LOW Cap Rate but GOOD cash flow...Should I BUY it??

[Nick Romano]

Hey guys- SHOULD I BUY THIS PROPERTY??  Thanks so much for the input.

I have a property that is an ideal area.  Rents are going up and rental market is super hot. Currently rent is well below market. 

Cash flow looks pretty good (about 900/month) but the Cap Rate seems low.

Cap rate: 6%

$59,160 (rent)-$6,800(taxes)- $2,150(ins)- $2,600(Water)- 2001.00(ins) /$770,000(purch price)= 6% CAP RATE (let me know if this calc is off)

Cash Flow: $925.76 per month (calculation below)

 Property: FOURPLEX-8 bedroom, 4 bath. This units has 4- Two (2) bedroom and One (1) bath per unit.

Neighborhood: Zipcode- 02171. Absolute lowest 2 bedroom on the market in this neighborhood is $1500. 

-Current tenant situation- I will inherit these tenants and raise all rent. They have never been late on rent. I'm told they will all stick around for at least a few years. The condo needs a little work and could use updated bathrooms and kitchens. The plan is to gradually raise rent to market value, when the tenants move out I will renovate each unit one by one.

Unit 1: Current $1,180 Will go to $1250 when I buy.- 4 year tenant

Unit 2: Current $1,130 Will go to $1230 when I buy.- 15 year tenant

Unit 3: Current $1,120 Will go to $1220 when I buy.- 6 year tenant

Unit 4: Current $1,130 Will go to $1230 when I buy.- 5 year tenant

-Utilities: All tenants pay their own utilities (Gas, oil, heat...not water)

-Water Bill: $650/Quarterly- Paid by owner (me)- $2600/yr

-Taxes: $1700/Quarterly- $6800/yr

-Home Insurance: $2150/year

-Flood insurance (needed): $2001/year

-New roof 2013

-New hot water heaters

-New electrical

-Mortgage info:

-Purchase price: $770,000 

-20% down: $154,000

-30 year fixed @ 3.708% (**Current level)

-Total mortgage payment (including taxes, ins, etc)= $4,004.24/Month

-Total income from rent= $4,930.00

-Cash flow: $925.76/month 

[Owen Dashner]

Nick, with all due respect, your replies are sounding like a guy who is trying to make a good deal out of a bad one.  You can't ignore vacancy.  If you think it is going to be 0%, especially when you are coming in and raising rents right away, then you likely do not have very many of these situations under your belt.  Just because an area is hot, doesn't mean a tenant isn't going to lose a job, stop paying, damage the unit and possibly stick you with utility bill(s).  And if it takes you 2 months to evict a non-paying tenant, that unit is effectively vacant for 2 months - even though someone is living there. And then you have the time and expense of installing carpet, paint, drywall, changing locks, etc...

You also have not acknowledged that there are snow removal and lawn care costs, utilities while vacant, pest control, etc... CapEx costs need to be escrowed if you want a self-sustaining business. You need to take the expected useful life of a mechanical item or building component and set aside that percentage of the replacement cost each year (i.e. If a central air unit lasts 10 years and costs $3K to replace, you should ideally be setting aside $25 per month so that you have $3K set aside after 10 years).

Your 2 most common calls are going to be HVAC and plumbing.  They are going to happen whether you like it or not, and you need to budget for them.

Putting more money into a deal does not make it a better deal.  To compare apples to apples, each deal should be evaluated independent of potential financing.  I always evaluate deals as if I am going to use 100% financing on them.

Sorry, I know I sound like Debbie Downer, I just think you really need to underwrite more conservatively instead of optimistically.  I have learned the hard way after buying them that there are real costs involved in owning these types of properties, regardless of my pro forma projections.

Owen