Re: Hey Everyone, Do These Numbers Add Up? - Posted by Jim Beavens
Posted by Jim Beavens on April 14, 1999 at 14:11:06:
When you get up around 4 units and above, the financial analysis starts to take on a different slant than how you would look at a house. This is because for somebody owning such a property, their sole purpose for buying it is the income that it generates. Thus the value that the property is worth is based solely off the income it throws off. The key measurement for comparing different investments based on this criteria is the cap rate, or capitalization rate.
For more information on cap rates and valuating income properties, I wrote up an article called Crash Course in Commercial Real Estate, which JP graciously offered to post in the Money Ideas section of this website.
The thing to watch out for with this deal is what makes a lot of deals look better than they actually are: the expense estimates look too low to me. If we assume that the loan is a 30-year loan at 9%, then the annual mortgage payments come out to about $23,300. That $29,000 expense figure then leaves only $5,700 for other things like vacancies, utilities, taxes, and maintenance. That’s only 15% of the gross income, where 30%-40% is probably more realistic for a 4-plex.
Here’s how I pencil this out:
Gross Rents: $36,240
Vacancy (10%): -$3,624
Gross income: $32,616
We’ll be optimistic and say 30% of the gross income goes towards maintenance (this pretty much rules out a management company, so I hope you want to be a landlord): - $9,785
Net Operating Income (Gross - Expenses): $22,831
Cap Rate (NOI/Sales Price): 8.5%
This means that if you were to put $269,000 of your own cash towards this deal, you would receive $22,831 a year, or an 8.5% yield. Now I ask you…if you were to borrow most of this amount at 9% interest, do you think you would have a positive cash flow?
Unless you can get a substantial discount on price, or if you know that rents are way under market and you’re confident in your ability to quickly raise them (and have the cash reserves to handle the ensuing vacancies), then this isn’t a deal.
However, even if you do find a deal on a multi-unit building like this that looks good, you have to ask yourself if this is really what you want to do. I once thought like you did, and actually went out of state to find cheap multi-unit residential property. I found two 6-plexes that were a ridiculous $90,000 each and had 15% cap rates (this is the basis for the example in that money ideas article). So I liquidated all my stocks, took out a home equity loan and mortgaged my house to the hilt, and plunked down a 15% down payment on those properties. They should provide about $1,000 a month in positive cash flow, and hopefully more once I raise rents, which are $50-$100 below market, and I am obviously very happy about these deals. But what do I do now? I’m broke! I figured that I was happy just simply treating this like another one of my investments like stocks or mutual funds.
But the CREOnline convention really opened my eyes, and made me realize that I can have a very successful real estate business even in my overpriced local market. Now this doesn’t mean buying and holding over-leveraged rental properties, it simply means that there is a place in EVERY market in the country for a creative middle man to offer solutions to motivated sellers and to buyers who have been kept from their dream of homeownership by banks. Through courses I picked up at the convention, I’m realizing that by bringing these two groups of people together, there is tremendous profit potential to be had.
I don’t have anything against buying and holding, but I do feel that many areas of the country are not conducive to this approach (particularly since many high-priced areas have been fueled by our strong economy, which I personally feel can only go down from here, although when is anybody’s guess). I wouldn’t be surprised if that 8.5% cap rate is very common for your area. This doesn’t mean their aren’t deals to be found, but you’ll probably have to do a lot more to find them than pick a commercial broker at random and have him show you his listings.
Sorry for rambling so much, I know this is way more than your question asked, and probably confused you. So to sum up, NO, this is not a good deal, go find another one and don’t give up. Remember this is all my opinion, which may be totally worthless.