To good to be true. - Posted by Jeff

Posted by JoeKaiser on May 16, 1999 at 23:10:48:

How do you figure he’s earned a five figure check here? No matter what you may have heard, it’s rarely a good idea to walk out of escrow with a check that was created by you just cleverly reshuffling the deck and ending up with all the good cards.

You walk out of escrow with checks when you buy at deep discounts, do a little prehab and snag a buyer who’ll pay you a whole lot more than you’re into it for.


To good to be true. - Posted by Jeff

Posted by Jeff on May 16, 1999 at 10:37:32:

I have a property being offered to me @ 100% owner financing.
Split closing costs.
Price at 174,500
Rents at 1570 a month.
Property is 30 years old in good condition.

As you can imagine I am very interested, but this is my first deal and I am unsure.

Any advise - encouragement.

Shame on you Jeff, look what you started here - Posted by Irwin

Posted by Irwin on May 17, 1999 at 07:39:50:

Ask a simple question, and you get Sean right?
Did you think it might be too good to be true because someone is offering you a property basically for free? There’s more to consider in a deal than purchase price and gross rent. Is this a single family home or an apartment house. Do you have any idea of market value? When sellers offer 100% financing it’s usually because that’s the only way they can sell a white elephant. How long is the financing for? Are you personally liable on the contract, or can you get out if things go sour. What are the projected operating expenses? How solid is the current tenant(s)? Can the rent be raised?

The easy answer based on the scanty information here is, Yes, take it on a contract with $0 down PROVIDED THAT YOU ARE NOT PERSONALLY LIABLE ON THE CONTRACT. (see an attorney on how this is done). If it makes money, and you’re happy with the cash flow, you keep it. If it’s a loser, you give it back to the seller.

Be Cautious - Posted by Sean

Posted by Sean on May 16, 1999 at 12:03:52:

I’m certain JPiper et al will snicker at this post, but you really do need to examine the capitalization rate of the property. It sounds like a rented single family residence somewhere in So. California or another high priced area.

So let’s make the generous assumption that you will have no vacancy and let’s assume that the expenses of the property will only come up to 45 percent of your gross income. Accordingly your net operating income will be $11,300 a year.

Since you are being offered the chance to pay $174,500 for the right to get $11,300 a year you’ll find that your rate of return, if you paid all cash, is 6.48 percent.

Now let’s assume that this guy is going to loan you the money at 100 percent financing at 7 percent. Do you see the problem here? You are borrowing money at 7 percent and reinvesting it for AT MOST 6.48 percent. That is a formula for losing money.

I would suggest that negotiating a lease-purchase would be your best bet. Since the rental amount is reasonably believed to be $1570-ish you could offer the guy that amount in payments a month on a 3-year term with a 25 percent credit and a purchase price of $180,000. He’ll be happy to get a premium price and you can even ease his worry a little by offering to handle all the maintenance on the property and to send him receipts for what work was done (which will be netted out of the rent amount).

Re: To good to be true. - Posted by PBoone

Posted by PBoone on May 16, 1999 at 11:53:28:

A little more detail would be helpful such as…
174,500 at what interest rate? look at this…
174,500 30yr @ 7% = 1160.95
174,500 30yr @ 8% = 1280.42
174,500 30yr @ 9% = 1404.07
The rate will make a difference. Then what is the real value? 174,500 based on what? Then 1500 rental rate how long have the tenants been there? what are the taxes and insurance costs?
100% financing is good if the deal is good, but if the deal stinks the financing doesn’t matter.

Re: To good to be true. - Posted by Bud Branstetter

Posted by Bud Branstetter on May 16, 1999 at 11:52:10:


You don’t give us all the info that is needed so I will extrapolate a bit. The 174,500 is probably FMV or even above. As an investor you make your money going in. This sounds like an income property. Duplex or more. Are the rents at market, above or below? In this area PITI will be near 1%. Do you negagtive cash flow? On income property figure 40% for management, maintenance, vacancies and all the rest. If it still returns cash after the debt service then it can be considered. 100% financing isn’t everything.

Re: Be Cautious - Posted by SCook85

Posted by SCook85 on May 17, 1999 at 10:36:36:

Are you actually doing deals? Or did you just read a lot? You act like you know what you are talking about, but it does not come across as experience talking, sounds more like BS.

In the time it takes for you to figure out whether or not you have a good deal I will buy them out from under you. If you are buying homes I’m sure the good ones are getting away to someone who moves a lot quicker then you. You are trying to reinvent the wheel when it just does not need to be done. Don’t confuse those who don’t know any better, and just in case you didn’t know you aren’t pulling the wool over the eyes of those who do know better.


Re: Be Cautious - Posted by karp

Posted by karp on May 16, 1999 at 18:03:27:


What I honestly can’t figure is that you calculate whether a deal is good or not using the cap rate while skipping many of the other variables that someone such as yourself would be the type to use…

You are skipping appreciation, depreciation, tax benefits, positive cash flow, leverage etc.

And the results are you suggest a lease option.]

But this seller wants to offer 100% financing.

What would the effects be of buying this on a wrap (if it is encumbered) and SELLING it on a lease option? I think your generous 45% for overhead may have just gotten WAY more generous…



Re: Be Serious - Posted by Joe Kaiser

Posted by Joe Kaiser on May 16, 1999 at 13:24:46:

I’ve bought lots of houses over the years and I’ve NEVER once figured the capitalization rate. It’s a TOTALLY meaningless number, especially when talking about single family houses.

Please, give it a rest. It makes you look ridiculous.

Cashflow, as always, is the ONLY thing that really matters here.


In interest… - Posted by Sean

Posted by Sean on May 16, 1999 at 18:47:49:

…of greater semantic accuracy I am modifying my usage of x = NOI/asking price to the term unleveraged rate of return (“URR”).

I personally find it simple to use the URR to determine what leverage the property needs to be at to reach my target return on the property. If others do not find it useful, let the cards fall where they may.

I do feel that there is a good possibility on this property to buy it and resell to the tenants but there wasn’t enough information available from the original post to go on. On the other hand it seems to me that the current owner is willing to sell 100 percent financed on the belief that he will net more money out of the property in that manner than he is by renting the property. Based on the numbers I see, I would tend to agree.

If the person negotiated a 30-year loan on the property at 7% the payments would be $1150ish PI a month. Taxes would be around $220 a month (depending on Mello-Roos, I’m still assuming this property is in California although I have no real basis to do so) and maybe $50 per month for insurance? I’m estimating $1,420 PITI.

Now I imagine if we took this property to the bank as a rental with $1,570 a month income and $1,420 PITI payments they’d tell us we had $(355.00) negative cash flow. Where I’m at banks only give you credit for 75 percent of your rental income figuring the rest is lost due to maintenance and vacancy. Maybe they’re not EXACTLY on, but it does serve as a nice rule of thumb. So I’m basically forecasting negative cash flow for the property.

So I was figuring, why pay $1,420 for $132 of equity build up when you can pay $1,570 for $157 a month equity build up AND you have the benefit that the old owner will still pay for maintenance that needs to be done on the property. I thought that might be better than doing the maintenance yourself and getting the tax benefits (although I hadn’t gone so far as to calculate it out).

Personally I’d aim for getting an 80 percent loan, using the proceeds to buy a discounted mortgage with unpaid principal around $174,500 and giving that mortgage to the seller in exchange for his property (a la John Behle’s “substitute refinance” technique, kind of a simultaneous substitute refinance at the closing table). The remainder of the 80 percent loan I’d pocket (not to mention the instant 20 percent equity is nice), but I thought that might be a little too complicated to explain. After that I might try reselling it to a buyer that intended to occupy it, but I’d personally like to do a 1-year lease-option to preserve the possibility of a 1031.

What would you do with the property?

After reading your post… - Posted by Sean

Posted by Sean on May 16, 1999 at 13:45:02:

…I came up with a very good reply.

Unfortunately it was unprintable.

Now I’m very happy that your years of blundering about without any kind of calculations have given you experience and expertise sufficient to enable you to make profitable decisions. I salute you. Now I would ask you to show a little patience for the rest of us mortals who think with a calculator in one hand and pencil and paper in the other.

Now if you would be so kind as to mind-meld with Jeff to transfer to him the years of experience and lessons learned errors that you made, none of us will have to post here again and he’ll be just as expert as you.

P.S. Thanks for converting me to the cap-rates-are-meaningless-fan-club. I’m starting a lobbying effort right now to ban the method from ever being used by appraisers. With luck perhaps we can even expunge the word capitalization from the dictionary.

This is completely nuts . . . - Posted by Joe Kaiser

Posted by Joe Kaiser on May 16, 1999 at 20:11:43:

I’ve probably already said more than needs to be said here, but just in case it isn’t obvious to some of the newer people, Sean has no clue what he’s talking about. I doubt he’d know a good deal if it whacked him on the side of the head.

I own three financial calculators. More often than not, they sit and collect dust. Occassionally I’ll need to drag one out to figure out payments on something I’m buying or selling, but thats about it. I’d never waste my time trying to figure out the “underleveraged rate of return,” (whatever the heck that is).

Absolute nonsense.

We signed up seven houses in April and are already closing on a couple this week. Big fat “five figure” profits on every one of them. Do I care about the cap rates or the internal rates of return or, (excuse me here), the “underleveraged rate of return?” Frankly, not a hoot.

Instead, I know we’ll leave escrow with $20k and $30k checks on little single family houses.

Sean, show me how to pull that off and I’m interested. This other stuff is just wasting my time and even worse, it’s just plain WRONG.

Put away your calculator and go talk to a motivated seller. Thats how deals happen.


Sean, You’re Getting to be a BORE - Posted by J.P. Vaughan

Posted by J.P. Vaughan on May 16, 1999 at 17:07:35:

Sean, both Jim Piper and Joe Kaiser know more about
real estate WHILE THEY ARE ASLEEP than you do when you’re
allegedly fully conscious.

NO ONE and I mean NO ONE who knows one whit about real
estate uses Cap Rates to place a value on single family
houses. While it might be fun for you to play with
those numbers, a Cap Rate has NEVER been a primary
valuation tool for single family houses.

This is simply WRONG information. And I think it is
unconscionable for you to be sharing this idiocy with
the newbies who visit this site.

Over the past week, you have proven repeatedly that you
do NOT know what you’re talking about. Now–seriously–
and I mean this VERY seriously–GIVE IT A BREAK.

JP Vaughan

Re: How The Rabbit ate the cabbage… - Posted by Ed Garcia

Posted by Ed Garcia on May 16, 1999 at 16:57:53:


My name is Ed Garcia. I am an Investor, Lender, and Broker.
There are many people on this forum that if they tell you something,
you can take it to the bank. The two who have tried to help you was (1)
Jim Piper, and (2) Joe Kaiser.

Joe , normally does not get sarcastic nor does Piper, unless you drive them
to do just that. Both men are extremely fair.

Let me see if I can help you clear this matter up once and for all when it
comes to Cap Rate, or calculating an income stream on real-property.


Are purchased on the basis of equity position, or cash flow.
You could look at it on a cash on cash return, but that would be deceiving.
The reason I state equity position first, is because you always make your
money on the buy. If you purchased with a good equity position,
everything else falls in place. Obviously the less you owe on the property
the more cash flow you would have.

Multiple Units:

Are purchase on the basis of GRM, ( Gross Rent Multiplier) or Cap Rate,
(Capitalization Rate).

GRM- A number which, times the gross income of a property, produces
an estimate of value of the property.

The gross income from an unfurnished apartment building is
$200,000 per annum. If the appraiser uses a gross multiplier of 7%
Then it is said that based on the gross multiplier the value of the
building is $1,400,000.

Cap Rate- The rate of interest which is considered a reasonable return on
the investment, and used in the process of determining value
based on net income.
It may also be described as the yield rate that is necessary to
attract the money of the average investor to a particular kind
of investment.

In the case of land improvements , which depreciate, to this
yield rate is added a factor to take into consideration the
annual amortization factor necessary to recapture the initial
investment in improvements.

This amortization factor can be determined in various ways:
(1) Straight-line depreciation method.
(2) Inwood Tables and (3) Hoskold Tables.

(To explore this subject in greater depth, the student should
refer to current real-estate appraisal text)
In conclusion the majority of investors that I know, usually figure
purchasing Multiple Units on Cap Rate.
However after saying that many lenders don?t.
I think it would be safe to say the larger projects would be figured on
Cap. Rate, and the smaller ones would be figured on GRM.

Commercial :- Good News Sean, they?re all figured on Cap Rate.

So you see Sean, you had the right answer, just the wrong property.

Ed Garcia

Does x=r2y^311 or 5/7x1129 @ 66% of 12,970? - Posted by hkCA

Posted by hkCA on May 18, 1999 at 15:33:37:

…dang, somebody else bought it before I got the chance to figure this out!

Joe, I can relate to your thinking completely. You don’t need a calculator to figure if a simple single family deal is going to make sense. Bottom line: is the deal going to turn a profit? Do I have to put any of my own money into it? If there is a profit potential, is it enough to warrant my time? I don’t need a financial calculator to answer these questions.

Most of my deals are “seat-of-the-pants” deals. If it feels good, I do it. Don’t overanalyze the friggin’ thing. You’ll just come up with reasons why you shouldn’t do it.


Re: This is completely nuts . . . - Posted by Matthew Chan

Posted by Matthew Chan on May 17, 1999 at 03:19:13:

Whew! I am glad I am not the only one who got lost. I didn’t know what the heck he was talking about. It was just too complicated for a beginner like me.

And I thought all I had to worry about is down payment spreads, monthly payment spreads, interest spreads, purchase price spreads, and current market value and rents. I guess Ron Legrand and Lonnie Scruggs has it all wrong. They make it too easy to figure out the numbers.

I guess I need to start learning about and cap rates URR’s. Either that or get out of the CRE business, right? :slight_smile:

Very Well… - Posted by Sean

Posted by Sean on May 16, 1999 at 21:04:18:

Good to know!

So how exactly would Jeff structure his deal to leave the closing table with a fat, 5-figure cashier’s check in his pocket?

I Agree… - Posted by Scott (AK)

Posted by Scott (AK) on May 16, 1999 at 20:21:00:

I don’t know the meaning of half of these numbers Sean is tossing around. Now that i think of it that may be a GOOD thing. If I had it would have kept me from doing the three deals I did in the last 30 or so days.

Best thing I ever did was throw the calculator in the briefcase so I can use it to wow the buyer when it’s time to convince them to let me assign my deal to them (and they dig a little deeper in their pocket) is actually a good thing.

Go make some $$


LOL JP! - Posted by Ben (IN)

Posted by Ben (IN) on May 17, 1999 at 09:03:17:


Yes, quite. CAP rates are one of the many things used by realtors to hype a property, as though its a really meaninglful number. When I was buying multi-units in L.A., every serious investor I brought properties to to buy would scoff at my emphasis on a CAP rate when I was trying to explain the deal. “Yeah, yeah, yeah, tell about the ‘property’!” was the kind of response I’d typically get.
What I learned from all that is a CAP rate is fine if all you are doing is sprouting off about a property. But when the dust settles after a closing and you are left with the property and all the worries that go along with it, CAP rates don’t seem that important anymore. There is much more there is much more important information to examine than a CAP rate, which afterall, is a contrived calculation that is meant to represent all these other things.
In the same way a map is not the terrain, a CAP rate is not the property.

And to use it on SFR’s is even more of a joke. How does a CAP rate tell me if I can buy a house and get it resold quickly to an owner occupant? Its just ridiculous.

Sean, take a pill. Your smarmy malcontent IS really boring. You obviously haven’t done anything in Real Estate. If you had you would recognise the priceless value of the experience that is being offered you in the resonses from Jim Piper and Joe Kaiser.

Try going and buying some real estate, and “then” come back here to tell us about it. Right now you are just stinking up the place with your sarcasm.

Lighten up. Go make some money.

Ben Innes-Ker

Re: Sean, You’re Getting to be a BORE - Posted by Mr. Jason Channing

Posted by Mr. Jason Channing on May 17, 1999 at 24:21:28:


I am sure glad to see you step in here and try to put the brakes on this nonsense!

I am new to this website and have been amazed at the wealth of great information available here for people interested in building a better future thru real estate investing. I am 63 years old and I wish I had turned my attention this direction sooner!

I am also amazed at the amount of egocentric, whiny-baby, temper-tantrum, sand-box psycho-babble nonsense that goes on on this message board!

You can sure tell who is seriously reading the books, listening to the tapes, going to the seminars, writing the offers and closing the deals, and, who wants you to think that they are too!

It is both comical and sad that the only one we ever fool with our “act” is ourselves!

There seems to be a large number of “newbies” out there sincerely seeking new knowledge to help them create a better future for themselves and their families and some of your “regulars” seem to be pontificating blowhards who strive to build their own egos at the expense of confusing and discouraging the newcommers.

I admire your “freedom of speech” posture about your board, but when the main use of it becomes using it as a bully pulpit by a noisy few for self-aggrandizement, it seems like time to monitor and moderate the board, and zap postings on the basis of relevance and sensibility so all who sincerely want to learn and exchange truly useful ideas are not turned off and just go away.

I hope all who read this and agree will grab their keyboard and let you know.

I realize that, throughout the recorded history of civilization, rule by committe has inevitably ended in chaos, and that this site is not a democracy but rather the domain of a benevolent dictatorship where you hold all the votes, but I seem to see a disruptive vociferous minority creating near anarchy here and destroying the very value you envisioned when you added a message board to your site.

I hope enough readers of this post express their agreement that you start to jump on the abusers like a duck on a june-bug and set the rest of us free of their obnoxious distraction so we can get on with the learning experience that makes your site the most valuable creative Real Estate site to appear on the web so far.


Mr. Jason Channing