Investment strategy in low cap rate location

Account Closed · 2018-10-09T22:15:33-07:00

Hi,I have been reading the blog and listening to the podcasts for a while, and now I’m trying to narrow down my focus and figure out the right investment strategy. It would be really helpful to get some input from more experienced investors.At the end of the year, I will complete the mortgage payments of a property that is worth $600,000. I’m already renting it out and it’s only netting approximately $15,000 per year after expenses and taxes, so it’s not the most compelling return and there isn’t really room to increase rent. I'm considering selling the property to pursue investment opportunities that can generate at least 5% of capital per year. I can probably refinance my mortgage for up to $300,000. However, that amount wouldn't buy me anything in Los Angeles that is where I live and where I would like to invest. So these are the options I can think of for now: Sell the property and buy one with better NOI (or one that requires some work that would lead to a better NOI) Re-finance my mortgage and buy a $300,000 house in a cheaper area outside Los Angeles (perhaps outside California) with all the downsides of distance when it comes to searching and then managing the property Enjoy the higher monthly cash flows of the existing propriety after the mortgage is paid off, save the money and wait until I have enough to buy a property in Los Angeles I'm sure this might come down to personal preferences and risk tolerance, but I would really appreciate having some direction on how to make a decision in this situation. It would be great to get any advice in case I'm missing any other options or important details.Thanks!

Russell BrazilBusiness Member

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Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes

8y

Low cap rates usually have huge rent growth. Patience will help you cash flow much more than a high cap rate that has no rent growth.

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Ali Boone

Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes

8y

I'd say run the numbers on all the options and see what looks the nicest. Be sure to run the cash-on-cash returns so you can see the returns for like the option of how much cash flow you have on the property with just the equity once it's paid off.

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Lee RipmaPro Member

Rental Property Investor · Prairie Village, KS · Member since 2015 · 2k+ posts · 2k+ votes

8y

@Matt B. Do you have the time to BRRR out of state? What about being the money partner for someone who does have the time? What about being a passive investor in LA and getting both cash flow and appreciation? I invest out of state in KC and I learned by making my own mistakes. Now I’m working for a MF investor in LA and seeing how great the deals can be in LA if you’ve got the capital and you buy right. I didn’t know that being passive was an option when I started but now I tell newer investors with limited time to consider it depending on their goals. It can be a great way to watch, learn, get a great return, and not take up a ton of time. Everyone has different goals and a different personality so this might not be right for you. I just wish it was something that I considered when I started and is not a frequently discussed way!

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Dan H.Pro Member

Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes

8y

In general, I agree with @Russell Brazil but your return is so bad that it would have to increase so much for your current investment to be a worthy RE investment. Your return on value based on cash flow right now is 2.5%. Hopefully you have made a lot of money via market appreciation and/or equity pay down.

$600K should provide much better return.

S&P 500 has a historical return of ~10%. RE is less passive than S&P 500. Any RE investment should have a projected return significantly greater than 10% to be worth the extra effort as compared to investing in the S&P 500.

I would look for a RE investment that has better current cash return for the investment amount and is likely to experience both rent and market appreciation (so not most of the Midwest). I agree that rent appreciation beats greater cash flow every time for the long term, but on your current RE investment I fear the long term may be decades.

Good luck

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Account Closed

OP

Member since 2018 · 2 posts · 0 votes

7y

Thanks everyone for the answers, that's really helpful!

@Dan H. I bought the property back in 2013 at a good price ($400,000), so yes I benefited from some appreciation. However, rent has increased less than proportionally and it doesn't look like it's going to increase significantly over the next years - I think you are right that it might be a matter of decades.

So far I looked at it like a low-risk asset that is unlikely to going to go down in value and therefore is only yielding 3%. I guess the question is if I want to trade it for a more risky asset that can benefit of appreciation and/or rent growth. In general, does it make sense to look at cap rates this way, i.e. higher cap rates could generate more cash flow but are also riskier?

I'm also thinking that it might not make sense to refinance the property since if I had to pay a 4-5% interest rate it would be more than what the property yields.

@Lee Ripma Time is not necessarily my constraint, actually I think I would have time to BRRR, it's just that I wouldn't feel comfortable doing that out of state. In your experience, what is the capital needed to make good deals in LA?

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Dan H.Pro Member

Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes

7y

Originally posted by @Account Closed:

Thanks everyone for the answers, that's really helpful!

@Dan H. I bought the property back in 2013 at a good price ($400,000), so yes I benefited from some appreciation. However, rent has increased less than proportionally and it doesn't look like it's going to increase significantly over the next years - I think you are right that it might be a matter of decades.

So far I looked at it like a low-risk asset that is unlikely to going to go down in value and therefore is only yielding 3%. I guess the question is if I want to trade it for a more risky asset that can benefit of appreciation and/or rent growth. In general, does it make sense to look at cap rates this way, i.e. higher cap rates could generate more cash flow but are also riskier?

I'm also thinking that it might not make sense to refinance the property since if I had to pay a 4-5% interest rate it would be more than what the property yields.

@Lee Ripma Time is not necessarily my constraint, actually I think I would have time to BRRR, it's just that I wouldn't feel comfortable doing that out of state. In your experience, what is the capital needed to make good deals in LA?

Cash flow is only one way to achieve a return on investment. You return is much better when accounting for the appreciation and equity pay down. What hurts the return is how minimal the leverage was.

Interest rates have risen substantially but are still low by historical standards.

I suspect your best option is dictated by what sort of appreciation you expect going forward. 50% appreciation in the last 5 years is pretty good but, due to your level of leverage, it did not produce a substantial ROI.

Looking back is always easy. You would have had the best return minimizing your equity stake in the RE and using the additional money for other investments. This option has greater risk than having a significant equity position. I will be very surprised if holding a 100% equity position going forward will be your best option. I would definitely leverage the equity to achieve better returns; no way I leave $600K of equity to obtain $15K/year.

Choosing to sell or just take money out would depend primarily on what I forecast the property and rent appreciation to be going forward. Your appreciation over the last 5 years would have produced a good return if your equity stake had been 20% or 25%.

Good luck

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Lee RipmaPro Member

Rental Property Investor · Prairie Village, KS · Member since 2015 · 2k+ posts · 2k+ votes

7y

@Matt B. That’s a hard question to answer since it’s all going to depend on your ability to get commercial loans. So if you can get commercial loans and find good value add deals with cash flow and upside then enough to close those deals.

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Investment strategy in low cap rate location

Investment strategy in low cap rate location

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