I was just looking at GKARL’s (hope you don't mind, GKARL) potential purchase of a 2.3% deal, (I calculate a cap rate of 18%) and wondering, am I foolish investor?

At my “best” house (one of 4), I put in 385k total (305k purchase and 80k improvements, since 2010) and now I get:

Rents: 70,800

Taxes: 12,700

Insurance: 1900

Repairs and maintenance: 4,350

Utilities I pay 1200

Vacancy 0

Net income 50,650 (not counting interest expense)

So this would be a “1.5% deal” with a cap rate of 13%

Using an average yearly GRM 9.6(avg around here) gives a current value of 680k, so I figure there’s an appreciation of 11% per year of the property.

My cap rate of 13% is 5% worse than GKARL’s rate of 18%, but my 11% yearly appreciation may make up for my lower cap rate (don’t know what GKARL’s appreciation is) so maybe my deal is good.

What do you think, am I a foolish investor? I did note at the beginning that this is my “best” house, in terms of return.

Oh, and thanks for any input you can give me!- Bill

That is my best property. Maybe I should have averaged all 4.

Yes, $5,900 per month. This includes 8 bedrooms, 5 baths, common space furniture and home theater.

I post because I always see people talking about 2% or better deals(month rent/purchase price) and I'm lucky if I get 1%.

I'm with the others on the "wow" factor as that rent would get you a decent place on Manhattan island.

Real estate markets are local. "Good deals" here are screaming deals or bad deals elsewhere. You have to decide your goals and plan accordingly.

Cap Rate recognizes only the "capitalization"... the amount of capital invested to produce the return. Since appreciation is a guestimate and the value will not be known until sold, it is not considered along with regular income net of expenses. So I don't think what you're doing is in any way foolish (looks pretty wise to me!), but Cap rates are typically only for commercial properties, not so much houses.

In a post earlier today, I talked about how commercial property is values based on income vs. SFH's are based on locations and amenities (i.e. the neighborhood). They are two distinct beasts and comparing via Cap Rates is about the only way to do it, although most investors don't run cap rates on SFH's. I do, just for kicks, but I realize I cannot force a gain in cap rates by lowering costs or raising rents. The sale price is determined by the neighborhood and what owner-occupant buyers are will to pay mostly independent of income.

One thing I noticed: your numbers are off when considering Cap Rate.

Repairs and maintenance budget are very low (6%) even for a freshly rehabbed property. 10-15% is more typical. Even if you do all the labor and "save" some of that money...what you're really doing is just working for free...bleh. Budget it.

No budget for management. Budget for it even if you pay that amount to yourself, or else you're buying a job same as with doing your own maintenance. 10% of gross rent is typical.

No budget for capital expenditures. Budget for it. That new roof HVAC system will wear out in 15-20 years. 5% of gross rent is typical.

I suggest reducing your net income by about 20-30% to cover the changes and re-run your calculation with more real-world numbers...if you want a true Cap Rate and anything an investor would consider legit "passive" income. Profit only comes after ALL expenses, whether your pay yourself or not.

No vacancy rate? need at least 8%

Maint and repairs 25% -- you only have 6%.

Not for me. Numbers seem ok but anything goes wrong you've got a big negative cash situation. Also, repairs on a place like this would likely be expensive.

For 385K, I could get 15 places @25K each and at 500 rent each get 7500 rent a month gross or 90K a year before expenses. Even at 50 percent expenses that would give about 45K a year, so close to the same.

You don't show any expenses for management or some other things either.

Richard MI this is where monopoly experience comes in. do you want 11 small cra pp y propertys---the purple, light blue, red and yellow property's on the game board or one park place or boardwalk?

To clarify, the numbers I used, for repairs, maintenance, etc., were the actual expenses, since I got the house in 2010. As for what expenses listed, I just copied what GKARL used in his post for an equal comparison. Though that’s a great point, S I d, and brings me back to earth, that I did not include my own time for management and repairs. It’s a pretty big number that I did not include.

I did not include a budget for capital expenditures because I figure, if you average all your repairs over time, including roof replacements, you don’t need to have a separate item for capital expenses, but I can see that might be flawed.

And yes, my vacancy expenses, except for the vacancy during renovation, were zero, since 2010. I advertise and show the (occupied) houses in November, and sign leases that start on June 1, the following year. So, there’s never been a time (by the grace of God) when I don’t have my houses leased.

Regarding Cap Rates, I think they may be applicable to my properties, as they are student rentals (8 bedrooms in 3000 sq*ft house) and valuation is closely tied to income.

Richard, I do agree there’s risk, and I do get anxious during rental season, as there’s a limit number of groups of 10 student’s who agree on a house, but on the upside, there’s only one lawn, one kitchen and one heating/cooling system. And I’ve posted before about my concern, if the laws change regarding the number of unrelated person allowed in a house. What will I do with my 8 bedroom house then?

Funny David, when I see people post about buying houses for 50k, and I think 50k buys a bedroom in my market.

Well thanks so much everyone!

BillW,

You're going great!

Some things to consider:

When you go to sell the buyer will include management cost and a vacancy factor in a cap rate. Congrats on 0 but buyer's will assume some vacancy. Definitely show them your track record!

Your increased value is due to your improvements, probably better management, and pushing up the rents. Appreciation would be the comparable properties selling for increased amounts without you doing anything to improve the building.

Multi's are bought based on cash flow, not market value. Keep finding ways to increase the cash flow and your value will continue to climb!

Go get em!

this is more rooming house than SFH or apartment. Can we ask is there any zoning issues? or never addressed?

Thanks BRAD. "show them your track record!" That makes me think there's value in my old lease documents and I should protect them either in a safe or scan and upload off-site.

And thanks for explaining the difference of increased value vs appreciation.

myob, I do worry about what you mentioned. Earlier this year I posted: "student housing risks" in the post was:

FWIW, below is a cut and paste from the NJ truth in renting document.

Any building having at least two (2) living units occupied by persons unrelated to each other without private kitchens and bathrooms is a rooming or boarding house if it does not meet one (1) of the exceptions in the Rooming and Boarding

House Act. (97) These exceptions include .....

buildings housing only college students

And yes, there are yearly inspections for smoke detectors and 3 year inspections of the whole house and legal occupancy limits.

Thanks!!

Hey Bill, I don't mind your using my example at all and I don't think your numbers are bad, particularly for NJ. I just made a comment in the string you referenced about the ability to force equity on commercial property and a lower cap rate in comparison to a SFH can definitely be offset by the ability to force equity; something one can't do with a SFH. Cap rates are like interest rates on bonds of various risk; one would expect a greater return on junk bonds versus investment grade corporate bonds. Most of these 2% deals carry more relative risk than you might be exposed to, so that has to be factored into the comparison as well. I didn't include management fees in my example either, so my cap rate is lower as well. Throwing the management fee in and increasing the repairs to around 10% of rent, I'm coming up with a cap rate of slightly over 10% not including vacancies for your place. The last couple of appraisals I had done used a cap rate of 9% to value which would imply your value is around 450,000 plus or minus.

I've been at this too long I guess because I've found you can make any deal "WORK" if you just forget this number or short that number. That goes for more than just cap rates.

Didn't include managemtn fees is classic-- they don't get managed for free! 25% maintenance isn't usually in the equation either-- because reserve for replacement isn't needed for the roof in 8 years?

Thanks GKARL for explaining forced equity, and the trade-off of cap rates and risk. That's helpful.

To calculate value, I use a yearly GRM of 9.6, which seems fairly consistent in this area, looking at what houses actually sell for, and what they rent for, using Zillow's numbers. This equates to only a ".8% deal"(monthly rent over purchase price), but that is what houses sell for in this area. And that's what makes me wonder if it's foolish to invest in an area with a typical .8% ratio? And BTW, I don't think the ratio is driven down by competition from owner occupied buyers, because there's not many in this market.

So when you say my numbers are "not bad for NJ", as other have said, does that mean that NJ is not so good for an investor? That why I said above: "Should we pack up and move to Florida or Texas, where the cap rates are higher than NJ? (just picking states out of a hat)"

After looking over what everyone wrote and thinking about it, there's a lot to consider. Cap rate, risk, vacancy, cost of capital. One thing I think also important, is enjoying what your doing, which most of the time I do.

Bill, I'm very familiar with NJ having lived there a long time and I know a few people who invest there. This discussion got me a bit curious, so I pulled a return for a client who's invested in NJ rentals to see what exactly his cap rates are. He has several properties located in Newark. His cap rates range from a low of 3% to a high of 18%. That's with management fees factored in and repairs as reported on the returns and actual capex that we're depreciating. The average across the portfolio is about 8%. This person is cash flowing in excess of $ 100,000. I would think Newark would demand a higher cap, but this guy only snagged one 2% property. So, in comparison to this person, I'd say your return is comparable if not better. There are some places where you are hard pressed to get 2% deals and that ain't happening in many areas of NJ.

To me there's a lot that factors into this. Location, ease of management, tenant risk, vacancy rates and etc. A property with a lower cap that is an immediate re-rent might be better than a 2% deal with a PITA tenant that wreaks the place or that requires close supervision.

Its hard to use a one size fits all rule when using Cap Rates. In a alright area around here, you can get a 10-13% cap rate with a class C property. Care to dip into a D property and that Cap Rate might be 18%. If that class C property is a fixer upper project, it might have a Cap rate of 15%. These cap rates are normal in the heart land.......go to places along the coast and finding a deal gets considerably harder.