Opinions needed...

[Sean_L]

Sean,

This thread is about purchasing investment properties. I know you understand what I'm saying and I certainly understand what your saying.

All investment value does is tell you where to start from and what the value of that property is to you.
Since your not the dumbest person in the world, I'm sure you'd agree that purchasing investment real estate should be based on the value of the property to the investor (investment value). If one's investment value matches up with market value, GREAT! That makes life easier. The sales comparison approach and market cap rates, as you know, are derived from the market. Therefore, as an investor, I am only purchasing properties based on my investment value, sales comps and market caps have no meaning. It might mean I lose out on some properties, but I wouldn't want them anyway if they don't meet my criteria.

From your previous post, your assuming that an investor is going after every property, this isn't the case. If I'm looking through listings to find properties, I glance at thousands before I find 1 that suits me and my investment goals. Yes, I am saying that investment value can't be found from sales comps and market values. Those are 2 external measurements of value, they have nothing to do with my requirements. It would be working backwards to find the sales comp value or market cap value, then see if it matches my goals. An investor should figure out what the property is worth to them, if they can't get it for that or less, move on. What comps are selling for might possibly be the most meaningless number in MY world when buying.

Listings have nothing to do with sale comps and of course you will scan all the listings before finding one you like, everyone does that. I think I explained investment value completely . What I don't understand is how you can state that you can not find investment value from comps. That is what appraisers do everyday. If the data is not there on the high end the appraisal gets cut or the bank denies it on the low end there is no issues. I am willing to guarantee that your investment goals are not that much different than the market at large.  I also guarantee that there are comps and market caps in your area that match you investment goals.  All building a cap rate does is to assure the investor that he is getting the required return out of his NOI if he has an accurate picture on expenses.

[DannyTheGreat]

Listings have nothing to do with sale comps and of course you will scan all the listings before finding one you like, everyone does that.

Chances are, the appraiser and listing agent used the sales comparison approach on a 4-plex to determine it's asking price. It's in the agents best interest to list the property for the highest the market will bear. Appraisers are there to determine the market value, they pay no attention to me having the world's lowest credit score and thus eligible for the world's worst financing. But that would be a very real, practical factor that I'd have to consider when purchasing.

What I don't understand is how you can state that you can not find investment value from comps.
Maybe I worded my statements wrong. When I'm purchasing a property for nothing more than it's income, (I want the property to pass on to my great grand children) why should I care what the market would be willing to pay? My credit is a little different, I might have more or less cash to put into the deal, I want a lot of equity (discount on purchase) so I can say I'm a millionaire, etc.

My investment goals are very unique from the next investor. I'd be purchasing this property with cash to rehab, others would be purchasing this property @ 100% financing for cash flow. We'd have totally different investment values and totally different prices we'd be willing to pay to meet our goals.

For long term holdings, building a cap rate tells me immediately if I should investigate further. If my cap rate based on my required return and debt service are 15% and I come across a property with a market cap rate of 4%, I don't spend another second looking at it. I'd use my own cap rate as a prequalification.

I'd only EVER be willing to pay my investment value for a property. If it is identical to the market value, I'll be competing with the market. If my investment value is greater than the market value, I'll certainly out-bid the market. If my investment value is less than the market value, the seller would have to be desperate or stupid to accept my offer, but that's still all I'd be willing to pay. NOT the market value. This is why I say that comps have no bearing to my investment value, unless my investment criteria includes reselling in the very near future. What comparable properties have sold for don't chance my credit score and they don't change the cash in my pocket. If you'd be willing to pay market value for any property, anywhere, at anytime, you'll be in trouble fast.

Most investors purchasing SFH's for rentals, can't compete with the market of homeowners. They have to go after the desperate, motivated, stupid, and distressed. They can only pay their investment value (which is usually less than market value) or they don't make money. They CANNOT derive their investment value from comps because what homeowners are paying for similar properties doesn't have anything to do with their strategy (renting).

[propertymanager]

I am willing to guarantee that your investment goals are not that much different than the market at large.  I also guarantee that there are comps and market caps in your area that match you investment goals.

Sean,

This is where you're completely off.  My investment goals are MUCH different than the market at large.  The market is buying at retail.  I am buying at a MAXIMUM of 70% of the market value.  The average new investor will fail and will be out of business in a rapid fashion, because they are paying retail.  Retail properties generally will not cash flow using real world numbers.  The average rental property owner has absolutely no idea what their expenses are.  I use an expense number that includes all the real world numbers expenses.  The average seller reports ficticious income and expense numbers.  I only believe what I can verify.  

As I said earlier, I need real profit  -  I do this for a living.  I don't need theoretical profit or I'd be working for someone else!

Mike

 

[DannyTheGreat]

Even if you do find comps and cap rates of properties that would meet your goals, it would be backwards to say you can figure out what your goals are based on those same comps and cap rates.

I don't look at comps to figure out the property I'm looking at is worth $2.2m, then decide my investment value is going to be $2.2m as a result. I decide what I am willing to pay to satisfy my needs and the awful shopping habits of my girlfriend, that becomes my maximum offer. Market value has no part in my decision making for a rental property.

[Sean_L]

Danny,

Again listing prices have nothing to do with sale prices. It also can be said that it is not in the best interest for the listing agent to list the property at the highest possible price. A lot of agents make that mistake.

As far as credit issues they are represented within the market caps. If you believe they don't then you don't believe in market capitalization and what it represents or you believe that other investors private and institutional of commercial real estate are totally ignorant to financial ability and it's effect on cap rates. It all gos back to the type of property your buying

Mike,


So you think that you the only one in the market trying to get a deal. That is a ridiculous statement. Every wholesaler in the city is doing the same thing as you are...lol Not to mention there are many issues with properties that sell for extreme discounts. Not to say that there are not diamonds in the rough because occasionally there are. As far as expenses are concerned of course you want to do your due diligence, I would never tell you any different. That is the prudent thing to do.

 

[Sean_L]

Even if you do find comps and cap rates of properties that would meet your goals, it would be backwards to say you can figure out what your goals are based on those same comps and cap rates.

I don't look at comps to figure out the property I'm looking at is worth $2.2m, then decide my investment value is going to be $2.2m as a result. I decide what I am willing to pay to satisfy my needs and the awful shopping habits of my girlfriend, that becomes my maximum offer. Market value has no part in my decision making for a rental property.

I agree. I never said that you should make your investment decision on comps. All I was saying is that comps and rates are representative of the market activity and that typically your investment rate will be within the range of market activity. I'm not telling you average the caps and comps and use those to make your decision. I'm just saying that your activity will typically be within range of the comps and the rates.

[DannyTheGreat]

In most cases, listing prices are based off market cap rates and sales comps. By saying a lot of agents make the mistake of listing properties for the highest price the market will bear, your acknowledging the listing prices (in most cases) come from market data.

The market is a representation of everyones credit, issues, problems, cash, goals, etc. If your on an extreme side of the many factors, market data will serve no purpose. Institutional investors (especially public REITs) are playing with financing that is damn near free. They also have much more cash than me to purchase a property. Therefore, they can cash flow with just about any property (aka: Lower Cap Rates). The practicality of using market cap rates as my very unique investment cap rate, is nonexistant. Market value is a representation of EVERYONE in the market. Investment value is a representation of ME. I don't care whatever everyone would be willing to pay, just what I'd be willing to pay, because I am a little different from anyone else in the market.

The problem with using market data to determine a purchase price is that everyones credit issues, financing rates, etc. ARE taken into account. In the real world, we are all unique, we all have a different amount of money, all desire a different amount of money, all would plan on holding a property for a different length of time, etc. A collaboration of everyones specific circumstances may be heavily skewed away from one's situation. In my case, it is! If I relied on the market to tell me what a property was worth to me, I'd be out of business tomorrow.

[propertymanager]

Sean,

You seem to have a good handle on appraisal issues, but very little knowledge of the rental property business.  The vast majority of buyers are paying near retail.  Otherwise, there would be no retail.  The prevailing Market Capitalization Rate is based on retail.  There are a small minority of successful investors that are buying at a deep discount.  If I bought at the market capitalization rate, I'd be out of business, like the vast majority of newbies who try to become investors.  

In my market, there are probably 50 duplexes on the market at any given time.  Approximately 80% of these duplexes will be priced between $80,000 and $90,000.  Approximately 10% will be above $90,000.  These will be on the market a long time.  Another 10% will be below $80,000 with most of these being between $70,000 and $80,000.  At any given time, there MIGHT be 1 property that can be bought at a big discount.  The last duplex I bought, I paid $11,000 and then spent about $25,000 on the rehab.  The property appraised in the $80's (I think $82K, but I don't have the exact numbers in my head).  So, I have about $36,000  in an $82,000 property.  That's 44% of the market value.  It grosses $900 per month and will cash flow.  If I paid $82,000 like the average newbie investor, it would not cash flow and I'd be going out of business like they do.

Many of these newbies hear the same cap rate talk from their realtors that you are talking about.  They buy at retail thinking that everybody else is paying these prices.  What they don't realize is that they just bought a negative cash flow property and will soon be out of business at a loss.

I am not in the flipping business, I am in the rental business.  I do not have to do a deal to eat and will only do deals when they meet my criteria of 1) less than 70% of market value and 2) a positive cash flow of at least $100 per month per unit using real world numbers.  I NEVER BUY AT RETAIL OR AT THE PREVAILING MARKET CAP.

Mike

[Sean_L]

In most cases, listing prices are based off market cap rates and sales comps. By saying a lot of agents make the mistake of listing properties for the highest price the market will bear, your acknowledging the listing prices (in most cases) come from market data.

The market is a representation of everyones credit, issues, problems, cash, goals, etc. If your on an extreme side of the many factors, market data will serve no purpose. Institutional investors (especially public REITs) are playing with financing that is damn near free. They also have much more cash than me to purchase a property. Therefore, they can cash flow with just about any property (aka: Lower Cap Rates). The practicality of using market cap rates as my very unique investment cap rate, is nonexistant. Market value is a representation of EVERYONE in the market. Investment value is a representation of ME. I don't care whatever everyone would be willing to pay, just what I'd be willing to pay, because I am a little different from anyone else in the market.

The problem with using market data to determine a purchase price is that everyones credit issues, financing rates, etc. ARE taken into account. In the real world, we are all unique, we all have a different amount of money, all desire a different amount of money, all would plan on holding a property for a different length of time, etc. A collaboration of everyones specific circumstances may be heavily skewed away from one's situation. In my case, it is! If I relied on the market to tell me what a property was worth to me, I'd be out of business tomorrow.

I don't believe that we disagree. But what I was saying is that cap rates come in a range within a market..ie 5.5 to 6.75 for a class A office space. You may be right at 6.75 or even 7.20 for your investment value. Thats all I was saying. There is no specific cap rate for any one property type. There is a range and more often than not you'll be within range.

[Sean_L]

Sean,

You seem to have a good handle on appraisal issues, but very little knowledge of the rental property business.  The vast majority of buyers are paying near retail.  Otherwise, there would be no retail.  The prevailing Market Capitalization Rate is based on retail.  There are a small minority of successful investors that are buying at a deep discount.  If I bought at the market capitalization rate, I'd be out of business, like the vast majority of newbies who try to become investors.  

In my market, there are probably 50 duplexes on the market at any given time.  Approximately 80% of these duplexes will be priced between $80,000 and $90,000.  Approximately 10% will be above $90,000.  These will be on the market a long time.  Another 10% will be below $80,000 with most of these being between $70,000 and $80,000.  At any given time, there MIGHT be 1 property that can be bought at a big discount.  The last duplex I bought, I paid $11,000 and then spent about $25,000 on the rehab.  The property appraised in the $80's (I think $82K, but I don't have the exact numbers in my head).  So, I have about $36,000  in an $82,000 property.  That's 44% of the market value.  It grosses $900 per month and will cash flow.  If I paid $82,000 like the average newbie investor, it would not cash flow and I'd be going out of business like they do.

Many of these newbies hear the same cap rate talk from their realtors that you are talking about.  They buy at retail thinking that everybody else is paying these prices.  What they don't realize is that they just bought a negative cash flow property and will soon be out of business at a loss.

I am not in the flipping business, I am in the rental business.  I do not have to do a deal to eat and will only do deals when they meet my criteria of 1) less than 70% of market value and 2) a positive cash flow of at least $100 per month per unit using real world numbers.  I NEVER BUY AT RETAIL OR AT THE PREVAILING MARKET CAP.

Mike

In my experience as a broker as well as an appraiser cap rates are very rarely used if ever in small residential deals. Cap rates are used in larger commercial properties. If you were going to use a cap rate in small residential transaction you would want to use "Mortgage Equity Analysis" aka "Ellwood model" to derive one. The former is a really involved analysis and not worth the time or effort. But, like I was saying cap rates are really not applicable to those types of transactions.

[DannyTheGreat]

I don't believe that we disagree. But what I was saying is that cap rates come in a range within a market..ie 5.5 to 6.75 for a class A office space. You may be right at 6.75 or even 7.20 for your investment value. Thats all I was saying. There is no specific cap rate for any one property type. There is a range and more often than not you'll be within range.

We're almost on the same page. But my very specific business model is actually quite different than the market. I change vacant industrial buildings (class F-?) and turn them into class A or B office space or some other use. If I were buying an occupied office building for an occupied office building, you'd be right on the money.

In my experience as a broker as well as an appraiser cap rates are very rarely used if ever in small residential deals. Cap rates are used in larger commercial properties. If you were going to use a cap rate in small residential transaction you would want to use "Mortgage Equity Analysis" aka "Ellwood model" to derive one. The former is a really involved analysis and not worth the time or effort. But, like I was saying cap rates are really not applicable to those types of transactions.

I'd say the reason for not using cap rates is that most small residential investors are not sophisticated investors. Talking about Ellwood, J-factors and mortgage equity analysis would be overwhelming. But I'm sure you'd agree that for an investor interested in collecting rents, this is the best way to go. Albeit, not always the most practical, certainly the most accurate investment value.

[FL Commercial Guy]

Great thread.

For what it's worth, as a broker, I tend to gravitate toward pricing cashflow properties based on cap rates than sales comps. I'm probably 60/40 pricing in favor of cap rates. The market's really changing right now and buyers aren't just buying things to have them anymore. I live in a fairly wealthy area, and even these guys are starting to think about what they're buying. Lots of investors in this neck of the woods.

6 to 7 caps sit for a while in this market. Big power centers (80,000 sf +) are surprisingly moving in the mid 6 ranges, but most everything else needs to be 7.5%+ to get much interest from investors these days. 8 caps make people happy and true 9 caps are gone before they get in front of the public.