Low Cash Flow Expensive Areas - Is this cashflow enough?

Question

Can some of you investors in extremely competitive and expensive markets help me understand how you are valuing a deal when cash flow is so low? I'm looking at 2 different duplex properties, one in NY, and one in CT. Both are in higher cost of living type areas being less than 1 hour from downtown Manhattan and both on the train line. At today's prices, nearly nothing can cash low at all unless your willing to do some major overhauling. I found 2 properties that need some work and I've done the hard math, and it looks like I can turn roughly $200 per door. Purchase price around $400K and I'll be putting about $20K into the unit to make it rent-able. After doing hard math and calculating expenses, mortgage at today's general rate, insurance, tax, and general costs I'm coming out to roughly $200 per door cash flow. That's without management fees since I'll be managing it myself, and its not adding in any capital improvements or vacancy % or anything like that. This is just what's left over after all costs and me doing the management. After down payment, repairs, and buying fees it looks like I'll be at 3-4% Cash on Cash return.

I'm not looking for actual profits and this is more of a long term hold for me. The $200x2 cash flow would go into a savings account that accumulates and is used for expenses the property needs. The area will appreciate well over time.

Both properties are undervalued and once fixed will appraise for about 10%-15% more than I will buy and have into the repairs. Rather than see this as a quick appreciation, I'm seeing it as a buffer so if the market drops, the value will still be roughly around what I have into it.

What type of numbers and cash flow are people in these extremely expensive and competitive areas bringing in, and what are your minimum returns to make it a worthy investment?

Marshall Leipprandt · Answer

@Joe Delgado Expensive markets are tough, but if you are truly in a solid area with long-term appreciation potential and good economic growth, your year 1 cash flow is not as important as it would be if you were buying in someplace like the Midwest for example. Let's say you plan for $200 cash flow but you plan to raise rents 3%-5% each year in perpetuity, then I think you've answered your own question particularly since you say you're not looking for profits but instead plan to hold for the long-term. When I look at deals in expensive markets, I look at three other areas in addition to cash flow: 1) Principal pay down - my tenant is paying my PITI each month for me. Therefore, what is the portion of that being applied to my principal? This can also be referred to as the equity being built. Let's say the portion of PITI going towards principal each month is $500. That's $6K per year and remember that interest is amortized over the life of the loan, so the portion of the principal payoff slightly increases each month over time. 2) Appreciation - I look at the historical appreciation rates for the market I am purchasing in and then use half of that number for an estimate. I figure this puts me more on the conservative side for a long-term play. Let's say you buy a $400K property in a market that has appreciated on average 4% per year for the last 30 years. Half of that would be 2% or $8K per year, or $667/month on average (in Year 1) and compounded over time. 3) Tax Advantages - lastly, I look at how the property will impact my personal tax situation. Factoring in depreciation over the life of the property is an additional driver towards how the property will actually impact my bottomline. Add all of these up for Year 1 on a monthly basis: $200 Cash Flow, $500 principal pay down, and $667 average appreciation. Calculating the monetary benefit of the tax advantages is a little less intuitive. That puts you at what I call a bottomline net worth impact of $1,367 per month or $16,404 per year (in Year 1) assuming the above parameters. This is how I look at deals in expensive markets.

Joe Delgado · Answer

Thanks for this breakdown and for helping me see the overall picture from these different angles. I'm finding appreciation hard to judge since the market is extreme now and not a true sense of what the value should be, that coming from the idea/guess that things rose too fast, and will soften soon. Prior to the 2008 bust, I see some houses sold for similar prices to today's market, and then others that are far higher. Strangely I'm seeing some places for sale at the exact same prices as those pre-2008 hot years so its hard to estimate and understand how that all plays into it since those people bought, things bust, and they had to wait 15+ years for this rebound only for it to possibly go back down. Where would I look to see what true appreciation has been in the specific region where these 2 hours are.I have no doubt that these 2 locations will always be winners in the market as a whole. In the past they were first to rise, and last to fall, and I expect no different as things look grim ahead since their proximity to work and the city has driven these areas for many decades.With rates going up, my cash flow is dwindling as the days/weeks roll by, and as the rates keep ticking up. So I'm trying to use slightly higher percentage rates to see how they will factor into my overall numbers.The area where these houses are have plenty of fix and rents going on and people are dumping good money into these areas as more and more houses have been bought and fixed. Not as many fix and flips, but certainly any duplex or multi-family are bought extremely fast the closer they are to breaking even on cash flow or a slight bit of green.The only time I was seeing properties decently cashflow was if they were bought in 2011-2013 when the prices were lower after the 2008 bust, I can't imagine we'll see house prices that low, but I guess its totally possible.Your break downs have definitely helped me understand some of those added benefits that aren't just cash flow, so taking those into account definitely helps the deal look sweeter.So I now ponder the idea of buying, or waiting. I've been sitting on some cash trying to make a move for the last year or so but nothing has presented itself based on how crazy the market has been. These 2 places are pretty much the only thing I can find that will cashflow. I just feel like its almost the worst time to buy considering rates have gone up so much, and the market could soften up.@Marshall Leipprandt if you have anymore to add I am open to hearing and I totally appreciate your insight. Anyone else have feedback, or in the same position and on the fence on making a deal or holding off?