Either my numbers are way off or people are buying for way too mu

[Eric Hempler]

I'm in the Minneapolis market and I'm aiming for an 8% Cash on Cash Return. 

I'm buying for cash flow and I'm coming up with about $75K per unit while the comparable sales that are listed are about $150K per unit.

I'm not sure but it looks like most deals are selling for twice the price per unit they should be OR people are buying at negative cash flow, making large down payments or my numbers are way off. 

I'm also just getting started with looking at deals, but I feel I understand the material well enough to work through a model and put something together. 

Although, I do recognize the need to find a spot I can run my figures by to see if I'm overlooking something. 

I'm looking at Michael Blank's mastermind...any other recommendations? 

[Dan Cioaca]

@Eric Hempler

There are any number of reasons for gaps between buyers, as mentioned by others, but most or all of them fall under differences in your assumptions. A few I've seen:

1) modeling assumptions. Models are only as good as their inputs, so it comes down the quality of your inputs and how conservative you are. A few examples are: required return, LTV, mortgage rate (if financing), closing costs, reserve requirements, rehab estimates, vacancy, operating expenses, rental increases.

2) cost and operating efficiency. If others are better at rehabs or operations, they'll have better NOI from the same property and can out-bid you.

3) accounting. The mom-and-pops use cash accounting as a shortcut and don't typically charge themselves non-cash expenses. For example, they self-manage, so management is free, whereas I model 8% even though I intend to self-manage. Same for lawn care and snow removal. Another big non-cash expense is capex, so they're often surprised with a large unexpected bill every few years, whereas I treat it as an expense and segregate the money, making it look less profitable today. 

4) return calculation - When looking at the overall return and hurdle rate, investors typically combine yield and appreciation, and in fairness that's the correct way to calculate IRR. However, it can lead people to accept deals the two are wildly out of balance and most or all of the return comes from appreciation, i.e., 0% cash on cash or even cashflow negative. People have made money that way the last couple of years, but it's very risky long-term strategy. Conversely, if you're not looking at IRR at all and requiring all your return from cash flow, you could be overly conservative.

What if your numbers are correct and this is the stable market equilibrium? I'm seeing something similar in my area of interest, and though these are ultimately also all related to modeling input assumptions, here are a few things I've observed:

+ there is a big range in price per unit. I pulled all sales for 10 years and the bottom/mid/top of market is about 100k/250k/400k per unit, which both a huge range and shockingly stable over time - all three trend up together slowly over time. That's partly due to unit quality and rehab needs, but also buyer/seller circumstances. You have to be in the bottom 1/3 of cost per unit with full rehab to cash flow in my market, so 90% of deals look too expensive to me and that's been true for years. 

+ if using comps rather than bottom-up modeling for valuation, there's a big gap between trailing comps and forward-looking estimates. Sellers/agents learned over the last decade to just step up 12-month comps by some amount, whereas today I'm only look back 90 days because the numbers are very different than even 6 months ago. 

+ unemployment and vacancy will rise with the recession, but those are trailing indicators that materialize over years. During the GFC, unemployment peaked 21 months after the recession started. I've been using recession-level vacancy rates which don't reflect the facts on the ground today, and underwriting is harder, but I think that's a good thing. 

If you're solid on your numbers, stick with them and use them to protect yourself. It can be frustrating to watch the calendar turn with no deals, but that's the required discipline.