Good cash flow, cap rate & CoC return - top of market price

[Sarah McCluskey]

There have been many discussions about this being a sellers market, and prices are high.

In my market (between Chicago and Milwaukee), prices are high, but many of the properties still would cash flow well.

When I run the numbers on properties that are in line with the market rates right now (highest it’s been since 08), I get the following.

- $400-$500 total cash flow on a duplex

- 10-12% cash on cash return

- 8% cap rate

I am taking into consideration property management, 10% for capex, 10% for repairs, insurance and property taxes. 25% down on a conventional 30 year.

These numbers look good to me, but I can’t get over the idea of buying “retail” when the market is high. And worrying about prices dropping again and losing the equity. I also hate the idea of paying full price/retail.

Does it make sense to buy these full priced/retail deals that cash flow well? Or should I keep trying to find an off market deal so that I have more equity in case the market drops?

A little background - I’m a bit more cautious than normal about this because we bought our first personal home in 2009 at the peak of the market, and we were stuck there 3 years longer than we wanted to be because we were so upside down. Still paid $20k just to get out of it....

[Steve K.]

@Sarah McCluskey if you’re calculating that much cash flow on a lot of properties, I’d be worried that you’re not underwriting properly. What are the gross rents on these properties? The reason I ask, and don’t like using percentages except as a first-pass before doing a deeper dive, is that on properties with low gross rents is it often doesn’t equal enough to maintain a property. For example one investor in a high rent market may be using 10% of $5,000 gross rent for capex and repairs, while another investor in a low rent market is using 10% of $500 gross rent. They’ll get vastly different capex and repair budgets, but the properties will actually have pretty similar operating expenses (assuming they’re the same age and condition of course, for comparison’s sake). I often see people on here using percentages of low rents without realizing they’ve only budgeted something entirely inadequate like $1,200/yr or something for both capex and repairs, which is obviously nowhere near enough to keep up with the expenses that every property inevitably has. For this reason I find that a better way to budget is to estimate what the property will need during your intended hold, and divide that number by the number of months you plan to own the property in order to come up with a more accurate monthly budget. For example if you know you’ll need a new roof, a new driveway, new windows, all new appliances and a new furnace over the next 10 years, because those items are currently on the backside of their useful life, then total all that up, pad it out a bit for Murphy’s law, divide by the number of months in your hold period, and that’s your budget. Using this method with low rent properties, it’s easy to see how the percentage approach can lead to seeing cash flow on paper that does not materialize in reality.