Properties that dont cash flow

[Colby Miles]

I was browsing some properties in manhattan, ny and some in the surrounding area and noticed that most of these properties have a negative cash flow. So i dont understand why anyone would want to invest in these properties.

One property for example was 8,750,000 and had a cap rate of 5%. that means it only brings in $36,458 per month after expenses. However i got mortgage quote frome CITI and it would be about $39,000 per month for the mortgage for 30 years with 20% down. And under a 5% interest rate.

This and many other apartment buildings in the city have negative cash flow. What is the reason for this and who would invest in this type of property?

[Sebastien B.]

I am at the forefront of the manhattan market when it comes to purchasing large properties. Here is a rundown of how it is:

You have to have A LOT of money to make a Manhattan property work. Either you are a well known landlord and get off market deals for 30-40% less than market prices. Or you are a big shot who can pay 3-4% cap rates because you can borrow at sub-3% (and this is 100% doable for some of the people I work with), renovate the property completely, and then cashflow at 8% after refinancing for 40% higher than you purchased the building for in 5 years.

For a "trophy" asset (I.E 5th avenue corner of 57th), expect a cap rate approaching 2%. The reason people pay 2% now is because a trophy property in Manhattan will generally get above average growth yields (ON TOP of the already ridiculous growth inherent in ANY Manhattan property) on it's leases when they expire or renew. A non-trophy asset may increase its rent by 30% in 3 years, but a trophy asset probably has a 70%+ growth in it's rents. 2% now is 12% in 5 years with almost zero risk of default. Almost every investment fund in the world wants that property. More than they want treasuries.

Foot for foot, It's cheaper than London, its cheaper than Hong Kong, and its technically in the same "Class" as those other areas. There is also the fact that all currencies lead to USD, and when the US does poorly, every other country does a lot worse on average. The US would default, and half the world would go into a deep depression before Manhattan got truly hit by it. I call that a safe investment. I'd much rather park my cash in a 2% cash flowing property in Manhattan than in a 2% yield treasury bond that has a 10% chance of default (which would cause interest rates to shoot up and destroy the value of that bond anyways).

Even average buildings are usually below "market" by 25% on rents that wont expire for another 2-10 years. You are talking guaranteed income for those years, plus a 40% increase in rent rolls once the building leases roll over. If a tenant defaults, GREAT! Another floor that can be brought to market x years earlier! If not, just wait until the lease expires and quadruple up. That is incredible growth for the relative risk profile. The large institutional investors buying the big deals are all cash, they hardly even borrow, or they are REITS and just issue shares at ridiculously cheap costs.

Lastly, 40% of Manhattan is landmarked or zoned historic. There is so little room to develop that only the huge players have a chance, and even when they do, it hardly puts a dent in the demand.

I was recently reading an article about a soho property that is being bought out by a large retailer. The article discussed that the cap rate was sub 2%, but at the same time, the retailer currently leasing the building was paying 1/20th of market. You buy a building that is cashflowing $200/foot and in 5 years its cash flowing $4000/foot? I'd take that for 2% going-in cap any day of the week.

I almost forgot. 1031 exhanges are the center of almost every deal in Manhattan right now. Usually no financing is involved.