Paying full market value with excellent cash flow, thoughts?

Question

Hello BP nation,

Wanted to get everyone's thoughts on this. Lets say you are looking to invest in a vehicle (residential RE for cash flow), in a market and area you are pretty familiar with and have made deals. However, the deals requires that you pay at or near full price, off the MLS to boot (always makes me feel guilty after listening to all the seasoned wholesaler's podcasts), etc.

Let's also say that with 25% down, you know will make a 300-500$ month cashflow; that is being very conservative with setting aside funds for property management (even if self managing), repairs, capex etc.

@Ben Leybovich @Joe Villeneuve

Going to call out a couple of colleagues who I consider to be insightful and enjoyable to follow you guys in your endeavours, Ben because I know you only go after the best deals and are very good at walking away from deals, and Joe for experience with cash flow and value investing.

Would appreciate everyone's input, if you've ever felt guilty about paying market value, buying from the MLS, or otherwise. Hate posting from here at 9 pm while everyone on the mainland is probably asleep! Cheers all.

Joe Villeneuve · Answer

@Andrey Y. First, how's the weather on the islands?  It's below "0"F here.

Second, read what @Ben Leybovich said.  We each look at things the same, and different, depending on the specifics of the deal.  Here is where I come in on this:

In this case, all we know is you are thinking about putting 25% down and getting a return of 300-500/month with all expenses figured in.  Do you know what that tells me?  Nothing.  25% of what?  $100k, $200k, $500k, $1M?  The answer to your question depends on how fast that $$$ cash flow recovers that 25%.

Having said that, to me it's really simple.  Let's assume that this property is in Hawaii, and it costs $400k, so your 25% would be $100k.  Let's also assume the high end of your CF model of $500/m, or $6k/yr.  That means you won't recover your down payment for 16 years/8 months (if all goes well and smooth...not likely).

Let me put it another way.  You are putting $100k in, and getting only $6k back in the first year, so when you start year two you are actually $94k behind.  Year 3 starts at $88k behind, year 4 at $82k behind...that;s a (-) $82,000.

OK, let's say the property only cost $100k, and you are only putting in $25k in a down payment (cash). That means you are going to have to wait 4 years/2 months to recover your down payment.

Your call...your money.

Jeff Rabinowitz · Answer

There are lots of strategies. They all can work and everyone will have their own preferences. Some people love the hunt and like to tell the stories of the amazing deal. However, if you want to build a rental portfolio you have to buy properties. You can search across the Country and look for distressed markets or situations or you can stay in your local market and make offers, and more offers, and maybe a few more until you get one accepted. You can find great deals but I always wonder what the return on the time invested was when I hear some of the stories. (You can always make more money but you can't replace the time.) If you are sure of the values in your market and are sure that is where you want to own properties you can make market offers (maybe a little more, maybe a little less) and start collecting the cash flow. It is not a get rich quick strategy but there are still some nice benefits to getting rich slowly.

Ben Leybovich · Answer

@Andrey Y. - acouple of thoughts for you:

1. I think you are thinking about the wrong things a bit.  First, the deal is either good enough, or it's not - based on you qualifying criteria and underwriting.  You could buy a 12 CAP and loose money all day long, and you could buy a 6 CAP and win big.  It's just not possible to say that market price is too high - the market could be wrong and under pricing an asset.

2. Now - the purchase price is important from the stand point of your exit.  Your IRR is driven first and foremost by your exit.  If there's reason to believe that in 5 years you will exit 25% higher than you got in, then the underwriting of the CF looks very different that it does when you are trying to drive all of you ROI with CF.

Having said this, I am not impressed with $500/month of CF beeing bought with 25% down.  I don't buy CF.  Now, if you saud - I'll have $300 of CF at 100% financing, but I don't see a way to take this down without a down-payment (which I don't mine), and that'll push my CF to $500 - that's different.  Then there may be a deal there...

I am outspoken against DP, but I am not against making a DP if the deal is good to begin with.  So - what would your CF be if you financed this thing 100%?

Ned Carey · Answer

My preference is to always buy below market - because I can. But there is nothing wrong with paying market price if it is a good deal.

Andrey Y. · Answer

Hmm, that's interesting. What about interest? Is it typically a fixed interest rate for 15 or 30 years until you pay back the loan..

Joe Villeneuve · Answer

USually all fees are rolled into the loan.

Andrey Y. · Answer

Lets just say its 20-25% down on approx. $200k. So given the $6k back per year, should be 6-7 years to recoup initial cash down. I understand the idea of paying all cash then cash out refing ~75% if the equity, to get around 100% CCR. But don't you need to pay escrow fees and interest to do this? Do you include these in your calculations? Because escrow fees and interest is also payed on traditional mortgages as in cash out refis.

Whether I pay all cash or get financing will depend on whatever it is that it takes to get a good deal.

Frank B. · Answer

I don't think they are saying never do a down payment. I think they are saying a down payment can skew the evaluation of a deal, especially when we don't know the cash invested.

For example, if the purchase price is $5 million, a 20% down payment is $1 million. $300-$500 / month cash flow on $1 million invested is not a good cash return.

This probably isn't a $5 million property, but you get my point

I think their point was you should evaluate the cash flow based on 100% financing to see how the numbers stack up, even if you plan to make a down payment.

Andrey Y. · Answer

DP huh... do you mean down payment? I see what you are saying, but coming up with a no down payment deal on a single unit is outright hard and time consuming. Plus I know I'll be paying some interest on the 20-25%, whether in time or money, and I believe paying interest on 75-80% is enough ;) Thoughts?

Joe Villeneuve · Answer

@Andrey Y. "I'll get back to you on the 100% financed. But keep in mind that Hawaii is never considered a CF market and even having property here surprises people " how could you risk / afford / insert other word here buying property " is a common sentiment."

This is why many successful investors flip in their home market, and invest in a different one...one that does cash flow.

Paying full market value with excellent cash flow, thoughts?

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