Need 17% cap to worth my while?

Question

I am looking at this listing in Bakersfield, C class, 16 units, total monthly rent of $10K, asking $1.2M, claiming 7.75% cap... Now, if I apply the 50% rule, I get $5K net rent, which goes towards paying the mortgage, and I would just barely break even.... Now, chances are expenses would be more than 50% between PM and uncollectible rent etc....So, even at 100% occupancy, I would be break even at the best but more likely lose money....at 7.75 cap....

Now, properties in this neighborhood had 0 appreciation in the last 14 years....

Lets say I need to make $2K a month to worth my while, that means purchase price can't be over $600K...

So, why are tons of investors buying up C at 6% cap? How did they make money when there is no appreciation potential?  Or my math is completely off?

Don Konipol · Answer

@Joel Owens hit it on the head.  You may have to look at 100 "for sale listings" to eventually find a deal.  There is A LOT more money in the investment pool than ever before.....Let me give you an extreme example.  In 1976, the highest price a co op or condominium apartment had ever sold for in NYC was $275,000.  40 years late the CPI nationwide is 400% higher, so based on CPI you would expect that highest price to be $1.1 million.  It is actually $120 million.  As I said A LOT more money in circulation, and much of it is interested in real property.

Joel Owens · Answer

Seller motivation makes deals. Buyer motivation with poor planning helps have big losses by overpaying.

I look for motivated sellers no matter the asset class. They are not as easy to find in the current cycle phases but they exist. You have to dig through a lot of coal to find the diamond.

We stay away from sellers trying to just test the market or take advantage of top cycle pricing. They often look for buyers that are new and not experienced to values in the market, 1031 buyers that have done poor planning and must buy something last second or (face big tax penalties with depreciation recapture, medicare tax, possibly state income tax, and capital gains), and foreign investors getting small to even negative returns in their countries and are facing possible political and economic unrest where they live. The foreign investors will often take a low return to get money into the U.S. and out of their country and it can possibly help them down the road if they want to fast track citizenship and move here.

Don Konipol · Answer

@Diane G., Most seller's price their property unrealistically high initially.  The properties that sell either accept an offer way below asking price or eventually lower their price over a period of time to market value.  Further, many properties put onto the market are not really for sale.  The owner may want to see what price he can get, may be willing to sell only at a fantasy high price, or may be making believe he's selling to satisfy a spouse or business partner.

To give you an example o pricing craziness: three years ago I was approached by an attorney who held a note on a small retail center with an UPB of $467,000, 13 years left on a 15 year note, and a 6% interest rate.  He was shopping the note and offering it at a $10,000 discount, or $457,000.  Countless investors passed on the note at this price; however; I had some information that he was desperate for cash to try to save another investment.  Further, this property had a few concerns.  So, I offered him $250,000, a little more than half his asking price, and his only response was "how quickly can you close?"  I bought the note for the $250,000, the seller paid all closing costs, and I have received all payment timely and have a note with a yield to me of almost 18% annually.

If you just look at seller asking prices you will never buy a property.

Account Closed · Answer

@Diane G. You're comparing apples and oranges (i.e. your own calculated cap rate vs the seller's 7.75 cap rate).  You're 50%-rule math doesn't result in a 7.75 cap, it's a 5 cap.  The seller's proforma 7.75 cap obviously has some very different expense assumptions than your 50% expense rule, which a prior poster already mentioned seems pretty rosy.

Don Konipol · Answer

@Jason Dillard, as crazy as it seems, Jason Dillard is correct.  At least having money invested in real estate, even at break even cash flow, has (1) inflation hedge (2) tax breaks (3) equity build up (4) appreciation potential.  Having a billion dollars to invest......quite a problem. LOL

Jason Dillard · Answer

If you think of it from another point of view, then you may understand why cap rates are so low. Assume for a minute that you have a billion dollars to invest in the next 30 days. How much are you losing to inflation by doing nothing and leaving the cash uninvested?    Go ahead do the math.....I'll wait..........The quicker you can get your money out of the bank, the faster you're not losing money.  There are benefits to owning a break-even property.   Cash flow just isn't one of them.

Need 17% cap to worth my while?

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