw in the added expense for maintenance that you’ll be paying, higher insurance for student housing and drunken students trashing the place on a regular basis, and what do you have left? My estimate is that the cash flow would be reduced to $6,500. Now, we’re down to only $90 per unit per month. This is at a cap rate of 22%!!!
Now, buy the same apartment building with a cap rate of 8-12% as 4EEM suggests and what do you have??? You do the math!
Managing the building yourself and being able to do minor maintenance makes all the difference in the world.
Mike
When I figure cap rates I expense with property management, Maint and Rehab.
Management: 7%
Yearly Rehab: 6%
Yearly Maint: 5%
“I have a 6 unit apartment building that I paid $88,000 for. The NOI is $19,000. This gives a cap rate of 22%. GREAT - right? Answer - no, it’s pretty good but not great. I borrow all my loans with a 20 year term and the mortgage payment per year is 8,000. This leaves an annual positive cash flow of $11,000. Great - right? Again no, it’s pretty good but not great. How much is that per unit per month - only $152!!! This is with me managing the building myself.”
Using property managers example of $88,000 purchase price, $19,000 NOI and assuming 20% downpayment with an 8% interest rate on a 20 year term you have a 67.81% return on investment.
Any one have any stocks or bonds that have an annual ROI of 67.81%?
How many people do you know that are sucking dust on rentals banking on market appreciation?
With the numbers that property manager is showing he could put his $88,000 property on the market for $160,000 and have it sold in less than 45 days easy.
But hey, “it’s pretty good not great” I’ll give you $120,000 for it.
Pat,
Actually, my return on investment is infinite, because I didn’t have any money out of pocket. I deal with small, local banks that will loan based on the appraised value of the property, not the purchase price. I have yet to find a mortgage broker that can do this. (I don’t know about others on this board, but if I had to put down 20% on every deal, I either wouldn’t have many properties or wouldn’t have any reserve.) This property appraised at $135,000 but I wouldn’t sell it. I’m in this business for the cash flow and I consider $152 per month per unit VERY marginal. Personally, I would’t do this deal if I had to use a paid property manager or had to hire out minor maintenance. It doesn’t take many service charges at $50-$60 a pop to destroy your cash flow.
You can’t take any one factor (such as rate of return, cap rate) on a property and decide whether it is a good deal. In my above building, even if my total annual profit were $1, I would still have an infinite return because I don’t have any of my money in the deal. However, a $1 profit certainly wouldn’t justify the risk of being in business.
What’s more, my point is that California investors are foolish to come all the way to Ohio to invest when there are 3,000 miles of good deals between here and there. Personally, I’d like to be close enough to my investment to check up on it once in a while.
Mike
Mike,
Many of the multi-unit rental properties being purchased in Columbus are being bought by investors from CA and DC. I do not see these properties going to the auction.
I’m not proposing that anyone do anything that is not already being done.
IMHO if your going to invest in rental properties it is better to do so with a responsible property manager in another state than to sink money into a property with negative cash flow a couple blocks away.
“…local banks that will loan based on the appraised value of the property, not the purchase price. I have yet to find a mortgage broker that can do this.” I can… If you’ve got great credit, you don’t actually need the loan to purchase the property and the property has great cash flow.
I just want to note that I respect Mikes opinon. I have my professional opinons and Mike has his. At the end of the day any investor must know what amount of risk they are willing to subject themselves to and for what potential return.
Face it. Some people get burnt in real estate and others do very well in the long-term. Real estate is not the best investment vehical for everyone. The bottom line is this: If you do decide to invest in Ohio there are capable people here to give you support.
Best wishes from Ohio.
Pat Lawson
Dell Investor:
I’m in Dunmore. My main market is the areas around Scranton, which I’m most familiar with, but I have decent knowledge about the Wilkes-Barre area too.
The lowest 6-unit I have found in my area was for $319,000’
Ohio might be good after all
RBallard,
I don’t see much appreciation in that market. Prices have pretty much stayed the same as far as I can tell. Unless I have missed something. Do you purchase in that area to earn rental income as opposed to the appreciation?
Now I do know that some area in Pike County have appreciated nicely.
Dell, you’re totally right. If appreciation is what you’re looking for, Scranton-Wilkes-Barre is a bad place. But here’s the scoop on rentals: You could pay retail (which who does that?) right now and still cash flow above minimal margins. For example, a 100k property (retail price) would gross $11-1200 month for two units. So if you had a traditional loan, your mortgage would be what, $650-700/mo? Obviously there are other cost factors, but as you can see, there’s plenty of wiggle room. As far as rehabs, which is my main thing, there are plenty of distressed properties… some in good rental areas, some in good resale areas and of course ones you don’t want.
RBallard,
Just curious but how is the Greenridge section holding up these days?
Greenridge is definitely the nicest part of Scranton. There a few houses scattered about that could use some fixing up, but for the most part it’s a nice area. Scranton is mostly full of renters, but Greenridge attracts buyers, due to its nice Victorians and Cape Cods. In fact, I saw in Greenridge the other day that they’ve started building some condos… based on the starting price (I think it’s like 220k) they should be pretty nice. I can’t tell exactly how many they’re building, but it’s a base of five… nothing on the sign to indicate if it’s just one row.
Mike (PropertyManager),
Thanks a lot in helping me understand this game (Not that I understand it fully anyway now).
Couple of Q’s for you:
-
Why do you borrow all your loans with a 20 year term ?
-
What percentage interest did you figure for that Mortgage ?
-
When you say 19000 is NOI with gross rent of 25000, that means it costs you 6000$ to do maintenance and other nuisance of maintaining the property? Are these repairs mainly ?
-
How many hrs per week, per day, per month does it cost you to hold this property?
-
“Throw in the added expense for maintenance that you’ll be paying, higher insurance for student housing and drunken students trashing the place on a regular basis”.
Is this cost not included in 6000 $ mentioned in 3 above ?
- Do you do anything else as well other than maintaining this property (and other properties) as well, I mean do you have another full time job as well?
See, I am not a very handy man and ‘will’ need someone to do all this. What that means is that I will have to get properties at cap rate of 30 to 35 % in order to make any money.
With pros like you working at 20% cap rate, I do not see any chance of survival out there 
Are cap rates for commercial different than residential. Somone sent me some comercials which are leased and occupied with cap rates of 10% etc. Is this a different animal ?
Sunny
Pat,
I am assuming, these are %age on Gross rent , right ?
Pardon me if I am too naive to make following statement.
Wondering, if rentals bringing in 8 to 10,000 a year are worth the effort.
Why not buy a pre-construction and sell it for 8 to 10,000 $ in Florida or soeting else ?
Sounded like too much work and stress for 8 to 10K as Mike (PropertyManager) explained.
Only if I can find someone to partner with to do the work and I can be a sleeping partner 
Sunny
I’m sorry, but it’s illegal to invest in Ohio.
LOL…stop Mike, you’re killing me! I think it’s illegal to investg here, too!
Keith
Sunny,
In answer to your question:
- I buy all my properties on a 20 year term so that I will get them paid off sooner. Once they’re paid off, then you’re really making some money!
- Currently, I’m expecting interest rates of 7.25% for investment properties (no points).
- With gross rent of $25,000 and NOI of $6,000, that means that expenses are $6,000. Expenses include taxes, insurance, maintenance allowance, utilities paid by the owner, management fee (if any), vacancy allowance, etc. It does not include abnormal damage such as tenant destroying the house.
- If you mean how many hours per week do I spend working on any given property - none. Once the properties are rented, you don’t have to do much unless there is a problem. However, I do work many hours per week rehabbing new acquisitions, cleaning out vacated properties, etc.
- No - see #3.
- I don’t have a job and thankfully haven’t had one for about 15 years.
You don’t need to be very handy - you can learn. Prior to becoming a landlord, I had never changed a toilet. Now I can change one in my sleep - really - without even waking up! Seriously, go to Lowes and get their home repair manual. It contains everything you need to know to be a hands on landlord.
Commerical properties are a completely different animal. They can be very profitable, BUT they can stay vacant FOREVER (or close enough to it to make you cry BIG tears).
See you at the REIA meeting!
Mike
CORRECTION,
In my last post, #3 should have said:
- With gross rent of $25,000 and NOI of $19,000, that means that expenses are $6,000. Expenses include taxes, insurance, maintenance allowance, utilities paid by the owner, management fee (if any), vacancy allowance, etc. It does not include abnormal damage such as tenant destroying the house.
Sorry for the confusion.
Mike
Thanks a lot for the clarification Mike.
I unfortunately still have a job (Software Consultant) and an IT Company to run with investments in INDIA as well. I have to be very carefull on how much do I take on.
Would love to do some joint ventures though
See you today evening REIA
Sunny
i think metro columbus is a great area, especially for a beginner like myself. you aren’t going to make a boatload on appreciation, but you can buy good cash flow properties that are pretty easy to rent.
i’ve thought about investing out of state, but it doesn’t seem very realistic. you have to have great trust and faith in somebody in the local market to partner with IMO.