Multi-Family Metrics in the Denver Market

[Marc Allen]

Hi All,

I'm relatively new to the Denver area, and very new to the Bigger Pockets forum. I've been keeping an eye on the Denver market for the last 6 months or so, and I've got a few questions for active investors in the market. Primarily, I'm interested in whether others are actually seeing many listings where the numbers work relative to standard buy and hold metrics. By that I mean 

• Rent >= 1% of purchase price
• Positive cash flow assuming
  • Conventionally financed properties 20% down
  • 50% rule or full estimates for operating expenses

I know that many of the best deals never hit the MLS, but I'm not seeing anything close to numbers that actually work. This leads me to believe that either everything where the numbers work are being snapped up before they hit the MLS, or that folks are buying multi-families that are not meeting the 1% rule, and/or are just barely breaking even with the hope that the market will continue to appreciate at a higher than average clip, or that rents will continue increase in the way they have the last few years. I'm seeing much of the same on the SFH market, but it makes a bit more sense there, because given the influx of new residents, and the limited inventory, we're competing with buyers looking for primary residences and the numbers don't need to work out beyond whether they can afford the payment.

Just curious what others are seeing. I'm looking to purchase a 2-4 unit property this year, but at this point I'm likely to stick with the Chicago market (my native market) where I'm still seeing Rent/Purchase at rates of around 1.5% and cash-on-cash return >= 15%, despite much higher property taxes.  My primary focus is cash-on-cash return, and I personally have no interest in gambling on continue appreciation or rents increasing at the rates they have the last few years here in Denver.

Looking forward to hearing from others on this topic.

Thanks,

Marc

[Scott Trench]

I had this same viewpoint when I was just starting out in real estate about two years ago. In exactly the same position, I wanted as much cash flow as possible, RIGHT NOW. If you want that to happen, you will have to leave Denver. There are plenty of properties on paper that will do much better than properties you can get here, if you abide by the 1% rule and the 50% rule. 

The problem is, here I am today, cash flowing $500 per door per month, just two years later. Why? Because the properties are local and I can manage them myself, and because rents have gone up. You can say that's not cash flow, but I get one call every few months, spend an hour or two solving the problem, and move on with my day.

When you say that you "have no interest in gambling on continued appreciation or rents increasing at the rates they have the last few years" that's smart - you shouldn't buy a property that bleeds cash on a monthly basis. But, just because a property doesn't meet the 1% rule doesn't mean that it isn't capable of cash flowing right now.

Take my duplex, using 2014 numbers whenI bought it. I had a mortgage of $1,550 per month, rents of $1100 on both sides, and a purchase price of $240,000. Using the 50% rule, I'm losing $450 per month. But strangely, that didn't happen. I've had almost no vacancy in two years, and rents have risen substantially. Furthermore, my expenses in managing this property are more like $100 per month for operating expenses, and even if you budget in $250 per month for CapEx, that leaves you with $300 per month in cash flow, assuming you self-manage (which you should).

The problem with the 50% rule is that it is ridiculous to apply it to more expensive markets like Denver, at least in my opinion. How on god's green earth can one argue that it is substantially different to operate a 1500 sqft structure in Denver, than it is in a market like Milwaukee? 

Suppose you bought a 1500 sqft duplex in the midwest for $50,000 and each side rented for $500 per month - $1,000 total rent or a "2% rule" property. It is ridiculous to argue that maintaining my exact same duplex is $1100 per month and that same property in another state costs $500 per month. 

Materials cost the same. Utilities probably aren't too different. Appliances cost about the same. Handyman or contractor work is perhaps a little more expensive out here, but not 2X. 

To this point, the person that hasn't invested in Denver will argue, "But what about vacancies, property management, etc? Those costs are a percentage of rent, so of course they go up, right?

And that may be technically true. But, there are two problems with this. 

First, here in Denver, vacancies have not been a reality and will not be a reality for landlords until more units enter the market. I'm not saying not to factor in vacancies, but you can probably survive by assuming 2-3% vacancy instead of 5-10% like in other markets. 

Second, because per unit rent is typically well over $1,000 per month, you can't afford property management. Property management should not consume more than an hour or two per month per unit, if you are willing to self-educate. Hiring a property manager for my duplex (which now commands $2,675 per month in aggregate rent, because yes, rents rose) would cost me about $267.50 per month (property managers tend to charge 8-10% of gross rent). I don't know about you, but I don't make that much money per hour. In fact, I don't make half that, or a third of that, or even a third of that, per hour. Why on earth, then, would I hire a property manager to maintain the property for me when I have the opportunity to take on easy work that 1) will help me scale in the future when I do acquire hundreds of units and need to outsource that task and 2) saves me tons of money right now?

If the property only produced $500 per unit in rent, and all the sudden I'm doing $20 per hour work in managing the units in a 2% neighborhood with higher turnover, then of course property management becomes a no-brainer.

Lastly, gambling on appreciation is a fools game. But so is ignoring it entirely. The question isn't how much cash flow are you going to get today, it's how much are you likely to get in 5 years, 10 years, 20 years, and 50 years. Who is going to have more cash flow after those timelines? Midwesterner, or Denverite? You don't have to go cash flow negative on a property to at least give yourself a reasonable chance at decent appreciation. You just have to understand that if you go to a place that will surely offer you cash flow today, you often (but not always) forgo the opportunity for increased cash flow down the line.

So, after all of that - You're right. There are no deals that approach the 1% rule here in Denver. Therefore, there are no deals that cash flow, if you assume that operating expenses are 50% of gross rents. However, in spite of math that appears to prove otherwise, I will continue to steadily buy a property or two every year, and will likely continue to cash flow by "cheating" and performing extraordinarily high paying work myself, with a large amount of cash saved up from frugal living in the bank. I expect this plan to allow me to survive and thrive in a market crash if it ever comes here in Denver, and to consistently take advantage of the city's appeal if it doesn't. Critical to that philosophy is the fact that I believe that over the course of 20, 30, or 40 years, prices in Denver will appreciate more than those in other cities around the nation and that I will continue to love living here.