A newbie question about multifamily

[Andrew McIntyre]

Going to throw out an example purchase for my questions, bear with me :) Ok, so I want to buy a duplex and rent it out. I'm going to just throw a number out, lets say total price is 180k. So question number one. I would divide 180k by 2 then multiply the 90k by lets just say 1% to get the amount of rent i should charge each tenant right? so annual income would be $21,600, for my example I will say my annual costs are $12,000 which leaves me with $9600. So here is what I don't get, if all I put into the property so far is about 50k (36k for 20% down payment and 14k for whatever else) do I just do 9600/50k? or 9600/180k? i get 19.2% c.o.c with one and 5.33% with full price. Which formula should I follow when buying a buy and hold multifamily property?

[Jeff Copeland]

Purchase price does not determine rent, and rent does not determine purchase price or ARV (though it may determine what a given investor is willing to pay). These are market-dependent and will vary widely from market to market.

To figure out what a unit will rent for, look at see what other comparable units are renting for nearby. That is quite literally your competition, and you can't tell a tenant "Look, I know that other similar unit down the street is renting for $700/mo, but I paid $180k for this duplex, so each side is totally worth $900/mo!". Your purchase price is irrelevant to potential tenants. They only care what their options are in the rental market. 

To answer your questions about the formulas: Cash on Cash Return and Cap Rate are two different things, and thus two different formulas. You are mixing up the two. 

Cap Rate is the Net Operating Income (NOI) divided by the purchase price. And NOI (and thus cap rate) do not factor in debt service.

If your NOI is $10,000/yr and you Paid $100k, your cap rate is 10%. If you paid $50k, your cap rate is 20%. if you paid $200k, your cap rate is 5%. How much you put down, or whether you financed or paid cash, does not effect the cap rate. (Because the purpose of the cap rate is to be able to compare asset perfomance in different classes, i.e. real estate versus gold, or a 4-plex versus a single family home, or two duplexes in different markets...etc, etc.). Whether a cap rate is good or bad is very market (and neighborhood) dependent. It's also buyer-dependent. Some investors will happily add a 4-cap property to their portfolio, others won't look at anything that's not in the double digits.

Think of a rental property as a box that spits out a set amount of money every year. If the box spits out $10k per year, what is it worth to you? Are you better off buying this box that spits out $10k per year, or an ounce of gold that appreciates at 6%? Or a mutual fund that averages 12%?

On the other hand Cash on Cash Return, as the name implies, factors in "How much cash came out of my pocket, and how much am I making back in return?"

See https://www.biggerpockets.com/renewsblog/2014/05/1...

And finally, here's the kicker. Try this: Go to your local bank and tell them you have $20k in cash that you'd like to invest in that mutual fund mentioned above that averages 12% per year. Tell the loan officer you'll chip in your $20k if the bank matches with $80k so you can buy $100k worth of the mutual fund and maximize that 12% return. Then prepare to get laughed out of the bank. 

But guess what? You can do pretty much exactly that with real estate! (Known as leverage)