Garbage In…Garbage Out - Posted by JPiper
Posted by JPiper on April 30, 1999 at 10:22:32:
What’s the old saying “garbage in, garbage out”?
Let’s take a look at your numbers here. You say the property is worth (based on comps) $80 per square foot. For some reason your seller is willing to sell this duplex $50K under market, with exceptional terms on the financing. Nice guy. Gross rent is $1220 per month. One thing we know is that expenses (including taxes and insurance, maintenance, vacancy, deferred maintenance, etc) over time will approximate 40%. So when I apply this 40% factor to your gross rent, I end up with NOI (net operating income) of $8,784 per year. Dividing this by the supposed value of this property based on square footage comps of $80 (this is $176,000) I get 4.99%. That’s what we call a capitalization rate.
Here’s what that means. If I paid $176,000 for this property, based on this income stream and reflecting expenses that I would pay, I will earn 4.99% on my money. Right now, I have some money in a money market fund earning about 4.5%. So here’s my question: who do you know who would pay their money to buy a property, take the time and effort to operate it, in order to make a return that they could make in the bank?? I doubt you would find anyone other than a fool, because it’s not rational. What this leads me to is that in a rational world NO ONE would do this, and therefore this property is not worth $176,000. Your comps are “garbage in”. Further information seems to confirm this: the owner is trying to sell it at $120K with exception financing. Wonder why? We have a nice property, with long term tenants, in a good area, $50K under market?.I can almost feel the hook going in!
Now let’s work the same numbers using $120K as the purchase price. When I do this I get a cap rate of 7.32% (NOI divided by $120K). Is the property worth this? It wouldn’t be to me. I don’t know the values in your area?.but 7.32% is certain not an exceptional return. To me this looks more like a deal you could find anywhere.
If I take a 10% cap rate, and apply it to these numbers I get a value of about $87K. And I can tell you that in my market a 10 cap is more apt to be a market value?.rather than a deal.
So based on what you have presented this deal is NOT a deal. The one factor that MIGHT change things is IF the rents are low. That’s information you didn’t provide. But you said you wanted to know a “yes or no” based on what you provided. Based on that my answer would be NO.
Somewhere in the information you have provided is “garbage”. One area in all probability is the “comps” that you provided. The other area may be that the rents are under market. I’d recheck your numbers?.but I wouldn’t do this deal based on what you presented.