How long to wait for profitability

Question

I'm looking at a 4-family in a town where I have other properties where I did not know what numbers to run. Those were mistakes but I live in one, so I can live with that, so to speak. I am not eager to make the same mistake three times, however. Now that I've learned what numbers to run, I see that this particular property will not cash flow for at least a 1-3 years. It's not a BRRRR and I will end up having to sink a fair amount of capital into it, including converting from oil heat to gas in order to get the tenants' utility bills off the books. With the utility bills that the owner is currently paying, there's no way this property at this price would ever cash flow. Without them, and at full ask, it will still take 2-3 years of raising rents before I see a modest 2-3% cash on cash return with a cap rate of about 1.5%. My agent says I need to look down the road rather than at what the numbers are now, as long as I'm not losing money. But even as I look down the road, as rents rise and the property appreciates, the ROI and the cap rate will stay the same, unless I'm missing something. Should I even be wasting my time on this, or is this a potential gold mine and I just can't see it?

Jack Oved · Answer

Life is all about opportunity cost. If you will find other opportunities that you can’t invest in because your equity or time is tied up in these bad deals, sell

Allan Smith · Answer

A 1.5% cap rate is. Well. Awful. Appreciation might dig you out but if that's best case scenario I can tell you you'll have a long, Slow road to being wealthy. I would highly recommend the stock market. It will beat 1.5% and takes WAY less of your time. Or fundrise. Something like that.

Mike James · Answer

@Joe Villeneuve AMEN! Cash flow now or no deal. You can find lots of agents who will tell you how great bad deals are because they're acting in their own best interests. Congratulations on doing the math. Now trust your numbers and stop trying to justify buying a bad deal.

Joe Villeneuve · Answer

The best deals you make are mostly the deals you don't make.  Having your money "sit around doing nothing" is miles and miles better than dying on the vine.  If you invest in this property, you might just as well wave goodbye to it as that ship sales away, sinks to the bottom, never to be seen again.

Daniel Beckius · Answer

@Michael Weis you're looking at the numbers deeper than most do.  Most look at the current figures and don't take into account all the deferred maintenance which includes deficiencies.

"Look down the road" is a broad statement, but that is exactly what you're doing.

1. Updates to bring up rents (vacancies and the cost of the reno)

2. Updating the major mechanicals

3. Market Appreciation or Depreciation (consider what the value of the property will be in a year from now)

4. How often these come available.

What upside will the property bring you in the future?  Large lot, location, new businesses in the area, etc.  Assuming you're not interested because it's the only one, take a hard look as to why you're still considering the property.  You can listen to a pro but it sounds like you are a pro.

Malcomb Stapel · Answer

@Michael Weis  if it's such a good deal, you can ask your agent if they want to invest their capital in it alongside yours. That would share the risk a bit.

While I would agree with your agent at looking long term, the real question is can you afford to have your capital sitting in a non-performer for the next 1-3 years? Which leads to the question of how much capital do you have left that you can use to pursue other deals in the meantime?

The big hedge funds are able to buy at FMV or over because of a combination of loan terms and huge amounts of available capital. Even if they bought a non performer they know that time is on their side, because they have such a fractional amount of their capital wrapped up in it.

Nick Barlow · Answer

@Michael Weis I’ve heard the phrase on these forums that appreciation brings you wealth and Cashflow is the vehicle that lets you play long enough to get the appreciation.

Hard pass in my book if it doesn’t Cashflow. Yes, you have to look long term, and yes, rents should go up over time.

You can find plenty of stories of tenants not paying rent for 12-18 months straight during Covid, eviction moratoriums, and you get the joy of repairing the property, ensuring heat/water/functionality with the threat of legal action from the city/county for non compliance, despite non payment.

Do what’s best for you-planning to lose money on REI, regardless of length of time, isn’t best for me, so I would recommend to keep searching, or restructure the deal in your favor.

Michael Weis · Answer

@Malcomb Stapel Thanks for the insight. The short answer is that my agent does not have the ability to invest with me. The other answer is that I don't want my money sitting around doing nothing AND taking up a lot of MY time to do it, as there is not enough income to support a property manager. The truth is that I don't have tons of capital lying around that I can afford to sink into a property like this.

@Daniel Beckius I am no pro, believe me, but I hope to play one on TV someday! :) Seriously, though, we like the fundamentals of the area (lots of business, university, hospitals, and strong rental market), but I would rather try to BRRRR than buy a property the old-fashioned way. The real problem is that I don't really understand how that's possible in a market like mine, where even the unlivable houses are overpriced for what they are. I think I can hear the answer already: "So, find another market to invest in."

George Azita · Answer

The most important thing is how the math pencils out. If you are buying add-value properties where you can fix up the properties, increase the rental income and increase the value of the property by increasing the rental income, then almost every property I purchase will be in the negative for the first 1 to 3 years, but when the numbers are correctly stretched out over a period of 10 years, then most of those properties (when the numbers are right before you purchase) are goldmines.

Example. I've been investing in real estate 55+ years and never gave a lot of consideration for properties under Los Angeles Rent Control where the rent increase is capped at a flat 3% and landlords have to pay tenants up to $22,500 to get them to vacate. Don't forget that Los Angeles has the highest prices in the country, but I just put a 6-unit property in escrow for $975,000 cash and the rental income is only $72,000 per year. The roof is currently leaking and needs to be replaced and everything in the units is what was installed in 1956. I figure it is going to cost me $200,000 to get the tenants out and rehab the units. I will increase the rents from $1000 per month per unit to $1650 plus a $40 increase every year. For the first 2 to 3 years I will be deeply in the red, but by the end of 10 years I will profit $1.5 to $1.8 million, or about $150,000 to $180,000 per year for a $975,000 + $200,000 investment.

I am 100% positive that the majority of real estate experts and so-called pros do not do the math, thoroughly nor correctly.

Go to bestlineplumbing.com, scroll down the home page until you see the link MS Access Software, download the free software and do your projections.

I am paying cash for the property, but my projections show that if I financed the property with 30% down my profit at the end of 10 years would be about $200k less, or $1.3 to $1.5 million. I  may seem to the experts that I could earn much better profits by using financing to purchase more properties, but the problem I have is I can't find enough properties with numbers that make sense, so it doesn't make sense to pay mortgage interest when I don't have to and I still have plenty of cash on-hand to purchase a fairly large apartment building.

How long to wait for profitability

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