Figuring out if you have a great deal

[Uzoma Onyeije]

Uzoma here. Just getting started. Interested in using a buy and hold strategy for multifamily units. I am having difficulty finding anything in DC in good neighborhoods that meets the 1% test (monthly rent should be at least 1% of sales price). I have been advised to either come up with a new method of evaluating deals or invest in a less affluent area. I don't want to change my target area. Any thoughts on a more flexible way evaluate deals that still leaves me in the black? Thanks.

[Jonathan Twombly]

@Uzoma Onyeije:  I think that once you are talking about MF, you are in cap rate land rather than "rule" land.  Once you start talking about cap rates, you need to understand the risk of what you are buying.  5-6% cap rates for A property in A submarkets with good schools, for example, is probably going to be fine.  But you should also be prepared to hold the property for a long time and ride out the market swings that are sure to come.  If the property is putting money into you pocket, with income exceeding holding costs by a comfortable margin, then you can hold indefinitely and wait for the right time in the market cycle to sell and capture your appreciation.  The key consideration is really to understand what goes into the cap rate.  Is this based on real rents and expenses (historicals) or what a broker is telling you that you "might" be able to achieve in the future.

In the last cycle, people got in trouble by over leveraging properties because they convinced themselves the properties would appreciate in value.  Many were paying carrying costs out of pocket to service their debt because debt service exceeded rental income.  When either the tenant left or the interest-only mortgage reset so that principal payments were included, people could not longer afford the debt service and walked away, losing their deposits, etc.

If you invest for a true positive cap rate, then the chances of this happening are much less.  Obviously, you need to verify the numbers and plan for vacancies, capital expenses, etc.  But if you focus on the cash flow and forget about the future appreciation, your chances of making a bad mistake are much lower.