$100/door debate-sell me on it

[James W.]

I see a lot of discussion with people saying they want at least $100/door but I don't really understand how it can be a good metric unless there would be a big value add opportunity with a big cash out (limiting the investment) and/or a reliance on appreciation (which I don’t like).

I think there is agreement that $100/door is not a good metric for a limited number of doors, but I struggle to see how it is reasonable even at 100 doors.

I would be interested in hearing from people who agree with the $100/door and those who do not agree with the metric. For those that do agree with the $100/door metric:

1. Have you been investing since before the last recession?

2. If so, how did that work out?

3. If you have not been investing that long, what do you have in place to protect you if we run into another recession like the last?

Below are some of the reasons I do not agree with the $100/door metric and why it is not attractive for me. I would like some good discussion on how I should be open to it as it is easy I can be missing something in my analysis.

For the purposes of the discussion, we will assume 100 doors and that the $100/door factors in PITI, all expenses, property management and a reasonable level of Cap Ex for the property. That is $10,000/mo coming in after expenses and reserves.

Some of the limitations I see with it on the surface are below:

Limited investment returns without relying on appreciation or a big value add

$100/door is only $1,200/yr per unit. If we assume $100/mo in principal pay down per unit as well, that would get the total return to $2,400 per unit per year. Assuming an investor would be ok with a 10% return (I wouldn't invest in this personally), the price per unit would need to be $24,000 which usually means you would be in a warzone or more of a rural area. Even if we assume principal pay down on the high side of $300/mo per unit ($30,000/mo) a 10% return would be $48,000/unit which is still low.

At $100/door, you need to assume minimal equity as the total return would be even lower if the borrower had any significant amount of money down.

At $100/door, this needs to account for a worst-case scenario

Unexpected changes in expenses, vacancy and Cap Ex can have a significant impact and any expense increases need to be passed along to tenants to maintain the $100/door metric. This might not always be possible if the units are already at market rents or are at above market rents. If the units are below market rents, increases can and likely will lead to additional vacancy when rents are increased. You would need an experienced property management team in place as well since there is not much room for error.

Limited ability to withstand changes in the economic cycle

100 doors at $100/door is a return of $10k/mo. If we say the average market rent is $1,000 (a little low for where I am at in MN) and market vacancy is 4% (lower in some areas now) that already factors in 4 units vacant at a given time. With 4% vacancy, the actual profit/door is really $104.16 to make up for the 4 units vacant at a give time but to make things easy we will assume $100/door.

If we enter a recession, we could see higher levels of vacancy and rents declining. The $10,000/mo income relates to additional vacancy of 10 doors to get to break even (86% occupied) or a rent decrease of $104/mo across the board. It seems feasible that either if not both could happen in a recession which means this investment at $100/door could easily cost money every month for as long as the recession lasts. If both happened, the investor will need to have deep pockets to cover $10,000/mo out of their own pocket. $120k/yr is a lot of money to put up for an investment that is losing money. I surely hope the investor would be diversified or has a large outside income source because if their sole source of income is rental real estate in a local area, income from multiple properties will likely drop at the same time limiting the investor’s ability to cover a property that is not performing. Selling it likely will not be feasible either unless the borrower has a lot of equity.

If the rent/unit is greater than $1,000/mo, the investor would have less flexibility in withstanding vacancy and changes in rents than a building with rents lower than $1,000/mo as each additional unit of vacancy will have a larger hit to the investor’s profit. Investing in lower class areas with lower rents would seem to be much more attractive in weathering changes in the economic cycle, as lower rent units are less likely to have large fluctuations in rent as well. At the same time, these investments may take more work to manage too but we can assume you have a strong management company.

Scalability options seem limited

In order to scale, you will need to be able to maintain a minimum DSCR of 1.25. If you have minimal cash equity in the deal above to get a decent Cash on Cash return, it may be difficult to find deals that will meet this metric in the current climate where most deals are overpriced for the level of income they generate. Absent a good value add opportunity with private pre-funding and a cash out, it seems like it might be hard to find many deals in strong areas that could provide a good return at $100/door and would meet the minimum DSCR requirements.

There is more to this and several variables to consider (unit count, avg rents…), but in a situation of 100 units at $1,000 or more a door avg rent, it seems tough for me to call $100/mo per door a great investment unless this a pre value add or is a worst case scenario number that factors in the performance in a declining economic cycle.

Summary

I would be curious to see the thoughts from others whether they agree or disagree as my primary purpose in posting this is to understand how this metric can be a good metric (in any situation) to base an investment decision on. I understand metrics are what they are and cannot be used in every situation, but I fail to understand how this metric can be a good one to use at all and want to clear things up in my mind as I see it being brought up every day on the forums-likely by people who have never even used it, let alone investors that have weathered an economic cycle.

Thinking this through more makes me start to side more with @Jay Hinrichs on his philosophy that wealth is the accumulation of free and clear properties not a bunch of high debt properties providing monthly cash flow as these are the ones susceptible to big problems in the downturn. 

I do not think the properties need to be owned free and clear, but they need enough equity and strong cash flow to protect against the next downturn.  $100/door would be a poor investment return in a deal with a lot of equity and does not lead to a strong level of cash flow in some situations.