4 Plex... focus on cash flow, cash on cash, cap rate???

[John Sherwood]

Hello Bigger Pockets brain trust,

I'm looking at a 4 plex... cash flow looks decent, ~$120/door. Cash on cash looks like it would be about 9.5% (Brandon Turner talks about trying to get 12%), and Cap Rate is looking like it would be around 8% - which seems ok for the area (not amazing) to me (I know these are very area dependent)- and if it were in Bay Area I'd kill for 8%.  I'm a little hung up on the cash on cash and cap rate. Am I being too picky? 

The place is at the edge of a gentrifying area, so there's some potential (but also some risk). Units are rent ready, but basic. 

[John Warren]

@John Sherwood you don't give many details about the area of the country this is in, but if this is in a good area (B class), and if your numbers include property management then this doesn't sound too bad on the surface. Remember that the BP numbers we run tend to be a bit conservative. For instance, most of the time my properties have always been much better performers in the maintenance department than the numbers at BP would lead me to believe. 

The other thing to think about is the construction style of the building. What is the age of the building? How are the mechanicals? Is this a boiler building? Forced air? What style plumbing is there? These are all things I go through with clients that I have learned over my investing career. 

[Marcus Auerbach]

Biggest opportunity for mistakes is future capex; make sure you understand what will be necessary in the next 5/10/15 years...! 

Using a % or rent is NOT the way to go! 

You need an actual budget based on condition, guesstimates are usually fine, as long as you have a list of itmes they will average out. 

[John Sherwood]

Thank you for the input @John Warren and @Marcus Auerbach. 

The building is in a C+ neighborhood that is currently undergoing a transition to a B, with many properties being improved in the area. If the trend continues, I’ll be a genius, if it stalls and stays the same, I’ll be ok, if it tanks, I’ll be a dumb speculator. 

The property is 100 years old, the mechanicals are 4-5 years old. I’ll be getting inspections, and need more info on the plumbing and electrical as well as the roof before moving forward. 

My model currently includes property management, vacancy and capex, but just as a 10%. Guessing with the age of the building, I may want to increase the CapEx, or do as @Marcus Auerbach suggests and plan out actual repair costs in the future. On that note, do you have a model for doing that planning (i.e. replace water heater after N years of life) ?

[Marcus Auerbach]

You can get very scientific with that, but ballpark is fine. You are so much ahead just thinking about it! Most important are your next 5 years. A water heater will often last 9-12 years, I saw one yesterday at an inspection that was 24 and still cranking.

Also consider non mechnaicals like floors, light fixtures and interior doors and trim, kitchen cabinets etc..

[John Warren]

@John Sherwood if you want to be really scientific, then break down every component of the building into its useful life. Personally, I would just focus on the big ticket items. How long do you have on the roof, windows, siding/brick, plumbing, electrical and hvac systems. The main place you will bleed on buildings is plumbing, but electrical is what drives you into full gut rehab territory on older buildings. I recently had to do a full electrical job on a 19 unit in Berwyn that was an old 1930's walk up apartment building. The walls were plaster, so we had to cut channels in every room for the conduit... expensive!

[Brian Roberts]

@John Sherwood

@John Warren gave you some great advise there. Personally this is how I break down cost for capex. The numbers will change depending on the number of units in each property.

Roof-$10k (30yrs)

Siding-$5-7k(20yrs)

Water heater-1k per (4 in your 4plex @10yrs)

Furnace-$4-5k per(20yrs)

Windows-$400per window(30yrs)

Entry door-$500 each(30yrs)

Replacement vinyl floors-$5per sq ft(20 yrs)

This isnt all the costs you will have but it's how I get a rough estimate for amount to work into my calculations.

So I take the a 30 yr total of estimated expense. 1 roof, 1.5 siding, 12 water heaters(4 units in your 4plex, 10 yr each), 4 furnaces x1.5, number of windows and entry doors and 1.5x the flooring calc. Then divided that number by 30 to get a yearly amount and then divide that number by 12 to get a monthly.

The math will change with size of property and individual features such as windows and doors and sq ft of the property but it will get you a rough number before you have looked at the property. Once you inspect the property you can adjust the numbers based on the like left on the existing items. For example if all the water heaters are new you can take that amount of life out of the calculations.

Hope that helps a little bit.

[John Sherwood]

Thank you so much for the detailed responses @Marcus Auerbach @John Warren @Brian Roberts. That’s extremely helpful. I do have a sheet/model that has low/high costs in the area to replace items in a property. The one thing I was missing was average life expectancies for each item, since it was geared towards straight replacement costs. So, another lifespan column and I’m golden!!!
Back to the Cash on Cash, Cap Rate and Cash Flow topic. I would assume that small multi unit property values are largely driven by rents and Cap Rate? (And condition of the property). So you will see appreciation as market rent rates rise in an area. 
I understand the $100/ door target, but I have a hard time not getting hung up on cash on cash, knowing what I could get putting that money elsewhere (or I guess loose based on the last few weeks ;-) 

[Brian Roberts]

@John Sherwood

I invest in small multi because of the CoC returns. Being in Ohio I depend on cash flow in order to make money. I will never see the appreciation rates that you will in California. For me any appreciation is a bonus not a goal. I personally won't consider investing in my area for less than 15% CoC. I know people will disagree but everyones investing strategy and goals will drastically differ.

As far as prices being set by rents/cap rate, I'd say at least in my area I'd say they dont... like everywhere right now it seems like the crazies are out there that will buy old houses in C neighborhoods for a 5 CAP. To me that's insanity, but it happens every day. In my experience small multi can be tough to gauge cost. 5+ units and it seems like commercial agents will get sellers more in line with what area cap rates are dictating. I run quick CoC numbers when properties become available and quickly eliminate ones that dont fit my goals. I dive deeper on ones that look as if they will. Only you will be able to figure out what you are comfortable with and that will depend on your goals.

[Ross Gleason]

@John Sherwood I am not an investor just yet but I am a huge math nerd, so I think you'll want to do your calculations based on the numbers of years you expect out of the items already installed. So I imagine a lot of this calculation will involve inspecting all the big ticket items and estimating how old they are and using that to calculate how many years you have left.

Like with that water heater @Marcus Auerbach mentioned he saw, I would have all of that on standby and be ready to replace that as soon as it has a problem, because that is a very old water heater.

[Craig Jeppesen]

My dad’s c+ area and b- building cash flows like crazy, but when tenants do move out there is more extensive work to be done to get it back to rentable. Also rent sometimes comes late for these types of places and the tenants like to complain to you about the other tenants. Just be ready for that. But they make a pretty nice return and have always rented quickly.

[John Sherwood]

Yeah, I've seen similar things of 7% CoC properties being snatched up pretty quickly @Brian Roberts . My targets have been 11-12% CoC and 9-10% CapRates for properties in the "C" neighborhoods in Louisville. I've seen a few come through, but with all good deals, you have to be quick. If you get into the nicer neighborhoods, those definitely drop, which accounts for the higher risk of the "C" neighborhoods and the issues you mentioned @Craig Jeppesen.  

Thanks @Ross Gleason. Based on the awesome input I got here from everyone, I've updated my CapEx and Repair model - takes into account lifespan over 30 years, and if the age is within 85% of its lifespan, it puts the cost in the replace column, and automatically reduce the capex lifespan cost by the initial replacement cost, otherwise it just takes the replacement cost per year over the span of 30 years. Just need to refine my Lifespan numbers (and the Per Unit Cost based on the area I'm investing).

Now just to find some properties that fit my investment profile, that I can pull the trigger on quickly enough!