What is Cash on Cash Return (CCR, COC, IIR)?

Post by  Ben Leybovich

The most easily understood metric of investment return in real estate is Cash on Cash Return, usually abbreviated either CCR or COC.  The concept is rather simple – CCR juxtaposes the cash investment that has been made to the Cash Flow (Income minus Expenses) being received.

For example, let’s say you invest $100,000 cash to buy a 4-plex which generates $2,000/month of Gross Income which results in $1,200/month of Cash Flow.  Since CCR is usually thought of in terms of annual return, we must multiply all of the monthly numbers by 12.  Thus, this $100,000 4-plex is generating $14,400 of Annual Cash Flow.

Now, CCR is simply the answer to the question – if I invest $100,000 in this 4-plex, how quickly, or at what rate, would I recover my cash?

Framed in this way, all we basically aim to find out is what percentage of $100,000 does $14,400 represent.  In mathematical terms, if $100,000 is 100%, then $14,400 is x – at which point we solve for x:

X (CCR) = $14,400 / $100,000 = 14.4%

 

Thus, having paid $100,000 and received $1,200/month of Cash Flow, our achieved CCR is 14.4%.
Let’s just say that in lieu of paying $100,000 cash for this 4-plex, you instead make a down-payment of 25% ($25,000) and finance the rest.

In this case, the presence of a note for $75,000 would require a monthly payment – let’s just say $450/month.  This extra expense would have the effect of lowering your Cash Flow from $1,200/month to $750, or $9,000 per annum.  But, what does this look like in terms of the CCR?
Well – the thing to remember is that while the cost of your investment is still $100,000, the actual cash investment to you is only $25,000 in this case.  Thus, what percentage of $25,000 is $9,000?
CCR = $9,000 / $25,000 = 36%

Infinity ROI

Indeed – the less money you have in the deal, the higher the Cash on Cash Return.
And if we follow this path of thought far enough, we would realize that any return on investment of $0, no matter how small, is actually infinity ROI.  Yes – it’s true; if you managed to purchase this 4-plex with 100% financing, without putting any money into the deal, then even if you were only earning $100/month of cash flow, it is still a return on investment of zero – infinity.
This is the neighborhood where I’ve lived for the past decade and how I’ve bought everything that I own.
Having said this, I must warn you to please not go out and buy a fully financed 4-plex if the extent of your cash flow will be $100; doing so will put you one leaky faucet away from not having the money to keep afloat.  However, it is indeed possible to buy with no money down and this represents the single greatest advantage of real estate as an investment vehicle.  But I’ve strayed, so let’s get to the IRR…

Limitations of CCR Which Are Corrected With IRR

CCR has some inherent to it limitations which render it inaccurate for the very sophisticated investors.  When very sophisticated investors evaluate investment opportunities, they must assign value to things like time value of money and opportunity cast, not to mention that any movement of cash in or out of the transaction significantly impacts the returns, this can not be addressed by simply considering the IRR.  Let’s talk about these one at a time:

Time Value of Money

Time Value of money is simply the reality that money is more valuable today than at any time in the future.

There are many economic reasons for why this is true, but it all comes down to the concept of buying power and erosion thereof over time due to inflation of the currency supply and the resulting price inflation.  Currency held today does indeed store more buying power that it will in the future – this statement is almost always true.
With this in mind, the sophisticated investors have to price this erosion of value into their return.  Let’s say that over a set period of time a given investment produces Cash on Cash Return of 12%.
But, in the same period the inflation clocks in at 3%.  On the day the money was vested, it had buying power equal to 100%, but on the day the return was dispersed the buying power is only 97%.  This has to be accounted for, and the IRR formula does exactly that, while CCR does not.

Opportunity Cost

As they say, there’s a right place and the right time to do everything.
So, if you invest the money now and lock it in for a set period of time, what other, and perhaps better, opportunities might come along that you will not be able to take action upon because your money is locked in…?
For sophisticated investors this is an ongoing problem.  For example, I bring to them my syndicated apartment building.  It looks good today, but what if someone else brings them a deal tomorrow that’s better?  What is the premium ROI that they expect to receive with me today in order to be willing to tie-up funds for a period of time…?
IRR formula addresses this as well.

Movement of Money

Finally, having weighted the opportunity for time value of money and the opportunity cost, IRR also is able to track movement of cash in and out of investment by tagging each movement with a date.
For instance, having purchased an asset, you might receive cash flow for two years, and then you might choose to refinance the building, which would constitute a large waterfall event.
Later, however, you realize that you were too aggressive on your refinance, leaving your DSCR too low, which result in your cash flow being unable to support the CapEx.  Now you have to dip into your pocket to pay for the repairs, which naturally adversely impacts your IRR.
Once this happens, you decide to sell the building.  And, since there are so many idiots chasing yield in the marketplace, you actually manage to sell a money-loosing asset at a profit – so you add that profit into the IRR.

Conclusion

The formula for IRR is rather complex, and I’ll let the mathematicians worry about why it works and how.  I simply use an excel spreadsheet to line-up and time-tag all of the in-flows and out-flows, and the formula calculates the return.
Perhaps some visuals or even a little video would be useful here.  But, I’m busy – may be next time.  I’ll simply tell you that to an individual investor buying long-term hold a 10% – 12% IRR might be quite respectable.  In terms of syndications, however, we shoot for mid-teens to make opportunities attractive to the partners.

Creative Approach to FREE Property Management

I met an investor that has a unique approach to RE investing. He has very little headache with renters because of this win-win philosophy. He looks for people in his community that have a down payment and want to buy a home but cannot qualify for a loan . He offers them a 25% stake in a multi-family that he buys. He puts in his own money for the rest and moves them into one unit in the building. They pay whatever rent is the standard for that unit. They get their share (25%) of revenue from the building later. This way, the building gets taken care of automatically. Since they live in a building they own, they keep an eye on the other renters, no surprises, no trashing. One unit (that they occupy) is permanently rented, no need to pay a property manager. Everyone is happy. This person has several such units he co-owns. Never paid a penny for property management.

I see a few flaws in this concept. But overall, I think it's brilliant. This is why I love real estate investing. There's so much room for creativity!

LLC - Should I form one or not?

Post by Attorney Deidra Hubenak
(The attorney in me needs to take over for a second.) I don't believe in LLC's for the average single family investor. There I said it. Why you ask?

• If you just have one or two houses, it is not cost effective. It costs about $300 just to form an LLC in Texas. This is the fee payable to the Secretary of State. Attorneys fees will run several hundred to a few thousand on top of this depending on the complexity of the documents.
• You can achieve liability protection through an umbrella policy much cheaper. (You should have this coverage regardless of whether you have a LLC).
• It is difficult for a LLC to get financing before it has established credit. (If you are going to utilize a LLC you should oftentimes finance the property first and drop it into the LLC after closing.)

So when would you want to use a LLC?

• If you have a partner other than your spouse.
• If you are investing in larger multifamily properties.
• If you own 100 single family houses, it may make sense to drop a few into one or more LLC's to protect the equity in each LLC from a lawsuit from a property in a different LLC.

Moral of the story - Don't knock on my door (or any other attorney's door) to form a LLC for you unless you really need it.

HUD List Price to Sales Ratio (Hartford County)

Have you thought about buying a HUD Foreclosure? The chart below will be pretty helpful for you. I looked at 90 HUD single family properties that sold in Hartford County between 1/1/14 - 5/31/14. I wanted to know if there was a magic number that they would accept when considering offers on properties.

 

 

As you can see in this chart, HUD gave the greatest discount off of the list price between 61-90 days on the market. This should make it a little easier for you when considering making offers on HUD properties. Just make your offer at about 88.79% of the list price and it should get accepted. Of course if you're making this purchase as an investment, make sure that these numbers line up with your acquisition strategy.

 

If you'd like a detailed analysis on your local market, email me here.

9 Unit Mixed Use Property (MOTIVATED SELLER)

9 unit mixed use property listed for sale in Meriden, CT for $389,900. Seller is extremely motivated and just wants to unload it. How motivated? So motivated that he's willing to list it at this price giving you a whopping 12% Cap Rate. Unit Mix comes with 6-two bedroom units and 3 commercial store fronts.

• Annual Operating Income:             $84,600  
• Annual Operating Expenses:         $35,973
• Annual Net Operating Income:      $48,267
• Monthly Net Operation Income:    $4,052

Click here to go to property website and see more photos & full financial disclosures!!

What is Gross Rent Multiplier

Gross Rent Multiplier is a simple calculation but because income plays no role in the formula, it provides limited insight into the apartment’s investment viability. Gross Rent Multiplier (GRM) is also easy to calculate but unlike Price Per Unit, GRM does incorporate the property’s income.

Gross Rent Multiplier = Price / Gross Scheduled Income (annual)

Gross Scheduled Income is the potential income a property would generate if it was 100% occupied. You can think of GRM as the number of years it would eventually take for the property’s gross income to total the price.

Example: A 10-unit apartment building is offered for sale at $1 million. Each unit is 2Bd/2Ba and is renting for $1,000. What is the Gross Rent Multiplier?

Gross Rent Multiplier = $1,000,000 / (10 x 1,000 x 12) = 8.33 GRM

As long as you can get your hands on the rent roll, then the Gross Rent Multiplier measurement is preferred over Price Per Unit. Generally speaking, properties in prime locations have higher GRMs versus properties in less desirable locations.

Advantage – It’s More Useful and Reliable than Price Per Unit
Pop quiz, what are you buying when acquiring an apartment? You’re buying income stream. Given the fact that GRM accounts for income into its formula automatically makes it a more reliable method for evaluating investment properties compared to Price Per Unit. Additionally, by taking into account income, property features are automatically factored into your evaluation. It’s reasonable to assume that rents reflect unit size, amenities, location, and even external factors such as general market conditions that may add to or deduct from its price level. Rents are market driven – you can only charge as much as a tenant is willing and able to pay. By factoring in a market-driven data point (income), GRM is more reliable as a measurement for comparing properties. In areas where operating costs can be expected to be uniform across properties, GRM is especially useful for comparing and selecting investment properties for further analysis.

Limitation – Ignores Vacancy & Operating Expenses
Gross Rent Multiplier serves to indicate what the market is paying as a multiplier of the gross income. As explained above, gross income is generally a good data point because its market driven and accounts for enhancements and deficiencies of the property as well as general rental demand. But because it is gross instead of net income, GRM fails to differentiate properties with lower or higher operating expenses and vacancies. Tenants may pay for some, all, or none of the operating expense. For example, a landlord may pay for all utilities because the building is master metered. This will result in higher rents compared to an identical property where those costs are directly passed to tenants. If you were estimating the price between the master-metered versus the individual-metered property using the same GRM number, then this would result in a very questionable value.
As with Price Per Unit, it’s important to understand the reason to use Gross Rent Multiplier. Always keep in mind the above limitations and remember that its purpose is to get a quick feel for the potential market value of the apartment.

Is "Price Per Unit" really important?

If you’re evaluating many apartment investment deals, oftentimes you need a quick way to determine ones that warrant more detailed analysis. After all, your time is valuable and any time spent analyzing deals that don’t make sense from the very beginning may result in other lost opportunities. What you need are techniques to act as filter mechanisms and help you quickly decide if the investment deal will really work.

Price per Unit is often used because it’s simple and quick to calculate.

Price per Unit = Price ÷ Number of Rental Units.

 

What makes it popular is that it’s easy to gather the necessary information to run the calculation. All that’s needed is the asking price and the total number of units.
Example: A 10-unit apartment building is offered for sale at $1 million. The property has a total of 20 bedrooms and 20 baths. What is the Price per Unit?

$1,000,000 ÷ 10 units = $100,000 per Unit.

If the general price per unit rate is $50k per unit, and the property is offered at $100k per unit, then red flags should be raised immediately. If evaluating multiple deals, this might be one you choose to set aside.

Precaution #1 – Neglecting to Factor in Property Features
What if the general rate in the area was $75,000 per unit? Will you still be quick to discount the property? One precaution to take with Price per Unit is that it doesn’t take into account property features such as amenities, location, or floor plans. Each of these can add or subtract to the Price per Unit value. Let’s say the 10-unit subject property’s 2bd/2ba units are generous in size at 1400 sq ft each. Other surrounding properties have outdated floor plans with only 2bd/1ba models and average 800sq ft each going at the general rate of $75k per unit. The higher price per unit of the 10-unit apartment would then be warranted because of its more modern features and larger floor plans. If you were strictly comparing price per unit rates, then you may have dismissed this opportunity by thinking the property was overpriced.

Precaution #2 – Ignoring the Investment Feasibility
Since Price per Unit is based on the physical feature of the property, it’s really a physical measure, not a true financial measure. Because the income is never reflected in the formula, price per unit provides little insight towards financial feasibility of the investment property. You can’t derive from it whether the investment property will provide a suitable return or not. A property could be offered at a low price per unit but still turn out to be a horrible investment because of negative factors such as bad location or problems due to deferred maintenance. Alternatively, a high price per unit doesn’t necessarily mean it’s a bad deal as illustrated in the section above.
Price per Unit is easy to calculate so it’s often a good initial measure to use. However, keep in mind that Price per Unit only looks at the number of units; it completely ignores everything else about the property including its features, location, and income and is limited in its usefulness. Therefore, if the deal passes the Price per Unit test, then move on to the GRM test or the Cap Rate test.

What is a Cap Rate? (Capitalization Rate)

What is Capitalization Rate?

I'll give you the short answer and the more descriptive answer... The short answer is that the Capitalization Rate is the rate of return that you would expect if you were to purchase a property using all cash (no financing). It's just that simple. But I'll dig a little deeper so you fully understand what it is and why it's so important.

The Capitalization Rate, often referred as Cap Rate or just Cap. It is similar to GRM but can be more precise because it considers vacancy loss and operating expenses.

 

Cap Rate = Net Operating Income / Price

Net Operating Income (NOI) is the sum of all potential income less vacancy and operating expenses. NOI does not consider debt payments, depreciation, or capital improvements.

Calculating Cap Rate: An Example

A 10-unit apartment building is offered for sale at $1 million. Its annualized rent roll is $100,000 with operating expenses totaling $40,000. What’s the Cap Rate if average vacancy rate in the area is 5%?
Capitalization Rate = ($100,000 – ($100,000 x 5%) – $40,000) / $1,000,000 = 5.5% Cap
If you know the going Cap Rate for the area, then you can also derive the property value from the NOI.
Cap Rate addresses the limitations of Price Per Unit and Gross Rent Multiplier by including income, vacancy loss, and expenses in its calculation. However by doing so, other problems are introduced.

Precaution #1: Is the Cap Rate Distorted?

Capitalization Rate isn’t flawed, per se. The problem is with Net Operating Income. More often than not, NOI may be inaccurate, which distorts Cap Rate and consequently, misrepresents the estimate of value.
The inaccuracies stem from three primary reasons:

1. Misrepresented expenses
2. Excluded expenses
3. Improper expenses factored into the calculation

Common expenses include insurance, property management, real estate taxes, business fees, maintenance, trash removal, electricity, gas, and water. While reviewing each expense item, confirm the validity of each number. Try and obtain the actual amounts rather than estimates. Are items inappropriately labeled as operating expenses? Remember that depreciation, capital improvements, and mortgage payments are excluded.
Ensuring that expenses are complete and valid will enable you to estimate a more credible value.

Precaution #2 – Is the cap rate calculation based on current or pro forma numbers?

Sometimes sellers or brokers will base their asking price against the future income of the property. This future income is almost always higher resulting in a higher Cap Rate. This tactic is used to lure the unaware investor.
While it’s important to understand the potential upside in rents, projected numbers shouldn’t act as your baseline for estimating value. When estimating value, use current income and expenses. Then evaluate how much premium you’re willing to pay based on projected increases.

Precaution #3 – Financing is not considered.

Investors often use Cap Rate to gauge the potential return of a given investment property during the first year of ownership. Generally, a 10% Cap would indicate a 10% return on investment. Based on expected return, the investor then determines how much they are willing to pay. For investors who pay all cash, Cap Rate enables them to quickly do this.
Since NOI does not consider debt payments, Cap Rate ignores the impact of financing. Cap Rate stays the same whether a property is leveraged or all paid off. If financing is planned, then Cap Rate cannot be used as an estimate of value. Additional methods (ie. cash-on-cash or IRR) are required to assist in that task. However, Cap Rate is still useful as a comparison tool even with financing involved.

The Anatomy of a Real Estate Contract

This is going to serve as an overview of real estate contracts.
This blog post is intended to provide general information regarding real estate contracts, specifically residential resale of single family residential housing, but in no way does this constitute as legal advice.
I am not a lawyer, nor have I played one on TV.

The Parties

The parties section of the contract will typically contain information for both the buyer and the seller. If you are buying in an entity be sure to note it here. If the property is still owned by the estate, you will likely need to write in “estate of” name of deceased person on title for the sellers portion .
Similarly, if someone has power of attorney for the seller, they can write in their name here as well followed by “POA” or “Attorney in Fact”.

Sales Price & Financing

Although this section may seem fairly obvious, I have heard of many stories where both investors and real estate agents fill it out incorrectly. Typically this section will be broken into two parts, one for the cash portion of the sales price, and another for the financing portion. If you are doing an all cash offer, put the sum total sales price here and put $0 or mark through the financing section of the contract. Be sure to fill this out completely.
For example, if you are acting as a real estate agent in the transaction, and representing the buyer, if you leave one of these sections blank you will essentially have an incomplete offer. Not only that, but it looks very unprofessional if you do not fill out the absolute basics of the contract correctly.

Earnest Money

Earnest money is sort of a interesting subject, in essence it is to show how series you are about buying the property. I find it funny because if I am writing the contract obviously I am interested in purchasing. Earnest money can sometimes be considered “hard” (non refundable) as well. Typically 1% of the purchase price is put down as earnest money.

Addendums

Common addendums that you might use include: sellers disclosure or property condition, lead based paint, mineral and gas rights and any personal addendums that you use for your real estate transactions.  Some addendums such as the lead based paint addendum may be required by the state but only if the property was built prior to 1978.

Special Provisions

Many promulgated contract forms will have a section for special provisions. Here is where I typically list any personal addendums that I may be attaching to the contract, or disclose that I am a licensed real estate agent but not acting as one in the transaction. You can also include special instructions like buyer to pay all normal closings costs.
In addition, you can be creative with this if you are making a ton of offers such as this offer will expire by (insert date and time here).

Use Your States Standard Promulgated Contracts

I recommend using your states standard promulgated forms for whatever type of real estate transaction you are participating in. There are multiple reasons for doing so, unless you already have a custom contract prepared for you by a real estate attorney. For one, using the states standard promulgated form typically puts both you and the seller on equal footing. If you're investing in Connecticut, just email me and I'll send you a local contract.

3 Commonly Overlooked Property Expenses

I’ve seen many different spreadsheets and pro-formas over the years, calculating potential return on investment for a given rental real estate investment. It’s not uncommon to find wholesalers inflating returns by eliminating all sorts of typical expenses (ie. vacancy, property management, insurance, etc). While this may trip up a newbie investor, most folks know to build in the usual expense categories when developing a pro-forma. Even so, I find it interesting how infrequently I’ll see the following three categories in a typical ROI calculation:

Turnover

What is turn-over expense? It’s money spent on a property when a tenant moves out to get the property ready for the next tenant. Inevitably, when a tenant moves out of a property there is some level of work needed to get the property in marketable condition. Most investors will touch up walls and paint (if not completely re-paint), clean and replace flooring as needed, take care of minor handyman items, etc. All of this can easily add up to over $1,000 (and sometimes much more) depending on the size of the property and the condition that it was left in.

While most investors have a line item for maintenance in the pro-forma, I find that it’s rarely enough to include turn-over expenses as well. Maintenance is really an ongoing budget item as repairs will inevitably be needed over the life of the property. Turn-over expense is really associated with the moving in and moving out of tenants.

Bookkeeping/Tax Prep

Another budget item that may or may not belong on a specific property proforma, but should be calculated nonetheless is bookkeeping and tax preparation. For the small investor who doesn’t mind tracking expenses and doing his own taxes, this may not be an issue. However, for the investor with multiple properties and an operation more like a business with properties in multiple LLC’s, it’s likely that there are costs associated with bookkeeping and tax prep. It’s important to include these figures when evaluating new properties for acquisition.

CAPEX

CAPEX stands for Capital Expenditures and pertains to big ticket expenditures that increase the useful life of the property. I think the most obvious CAPEX type expenditures on residential properties are items like the roof, HVAC, water heater, etc. I consider this slightly different than maintenance because they are higher cost items.

It’s very common for investors to buy a property with an old roof or an old HVAC and not budget for future replacement. For example, if you determine that you only have 5 years left on an old roof and you determine that a new roof will cost around $5,000 to replace … don’t you think you should budget $1,000 per year for the next 5 years to cover this expense? It seems obvious, but I almost never see investors doing this.

Understanding the true cost of an investment is one of the most critical elements to successful investing. It’s important that investors use accurate numbers and budget for all appropriate expenses associated with a potential acquisition.

Creative Strategies on Selling Properties in a Down Market (Q&A)

 

Click Here to email me your real estate investing question

Question: Cameron thank you so much for this (Q&A) segment of your blog. You have some really good advice in which is why I'm coming to you with this question... I live in West Hartford now but I have two houses in Puerto Rico that I can't think of no exit for the next 5 to 10 years. One I own free and clear but it is located in a non desired area. On top of this, the way it is constructed makes it hard to get conventional financing so it can only be sold to a cash buyer. I have rented it in the past but it has been vacant for the last 5 months.
The other is a condo that it is located near a medical and law school. It's currently rented and I don't owe much more on it. I would love to find a creative way to get rid of both of this properties. What makes the exit hard, is the current economic situation of Puerto Rico, Government Bonds were classified as Junk bonds and most of the people in the Puerto Rico are employed by the Government. The current trend is a sharp decrease in population and unemployment well above the double digits. There are hundreds of vacant homes and rents are at all time low. I have offered seller financing, made attempts to swap my house for a house, land or even an RV in the US but no luck. I can not even take the equity out by re financing since no bank in the US will make the loan. I have offered Agents $5,000 bonus on top of the commission for the sale, attempt to rent it as a vacation home, etc..  My current strategy is to buy more houses to make up for the negative ROI but it really sucks to have two properties making you no money.
I need a brilliant idea to turn this around since I have run out of them.

Answer: Wow Luis that really is a crazy situation. I think that you've been pretty innovative in trying to come up with different solutions but here are a few more that you can try out. First is to check the price. I don't know what your asking price is but often times if you just bring it down a few thousand, you might be able to pull in a buyer, even if it's just on the property that you own free & clear. Then you can use the proceeds to pay off or pay down the condo and then sell it at a discounted rate as well. Another option is to do an Absolute Auction on the free & clear property. Again, use the proceeds to pay off or pay down the condo. You could also find other landlords in the neighborhood by searching public records. Contact them to see if they are interested in purchasing both condos as a package deal. Another option for the condo is to market it to students and their parents at the college. Stress how close it is and how it makes sense for a student/parent and can even have roommates help pay the mortgage. The college might have a housing office or a campus newspaper to advertise the condo. I hope this helps. If I think about any other options I'll email/call you.  

Click Here to email me your real estate investing question

If you have a different opinion or just something that you'd like to add, please feel free to leave a comment below.
This is not legal advice. Please contact an attorney for professional legal advice.




How To Use A 401k to Invest In Real Estate (Q&A)

 Click Here to email me your real estate investing question

Question: I currently have a primary residence, a vacation home/rental and a rental property, and have a loan on each of these three properties. Would like to buy another rental property but debt/income ratio is too high and was told that I could not qualify for another loan. Have a combined of approximate $140K equity in three properties, and $70K in 401K. Also had $25k in saving account for down payment. I'd like to know how to leverage the 401K balance to qualify for a loan to buy a $100K rental property. Will appreciate any suggestions you can offer.

Answer: Hi Pei, there are a few options that you may have available. First I'd recommend that you totally exhaust your banking options. Try 10-15 banks to see if they'll give you the $75k loan. If that doesn't work out, find out if you can barrow against your 401k. As you may know (based on the way that you phrased your question), many plans allow you to barrow up to 50% or $50,000 which ever is less. That would give you access to $60,000 (including your $25k in savings). If the bank won't loan you the remaining $40k, you may be able to find a seller that is willing to carry it back by way of owner financing. Another option is to partner-up. Maybe a friend, family member or a colleague will be willing to invest with you. You can structure it anyway that you want but if you're looking to buy a property for $100k then maybe you can own 60% of the property and your partner can own 40%. Also, having 2 years of rental income and equity buildup may put your Debt to Income Ratio in an acceptable range, so you could use a short term loan until you have the second year of rental income,but make sure that will bring your DTI to an acceptable level before you try this or you could end up with a high interest loan and no way out.

Click Here to email me your real estate investing question

If you have a different opinion or just something that you'd like to add, please feel free to leave a comment below.

This is not legal advice. Please contact an attorney for professional legal advice.


How to Determine an Income Property's Value (Q&A)

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Question: I've never purchased real estate as an investment before. I acquired a Quad Multifamily recently in Lowell Mass. My closing is on March 7, 2014. It took me about 5-6 months to find it. I picked this property through an MLS. While going through realtor.com, I found this property. I have an agent who sent me the MLS update daily, but it was not fast enough. I don’t think she really knows much. She does not know the concept of cash flow, cap rate and never helped evaluate a property worth for me. I am a cash flow guy. It is my priority and equity is secondary. Looking back, it was easy for me to determine cash flow, but I have a hard time determining the value of the house. For example, I don’t know if the house is selling at the market rate or has any equity. I looked over the lender appraisal report, and see how the appraiser evaluated the house worth. It is complicated. He could not find much 4-Fam in my town, so he went to towns close by the used those houses for comparison. He picked 4-Fam with similar living space and number of bed rooms.
My question is:
How do you evaluate the house worth? Is there any reliable website that I can use to determine if the house has any equity at the given sale price? I need help – step by step how to perform research and good reference websites.

Answer: Hi Chan, It’s actually very simple. When it comes to “Income Properties”, the buyer sets the value. I wouldn’t even worry about comps because there’s probably not many 4 unit properties within a 5-10 mile radius with the same square footage, amount of bedrooms & bathrooms in each unit, acreage, operating income, operating expenses, maintenance issues etc etc etc. Plus, just because the other guy didn’t do his due diligence and overpaid doesn’t mean that you have to!

I suggest finding a minimum cap rate that you are willing to except and make the offer based on that. So let’s say your minimum cap rate is 10% and you find a property on the MLS listed for $300,000. You do your due diligence and find that the property’s average net operating income is $24,000. $24,000 / $300,000 = .08 or 8% (The Cap Rate). So from here you would just adjust the offer to $240,000 to give you that 10% cap rate.

With that said, there is a big difference between $300,000 and $240,000 so before I submit that offer, I'd try to get some background info on the seller and check public records to get an estimate of how much they owe on the property to see if my offer is even feasible. Also, if you find yourself getting rejected too often, then you're probably asking for an unrealistic cap rate.

As for any helpful websites, there are many out there that will give you comps, but I don't know of any off the top of my head that will help with this method but as you see the math is actually pretty easy.
 

Click Here to email me your real estate investing question

If you have a different opinion or just something that you'd like to add, please feel free to leave a comment below.

This is not legal advice. Please contact an attorney for professional legal advice.

Buying Investment Properties On The MLS (Q&A)

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Question: Hi Cameron, I must not be seeing eye to eye with many investors that I've spoken to. I'm into buy and hold properties and I'm thinking of making my first purchase soon. The thing is, I know that purchasing and financing a home for a really good (cheap) deal is always a plus. But when it comes down to it. Isn't just buying a good quality property at normal price and renting out for a monthly cash flow a good thing too? Instead of waiting for that one deal that could take months and months to get. Why would it not just be a good idea to pick from the plenty of houses on the market at average cost and make sure you cash flow from the rents for the next 20 years? Wouldn't this type of thinking result in investors getting even more homes and even more cash flow?


Answer: Hi Morgan, Since you're a beginning investor, I'd recommend that you buy a regular ol' move-in-ready property. The key is doing your due diligence to make sure that it will cash flow. Keep in mind that most great deals aren't seen with the eyes, they're seen with the mind. What do I mean by that? Price is just one factor to consider when evaluating a deal. Terms are just as important. So if someone is stuck on finding that property for fifty cents on the dollar, they're going to miss a lot of hidden deals. So to answer your question, I believe that you're right on point with your philosophy. Especially since you're new to investing.

Click Here to email me your real estate investing question

 

If you have a different opinion or just something that you'd like to add, please feel free to leave a comment below.

This is not legal advice. Please contact an attorney for professional legal advice.

HUD Foreclosure "List Price to Sell Price Ratios"

Have you thought about buying a HUD foreclosure? Well you'll be glad that you read this article before you make that first offer. I was recently working with a client that was interested in buying a HUD property as an investment. When the time came to make the offer, I decided to do a little research to see if there was a formula that HUD uses when deciding how much of a discount off of the list price they are allowed to give to buyers. After surveying 115 HUD Homes that sold in Connecticut in 2013, this is what I found....

 

List Price to Sell Price Ratios

 

 

As you can see in my chart, there appears to be a formula that they are using to decide when & how much discount they are allowed to approve for buyers.

• Between 0-30 days on the market, buyers didn't receive any discount at all
• Between 31-60 days on the market, buyers purchased the properties at 90.57% of the list price
• Between 61-90 days on the market, buyers purchased the properties at 80.7% of the list price

So according to this chart, it looks like it's best to offer HUD just over 80% of their list price after the property has been on the market for between 61-90 days..... Your're welcome :-)

Real Estate Investing is all about the numbers, If you're interested in buying a HUD Foreclosure in Connecticut, and you want to work with an agent that will stop at nothing to get you the best price, Click Here to fill out a quick form and let me know exactly what you're looking for.

How I REALLY Feel About "Subject To's"

I'M NOT A FAN!! I’ve never used it personally and I don’t use it with my clients however, it’s very popular with those so called gurus on late night infomercials and people always ask me about it so I figure that I’d at explain what it is and why I don't like it. In all fairness, I’ll say that the subject-to method is a great way to finance a real estate investment quickly, though it will be a short-term solution. The name "subject-to" comes from the phrase "subject to existing financing." This means that you buy the property on the condition that the existing financing stays in place. The title is transferred, but the loan will stay in the seller's name, and the buyer will make the payments. The reason why this is a short-term fix is because seller's aren't going to be very comfortable leaving the loan in their name for an extended period of time. Some investors will use this method when they don't want to come up with a down payment, knowing they can refinance in six months and get the loan put in their name. This method is commonly used when buying pre-foreclosure properties. The investor gets into the property with zero down or by just paying the mortgage arrearages and the seller is willing because they have to get rid of the property immediately.
But here are a few of the reasons that I don’t like this strategy;

1. In order to do it "right", you must place the property in a land trust in order to hide the fact that you assumed the mortgage from the bank. If the bank finds out, they could call the mortgage due in full putting the seller back in the same position as they were before.
2. It’s unethical. As a real estate professional, I have built my reputation on Trust. The fact that I have to try to hide the assumption from the bank just makes me uncomfortable. I know that banks are big institutions and its not like I’m hurting anyone but I just feel like my integrity would come into question and I’m just not comfortable with that.
3. It’s not as easy as the “gurus” make it seem. Just imagine Joe Investor coming into your home to make his purchase offer. He sits down on your couch and tells you that you have to sign the deed to your home over to him (giving him ownership) but the mortgage stays in Your name (and if he defaults on the loan, there’s no penalty for him but you’ll end up with the foreclosure on your credit). Oh yeah, and make sure you don’t tell the bank or anyone else about this deal. I understand that it happens all the time, but it’s very hard to find a seller that’s willing to do something like that.

Again, I don’t use this strategy in my personally investing or with my clients. However, If you use this method to finance a real estate investment, just make sure you uphold your end and make the payments on time.

Real Estate Negotiations (Part 5) "Stay In Control"

Today's Real Estate Negotiations Tip is....

"Stay In Control"

 

Negotiations can sometimes be a highly charged and emotional event. Check your emotions at the door. Never let the other party get you to a point whereas you end up losing your cool. It's just not worth it. If the other party seems to be getting emotional, or if their just demanding that you answer questions that you're not prepared to answer, it may be time to take a break. Just stop the conversation and go to the restroom or get a drink of water. Allow the conversation to have time to "reset". If this doesn't seem to be working, just call it a night. Say something like "Well I've gathered some valuable information tonight, but I've got to do a little more research before I can make/accept an offer" or "Unfortunately I have another appointment that I need to get to in 15 minutes". Maybe you need to go over some details with your partner, spouse or contractor. Bottom line, Stay in control of the negotiations at all times. Don't lose your cool, and don't let someone else bully or intimidate you into doing anything that you don't want to do.



Real Estate Negotiations (Part 4) "Know Their Situation"

Today's Real Estate Negotiation Tip is....

"Know Their Situation"

You'll find that negotiations are MUCH easier when you know the other person's situation. Knowing their situation will allow you to give on the things that matter to them but are insignificant to you. For example, a few years ago I was negotiating to purchase a property that the seller owned free & clear. I was offering to purchase the property using 100% owner financing. The seller's only hang-up was that he wanted to use the proceeds from a traditional sale to pay off a house in Florida so that he has peace of mind in knowing that if anything was to ever happen to him, his wife would be able to remain in the Florida home without worrying about a mortgage payment. Armed with that information, I offered to have him take out a term life insurance policy and I would pay the monthly premium. In exchange, he would hold a note for 100% of the purchase price at 0% interest until I either sold the property or refinanced.

Bottom line, I would have never been able to negotiate those terms if I didn't know his situation. Click here to see my post on how to find free & clear homes.

Real Estate Negotiations (Part 2) "Know What You Want"

Today's Negotiation tip is....

"Know What You Want"

There are  many different strategies to investing in real estate. If you've found a property that you're interested in purchasing, you should first know what you want to do with that property before you begin negotiations. If you're planning to buy-&-hold this property using owner financing, then you can probably influence the seller to give you the terms that you want (such as 0% interest) by offering a higher purchase price. If you're preferred strategy is flipping houses, then you're primary goal is to buy that property for as little as possible so you can't offer the seller more money, but you can offer a super fast closing by either paying with cash, or using a hard money lender.

To be a successful negotiator, you must understand and think through what you want to accomplish in the negotiation. One great way to do this is to take the time to write out a list of questions that you can ask the seller. The answers will give you the knowledge of how to successfully get exactly what you want and need. 

Connecticut's Best Real Estate Deals are in.....

I'm often asked "Where are the best deals in Connecticut right now?". My answer is "Right between your nose and your hairline!" (Ok so maybe I don't say it quite like that but you get the picture.)

The best real estate deals are not seen with the eyes, they're seen with the mind. That being said, you can find great deals in every city, in every state, at anytime. All it takes is a little ingenuity and some education on creative investing strategies.

Notice that I didn't say "creative real estate investing strategies". That's because this concept transcends beyond just real estate.

When I was a kid, I had a friend that was upset that the candy in the vending machine at school was much more than it was in the store. Seeing this as an opportunity, he then took a trip to the local wholesale club with his mom and bought that candy by the bulk and sold it at school for much less than the candy in the vending machine. He made a ton of money and he's a successful entrepreneur today.

Bringing it back to real estate, let's say that you have a deal on the table whereas the owner is over-leveraged (owing more than the house is worth). At first glance, it may look like there's no money to be made there. But instead of walking away from the deal, you rack your brain and come up with 3 different options.

Option 1 - Short Sale: If the seller is behind on his mortgage, you can negotiate directly with the bank (or hire a short sale specialist to negotiate for you) and end up purchasing the property for less than market value.

Option 2 - Sandwich Lease Option: I wouldn't recommend this if the seller is behind on mortgage payments. But this type of deal would allow you to have control of the property (without purchasing it) and rent it out to a secondary tenant. The secondary tenant stays in place until the mortgage is paid down enough to go forward with the sale. In short, you're paid to be the middle man.

Option 3 - Subject-To: Before I go into this one, I must say that I don't personally participate in assisting buyers or sellers with Subject-to deals. The reason is that it's a very slippery slope and I can face a lot of ethical issues if the deal goes south. That being said, It's still an option for you in a private transaction. A subject-to deal would allow you to assume ownership of the property while the seller maintains responsibility for the mortgage. In a perfect world, you would find a tenant for the property to pay down the mortgage, and then either sell the property for a profit, refinance it, or keep it for cashflow once the mortgage is paid off.

So as you see, just about any property for sale out there is a potential "deal" if you know how to properly structure the transaction. Education is key! I highly recommend that investors continue to educate themselves in all areas of real estate. You never know it all!

For more information on Short Sales, Sandwich Lease Options & Subject-To's, visit my website at www.MyInvestingAgent.com