Who buys expensive multi-unit properties in downtown?

Question

Hi, I have been browsing some properties, and the more I drift towards downtown big cities like Boston or Manhattan, I see these 8 to 16 unit complexes priced at ridiculous prices (understandable because of location) but it seems extremely high compared to the rent you can collect off of it. And what is more funny is how brokers advertise it as an "investment property" when the total rent clearly doesn't even cover the mortgage itself, let alone taxes and other expenses. Like a child can see that it doesn't make sense. Whats the point of putting down $1M to $2M as a down payment on a $5M-$10M property and lose money every month or at best break even? Like who buys these properties usually? Like these complexes are clearly meant for investors, so how come sellers price the property at an extremely high price that the rent wouldn't cover the mortgage and expect to find people buying them? That's like every investment property in downtown Boston or Manhattan..... Just want to understand the logic or market behind such properties? Or is it meant for cash buyers only?

Greg Dickerson · Answer

CAP rate is determined using Net Operating Income which is gross income minus expenses (not debt service) so your calculation is off. If you collect $180k you probably only net around $100k before mortgage so your CAP rate on purchase price would be 12.5% which is still very good.

To answer your question about more expensive properties investors that purchase those just put more down which lowers the return but does not necessarily create a loss. Higher end properties like this are more of a bond play.

Lien Vuong · Answer

I think you're also not accounting for some of the expenses of owning in a A class vs. C class area. Higher turn overs, management costs, and depreciation on property plays a large role in the lifetime expenses of the property you own. While on paper a more central Boston property is less returns, the appreciation rate is higher, quality of tenant is better, and overall a safer market to be in during a market shift. The rates for vacancy are high in C class areas in any down turns because of job loss or change in income. That's a cost you're going to have to account for.

Seth Williams · Answer

@Mahdi where are you living vs. looking? As a broker in the Boston area, im not familiar with properties that if purchased would "lose money" there is certainly some that require more money down than others in terms of quantity, but with commercial financing ( over 5 units ) a bank needs the Debt Service to be covered by revenue, or DSCR ( Debt service coverage ratio ) and usually its 1.2% here in Boston. Meaning, if the place has a debt service of 10k a month, it needs at least 12k in rent to be able to even go to the bank to get financing. Now, that being said, If I was just sitting on 10 mil, I could buy a building to your example and make a huge cash return every month, but its all in how you lay out the deal / whats important to you. The cap rate in Boston on average is like 4-6%, so, they still make money. There are also still deals to be had out in this market. Lastly, often brokers are over pricing based on the shortage of housing and potential for redevelopment too.

Just my $.02

Tj Hines · Answer

Account Closed every investor is different. We all have different goals. Institutional quality assets are purchased by institutional buyers who aren't buying for yield. But they're usually buying more in quantity than just 16.

It could be a successful small business owner who could be looking for tax shelter and wants to park it in a safe vehicle that doesn't have any hair on it.

Account Closed · Answer

Thanks everybody for the replies! I realized i had made some mistakes with the Cap rate formula.

I always love to get some perspective from people with more experience and knowledge!

As a young investor I am always focusing on yield versus growth, that's why I always preferred Class C areas where i can squeeze the most cash flow out of my money. I am willing to deal with high turnovers and headaches for a higher cash flow. But as my capital increases over time I will be moving towards Class A and B areas/properties. I got my answer to as why would people buy low yield but great properties in great areas, its the faster appreciation over time with less headache that substitutes the lower yield, never thought about it this way.

Thanks to everyone who contributed to this thread! I learned a lot from you guys today! Much appreciated!

Account Closed · Answer

Hey Seth, appreciate your reply. Cap rate means rental revenue/ purchase price if i am not mistaken. So I am going to do some math based on 5% cap rate (between 4% and 6% in Boston). If purchase price is 10M, 5% cap rate means I would collect $500,000 a year, roughly $41,666 a month in rent.

Now lets assume a 20% down payment of $2M, that mean I would need to get an $8M mortgage on the property. At 4.5% interest rate over 25 years, my monthly payment on my mortgage would be $44,467 a month. I dont need to incorporate the rest of the expenses since the mortgage is already higher than collected rent. And i am spending $2M as down payment....

Is my math correct? Or am I doing something wrong here?

The bank refused to issue a loan on a $3M 12 unit in Mansfield simply because the rent collected would barely cover the mortgage and we would end with a $2,500 a month income on a $750,000 down payment which is around 5% CoC return which is absurd. Might as well buy some government bonds at that rate.

For a property to generate income, i usually look fro 12% to 16% Cap rate. Meanwhile, for example, if you go down south to Fall River, although not a prime area, however we own a 15 unit complex that we collect $15,000 a month, we purchased it for $800,000, so down payment was around $150k, fixed it up, now ARV is around $1.6M as appraised by the bank based on rental cash flow. Regardless of ARV, collecting 15k a month = $180,000 a year . So Cap rate at purchase was 180k/800k = 22.5%. After paying the mortgage and expenses we net $8-$9K a month off that complex which is $8,000*12= $96,000 a year. So cash on cash return is $96k/$150k = %64.

Just to give you perspective thats the type of real estate we usually buy, excellent heavy cash generating properties. I know I wouldn't find such gems in Boston, but i was expecting at least to make %15 to 25% cash on cash return on my down payment since its leveraged by a mortgage, anything less would be unacceptable by my standards.

Feel free to double check my math if i am wrong. Just trying to make sense of Boston real estate.

Anthony Gayden · Answer

@Mahdi Termos

Stop assuming that investors in these properties are only putting 20-25% down.

Sometimes 50%+ down is required for DCSR. Also many of the investors are betting on rent increases which will greatly improve cash flow.

Spencer Gray · Answer

Return is generated by yield (cash flow) plus growth (appreciation).

Gateway and primarily markets (NYC, Boston, LA, etc) tend to generate the majority of their return from growth, not from yield.

Secondary and tertiary markets tend to generate a more balanced return generated from yield and growth.

In markets with declining populations or are in rough areas may generate most of their return from yield and may have very little chance for growth.

All three of these scenarios have the potential to generate similar total return andI IRRmetrics.

What it comes down to is the individual investors preference, strategy and goals.

Seth Williams · Answer

@Lien Vuong you nailed it. Appreciation in fall river, all though from a percentage may be super high, dollar wise it isnt. I have property just outside of boston that has doubled in value almost in 3-4 years, and its worth a lot more of doubling in fall river. And yes the cap rate calc was off.

Lastly, 3 million for a property in mansfield seems very high. Often, brokers / owners might try and use the cap rate value on a future pro forma of rents, it happens to often, and its important to not pay tomorrows price for a property today. If that is the case, then yes a bank wont cover it because the rent is insufficient, its more of an over priced property IMO. I recently ran into a deal that I wanted to buy but the rent roll wouldn't cover, its just a simple pass in my analysis at that point unless I can buy it at a price that works. I do love the uprising in Fall river tho, one of my agents is buying property down there.

Who buys expensive multi-unit properties in downtown?

Most Popular Reply