Cash Flow or Equity/Appreciation? - Posted by Brian

Posted by PeteH(NYC) on February 12, 2000 at 12:48:31:

Being comfortable with numbers has mostly to do with having absorbed information about the market you deal in over a period of time – there is no shortcut. The main things in my analysis that come from familiarity are (1) the fact that any property will have expenses to operate, and you need to be familiar with how much those expenses are in relation to how much income the property earns; (2) the fact that any investment, whether property, stock, bond, rare art, baseball card or jewel, can be compared on the basis of how much income that property will earn you over a period of time; (3) the fact that every area has its own “market rent,” which is what people in that area are willing and able to pay for a place to live (based on what kind of jobs they have and what sort of amenities they’re interested in paying for); and (4) the common sense idea that every investor (including you and your developer guy) is going to be motivated by a calculation of risk versus return – how much return they can expect to gain on a given investment versus the risk of losing any money. Play with those numbers and ideas enough while looking at different specific properties in your market, and eventually you get a feel for what numbers to expect.

Two books that I have found helpful for my comfort with numbers are “Real Estate Investments and How to Make Them,” by Milt Tanzer, and the “Real Estate Finance and Investment Manual” by Jack Cummings.

I wish you luck in your market.

Cash Flow or Equity/Appreciation? - Posted by Brian

Posted by Brian on February 11, 2000 at 14:28:12:

I have a rooming house that I get at least $1500/month in positive cash flow from. I bought it in 1995 for $84,000. I owe $55,000 on it now. I have a basis of $76,000 on the property. I told a developer I would sell it for $150,000 (to help replace the cash flow) and they seem willing to buy at that price. There is a 12 family (normal apartments) for sale close to my house for $495,000.

Questions: Is it better to have a larger amount of cash flow, or equity/appreciation build-up? I could sell to the developer and take my $100,000 gain and put that into the 12 family? I’d have a better building that would appreciate more and earn equity better, but not the cash flow.

Should I tell the developer I want more then $150,000? With the checking I’ve done, it sounds like a Jewel/Osco wants to build there, but an alderman I spoke with today said it’s all speculation right now. I’m still trying to find out if anyone else there has “sold out” to this developer. If not, is that good? and why do they keep calling me and not go for 2 other properties on the same block that are currently for sale with commerical real estate brokers?


Brian Fleming

That Last Sentence Is Interesting… - Posted by PeteH(NYC)

Posted by PeteH(NYC) on February 11, 2000 at 17:04:34:

The one about why they keep calling you instead of listed properties on the same block. It suggests they believe your property is more advantageous to them than the other ones. Is $150K a lower price than the market will bear? I’d be interested to hear more information: comps, your current rents versus market rents, what else might be a highest & best use, etc.

Re: That Last Sentence Is Interesting… - Posted by Brian

Posted by Brian on February 11, 2000 at 22:03:34:

$150K is lower then the other 2 that are for sale. One is at $160K and has about $35K in gross yearly rents. The rooms there rent for $60-65/week (this building sold for 73K in 1996). The rooms in my building rent for at least $68/week, majoirty of them at $73/week and I have gross yearly rents of about $44K. I don’t think they are wanting to buy my building to keep it running, they want to tear it down to build a grocery store.

I had a market analysis done on my building 2 weeks ago and that came back at $95-99K and the only comparable they had to use was the one mentioned above.

Hope that helps.


One Way to Look at It - Posted by PeteH(NYC)

Posted by PeteH(NYC) on February 12, 2000 at 24:26:45:

A few thoughts: your current positive cash flow – $18K/yr – is worth $150K at a 12% cap rate. In other words, if you determined 12% is how much you wanted to earn on your money, you would have to spend $150K to get a return of $18K/yr or $1500/mo. (This entire analysis, by the way, ignores any debt service you may have on your rooming house that gets paid before you’re left with $1500/mo. free cash flow.)

If the other building for sale is running a comparable expense ratio to your building (approx. 41% – your $18K net income on $44K gross rent), it has a net income around $14,300; a $160K price indicates a cap rate of 8.95%. That is significantly more expensive than your building, and would be one reason the developer is chasing you. (After all, you told him you’d sell for $150K – how’d you happen to pick that figure?)

It smells, however, as though the developer has another plan. (That’s what developers do.) I’d be surprised if he was genuinely moved by a 12% return on his money. He’s gambling for something bigger.

Meanwhile, since you’re doing so well on your building as is – you’re making 21.4% on your $84K investment – I don’t think you should be interested in the 12-unit unless the deal is good enough to earn decent cash flow AS WELL AS appreciation. Meaning $495K is overpriced unless the thing has an N.O.I. of at least $60K (12%). If you exchange your $95K of equity into the 12-unit, your loan amount would be $400K; if you could get a 9% loan for 20 years, your monthly principal & interest would run just under $3600. In that scenario, you would have positive cash flow of $1400/mo. – $5000 monthly net income less $3600 in debt service. Not too much less than you’re making now – PROVIDED the 12-unit is generating that much cash after expenses. (If the 12-unit also has an expense ratio of 41% including vacancies, your gross annual rent will need to be $101,694, which requires an average rent for each unit of $706 – does that sound reasonable for your area?)

Now I’m just playing with made-up numbers. To make any kind of informed decision, you need to have a much better idea of how real those numbers are. It sounds like you have a very respectable property in the rooming house; don’t trade it away unless you improve your position. Which means the developer is going to have to make a more interesting (higher) offer, and the 12-unit seller is going to need to come down a bit.

Re: One Way to Look at It - Posted by Brian

Posted by Brian on February 12, 2000 at 09:45:17:

How did I pick $150K?

I don’t know it’s just a number I pulled out of a hat really. I guess I should have thought about it more, but even if I did, I didn’t know how to put a “proper” price on my building.

You “talk in numbers” for lack of a better way of putting it and I like that. That is also a problem I have as a real estate invester, understanding how and why you use and came up with those numbers. Any idea of how I too can learn to be able to “talk in numbers”?

Thanks for your continued information.