Running the Number: Why does everything seem so Expensive?

Question

Hi Biggerpockets!  I need a little help or guidance.  I feel like many of the properties in my area are overpriced.

I'm looking to purchase SFR properties in Charlotte, NC and the surrounding area (concord/kannapolis).  I specifically targeting properties under $100k and that have been listed on the MLS for 120+ days.  The reason is i'm hoping some of these owners may be willing to consider some sort of owner financing.

I look at what the property would rent for (rentometer, hotpads, craigslist) and subtract common expenses to determine the NOI.  Then apply the cap rate i'd like (10%) to determine my offer.  Most of the times my offer is around half of their asking price.   I mean I should expect the property to be overpriced to some degree (that is why is still listed after 120+ days) but this seems crazy. And i'm using liberal expenses, if I apply the quick rule of  50%, the situation is even worse.

Ex:  124 Main St. will rent for $1000/mo.  Apply 50% rule and your monthly NOI is $500.  Yearly NOI of $6K.  Apply a 10% cap and purchase price is $60k.  They have it listed for $105k.  Even if I take out property management the offer price would be $72K.

I know my example basically meets the 1% rule, but after the finance charge, there just doesnt seem like much meat left on the bone.   Anyone else noticing this?  Are MLS prices just inflated? Is this normal for Charlotte, NC ?   Thoughts?

Thanks guys!

Cory Melick

Kevin Page · Answer

Realtors price SFR homes based on recent sales. They don't account for rental rates. You are competing with first time home buyers or move up/down buyers. They are buying for a place to live not an investment so they are willing to pay more than an investor. They don't care what the rental rate is or the cap rate.  A 100k mortgage costs less than $1,000 a month rent payment.

Eric Bowlin · Answer

Bob does sound a little harsh but I kind of agree with him. Cory is using commercial valuation techniques to try to value properties that are bought and sold based on comps.

What YOU are willing to pay and what something is worth on the market may be completely different. That new BMW is way overpriced in my opinion and would only be willing to pay half...but lots of people will pay asking price. This is basic economics.

Cap rates are wishy washy as well and are generally used on larger multi-family buildings ( or 6 units+) and commercial properties. I bought a commercial property valued at 95k..adjusted some expenses then rented a vacant unit and suddenly it was 'worth' 195k a month later. Use cap rates to bargain on your commercial properties but it is not a true indicator of what you will earn.

Also, I would verify the 50% 'rule' in your area. I have many units and can say that the 50% 'rule' is more like the 75% 'rule' for my properties. It is a good starting point but always verify the numbers. Around here taxes can triple moving from one town to the next so one rule couldn't possible capture that.

Also...I think SFR's are a complete waste of time to rent. That's just my opinion though.

Good luck finding a good property!

Jon Holdman · Answer

Most properties in most areas make crummy rentals.

Lots of people getting into this business (buy and hold).  Inventory is limited.  High demand and low supply means high prices.

I'd like to buy some more properties here, and am ready to do so, but the deals look about like the one you describe.  Mostly not even that good.

Now, I might actually consider buying a deal like you describe.  If you finance that with an 80% loan at 4.5% for 30 years and manage it yourself, I get that it produces a 12.3% cash on cash return.  That's based on rent of $1000, NOI of $640 (which includes money that would go to a PM if you had one), P&I of $425.62 leaving monthly cash flow of $214.38.

With property management cash flow drops to $74 a month for a cash on cash of 4.3%.  So this is a non-starter for me with property management.  OTOH, if you're in a speculative mood, this might be OK.  Its cash flow positive, so nothing out of pocket.  If it appreciates you may do quite nicely.

Account Closed · Answer

This is normal for properties on the MLS. It has gotten very difficult to find a decent deal on the MLS. The foreclosures (REOs) are even hard to get decent deals on now. Stick to your numbers and keep looking. You may need to find a local wholesaler or even do some direct mail to find some deals.

Juan Silva · Answer

I'd like to take a short break from the NOI & cap rate argument to ask Elizabeth if she'd be willing to share some insights into the "very different type of portfolio" she's built. It might be an interesting method of building wealth for others as well, so Elizabeth if you're willing/able to divulge your secret please do tell...

Jeff Greenberg · Answer

SFH and Cap rate are not usually discussed together.  There are other ways of evaluating value and returns on SFH as discussed above.

Account Closed · Answer

Craig, thanks for your contribution but you obviously don't know what you're talking about.  I won't argue 50% rule since it's only for people that buy for possible cash flow and not profit.  Anyone can jump in but my understanding was that it was ONLY for cash flow.  50% went to ALL EXPENSES and some of the rest went to Pi leaving some cash flow.  NOI ONLY includes operating expenses.  Show me a reputable source that defines NOI as 50% of rents.

If the op does not know market cap rates but "wants" 10 then he could well pay 20% OVER market value in his example if the market cap is 12%.  Anything else we need to discuss here?

Rob Caldwell · Answer

@Cory Melick

Yes, MLS is harder because of the competition, or multiple offer scenario.  Many investors end up paying more than they wanted to through MLS because they are low in inventory and just needed a deal at that time.  Which is not good business.

In our world, we get leads (calls) from people who have never listed their house on MLS so it's not ever seen or realized by anyone else.  This gives us exclusive access to sellers that never called another investor.   We also concentrate on the seller, not the house.  Whereas with MLS, all you know is the house.  Working with sellers directly allows us to create a helpful experience for the seller.  Not something that can be achieved through MLS.

Also, our numbers are a little different.  We have the 20-8-1 rule.  For every 20 leads we get (callers that respond to our advertising), we schedule 8 appointments and get 1 purchase contract.  Of course this is an average and based on the fact that we have over 500 offices across the country.

Mitchell Jaworski · Answer

@Kevin  Page very good point.  I see the same in my area of Florida.  You can buy a two bedroom condo and the mortgage, taxes, HOA still costs less than renting that same two bedroom.  However, the margin is thin - good for homebuyer, not so good for investors.

Luckily you can still get the 1% rule around here by a hair, but 8% Cap rate, etc, good luck!

Running the Number: Why does everything seem so Expensive?

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