Multifamily property value.Please respond.

[propertymanager]

If you don't believe me that the cap is the most widely used and accepted formula for evaluating properties the simple fact that there are millions of hits for 'cap rate' but not a single one for '2% rule' or anything else along those lines should maybe carry some weight.

JBaldwin,

OK, since you've done extensive reading on cap rate, here are a couple of questions for you?

Where are you getting the market cap rate for your area?  How did that person or entity get accurate expense data (who did they get it from) so that they could determine NOI?

Even if you could get a market cap rate, what does that tell you when YOU don't know what the actual expenses are for YOUR property and are using ridiculous expense numbers like maintenance of $7 per month?  You see, even though you supposedly knew all the cap rate nonsense, it didn't do YOU any good because you compared a ficticious cap rate for your property to an inaccurate (imaginary) market cap rate.

Why do you think the vast majority of newbies fail in a short period of time?

You can't buy cash flow here; you haven't been able to buy cash flow for the entire 30 years I've invested in this area.... I don't expect every property to stand independently; older properties help carry new purchases.

That's my point exactly.  You can either follow the 2% rule (which is nothing more than a simple math equation) or the property will not cash flow properly.  Where you live has absolutely nothing to do with the math.  If you can't buy properties that are very close to the 2% rule, you don't have adequate cash flow.  It's that simple.  That's the mistake Jbaldwin made.   

There are lots of ways to make money besides cash flow. Build spec houses, subdivide land, buy out in front of development and wait for it to catch up to you. Buy without cash flow and wait for rents to catch up. Buy timber. Buy apartments and convert them to condos. Buy property that can have value added. Do equity splits.

In other words, if rentals won't work in your area, do something else!!!  Again, my point exactly!

Mike

[buffinvestor]

Tell me this, if we both walked into a big time bank and you started telling them that you buy based on 2% of the gross rents and I started quoting local cap rates, national cap rates, and how I only buy at a 12 cap and so forth who would look like they know what they're talking about.  That's the last thing I'm saying about this, but I do appreciate the dialogue I learn a little bit from each of our conversations.

Am I missing something here?.....Following the 50% and 2% rules equate to a 12% cap rate and a 50 Gross Rent Multiplier for those of you into using the GRM rule...Sounds like you guys are talking about the same thing...

JB - If you're looking for 12% cap rates, then you're following Mike's 2% rule, but just calling it a different animal...

[propertymanager]

Am I missing something here?.....Following the 50% and 2% rules equate to a 12% cap rate and a 50 Gross Rent Multiplier for those of you into using the GRM rule...Sounds like you guys are talking about the same thing...

JB - If you're looking for 12% cap rates, then you're following Mike's 2% rule, but just calling it a different animal...

Buffinvestor,

What you're missing is that they he's not using the 50% rule for expenses or the 2% rule for maximum puchase price, not even close.  What he's doing is using an imaginary expense figure with no management expense; $2 per month per unit maintenance expense; no tenant related expenses (evictions, legal fees, etc); no capital expenses (although not technically an operating expense), no advertising expense, no office supplies, etc, etc, etc, etc. 

So, obviously what happens when you put garbage into an equation is that you get garbage out of the equation.  When the expenses are garbage, the NOI is garbage.  When the NOI is garbage, the Cap Rate is garbage. 

For the property he purchased, the gross rents are $1,750 with a purchase price of $135,000.

So, here is how the cap rate really looks.

Gross rents:  $1,750
Operating Expenses:  $875
NOI:  $875
Purchase Price: $135,000

Cap Rate:  7.7% (not 12%), which means that in this case there is a negative cash flow of $69 per month.

You are correct, IF he had used the proper expense numbers (50% rule) and IF he had bought using the 2% rule, that would have been the same as a real 12% cap rate.  However, since he didn't do that, he has a property that will lose money over the long term. 

Moreover, another important distinction is that he is basing his purchase price on a mythical market cap rate that he is apparently getting from a realtor.  Most rental properties are purchased by newbies.  Most newbies fail in a short period of time.   When you base your purchase (of SFHs and small multis) on the market cap (which is a garbage number to start with), then all you have done is pay what the losers paid for their property.

Mike

[tatertot]

This is my experience with CAP rates:

The figure that the realtor puts into the listing is totally worhtless. In order to get a  Cap rate attractive enought to get investors to take a look, the agent leaves out all sorts of expenses. (and that is in 100% of the commercial properties I've looked at)

Anyone who wants to use cap rate to decide whether or not to make  a purchase, had better be doing their own figuring to come up with the cap rate. And that means hunting down the real costs: you have to call your insurance agent; you have to call the power company; you have to refigure the property taxes, because they are going up when the property changes hands.

Then, in addition to the cap rate, you have to look at the area, you have to look at repiars needed, and you have to go and find out what sort of new develpment and changes are on the schedule for the surrounding area.

I don't do cap rate and I don't so the 2% rule. This is how I figure it. First, I decide if the property is something that I would like to own. If not, we are done. If I want it, I add up all the income. Then I add up all the expenses. Subtract the expenses from the income and if what is left over is enough to make me happy, then we start negotiating to try to purchase.

[LIGHTBEING]

I'll say this again.  Cap rates are important but are not neccesary to evaluate a deal.  Do your cashflow analysis.  If you feel comfortable with determining the cap rate % to make sure it's inline/above/below market rates, fine.  But the bottom line is your bottom line i.e. cashflow.
COCR is crucial.

Cap rates are still a very important part of understanding your market/submarket and making future projection.  If your plan is to buy and hold, well you need to have a formula to project the outcome.  Cap rates(past and present) and certain market trends will help predict future value.

I really don't like to generalize anything.  Your evaluation needs to be specific.  Verify and confirm all expenses.  In my market, I know what the typical expenses are per unit per asset class.

Investors using Cap rates only presented to you by brokers and sellers is a recipe for disaster.    On the other hand, Brokers love to use cap rates, or should I say inflate Cap rates.  They know a high listed cap rate regardless of actual performance will draw attention.  That is a common mistake by newbies.  They focus on Cap rates and what the interest rate on the debt service is/can be, and mathmatically trick themselves into the deal.  But the truth is, in the end, most of, if not all of the spread, will get eaten up by the actual expenses.

[roostking]

Hello. I am looking into doing some multi-unit investing in about 8 months, so i am trying to learn what I can now. Although the following 8 unit apartment complex does not appear to be a good deal I want to be sure that I am doing all of the calculations correctly.This is simply an example I found in the local paper

$55,600 annual income (Does not give rents, so i am going to assume 55600/12 = 4633 (total rent) / 8 =  579 a month per unit rent

4633 / 2
2317 for expenses
2317 Net Income - mortgage

Building cost $624,000 * 7.5 = $4680 mortgage payment.

Did I do this right? Obviously, this building is way over priced when using the rules that have been set forth. 

Now what if I was able to offer $231,670 =  $4366 / .02
So monthly rents $4633 / 2
2317 expenses
2317 Net income - mortgage
Building cost $231,670 * 7.5% = $1738 mortgage
$2317 - $1738
= $579 total profit / 8(# of units)
Equals a profit of $72.38 per unit, per month, which fits in with what you guys are saying.

If any of this is incorrect please let me know...

[propertymanager]

roostking,

You used the formulas correctly, however I didn't come up with the same mortgage payment that you did.  For example, a $231,670 mortgage for 30 years at 7.5% interest gives a payment of $1,619.  I didn't get $1,738 for 20 or 25 year terms either.

Mike

[jbaldwin]

Once again, the 2% rule will steer you towards unrealistic goals and subsequently unrealistic offers.  You go around offering $231,670 for buildings that are priced at $624,000 and see how long your reputation lasts.  The problem once again with the 2% assumption is that you are using a GRM of 50, again unrealistic.  Read over this story and you may reevaluate your usage of the 2% and GRM valuation methods.

http://ezinearticles.com/?Say-Goodbye-To-The-Gross-Rent-Multiplier&id=303508

happy holidays!

[propertymanager]

jbaldwin,

Once again, all one has to do to judge the viability of your argument is to look at YOUR DEAL!  YOU bought a rental that will LOSE money over the long term because you paid too much using your imaginary cap rate and ridiculously low expenses (claiming $2 per unit per month in maintenance, for example).

Once again, let me clarify that it DOES NOT MATTER what the asking price of a property is.  It also doesn't matter if 99.999% of the properties in a given area won't cash flow.  If you want to have an acceptable cash flow from a property, the rent needs to be a minimum of about 2% of the acquisition cost.  This is simple math.  The article is right, if you are paying very high interest or there are unusual factors, you may need to pay EVEN LESS for the property, meaning that the rents need to be MORE than 2% of the acquisition cost.   That is why the 2% rule is a screening tool and you still need to do a cash flow analysis WITH REAL WORLD EXPENSES.

Mike

[roostking]

Thanks for the help guys, I dont know if im doing my math wrong but I get the point. I am concerned with my ability to find a deal that is suitable given the market of the last few years, unless of course they are in foreclosure, but I will certaiinly try!

Rk