can u help me analyze this 4 unit place in small town?

Question

i would like some advice on how to analyze this property...i am very new to real estate investing....

a friend of mine said this is NOT a good buy simply because my money could be placed in a money market (over 5% interest) while this property's cap is ONLY 3%....

other than that, can u help me analyze WHY this is a good purchase or NOT based on the numbers?  i know there are a lot of factors one needs to look into but FIRST i would like some tips on HOW TO ANALYZE based on the NUMBERS first.

Primary Type:	Multifamily
Garden/Low-Rise
No. Units:	4
Building Size:	3,150 SF
Lot Size:	8,019 SF
Occupancy:	100.00%
Price:	$799,000
Price/Unit:	$199,750.00
Cap Rate:	3.38%
Year Built:	1971
Date Last Verified:	6/8/2007

Scheduled Gross Income:	$43,860
Vacancy:	$1,316
Income Item:	$195
Effective Gross Income:	$42,739
Maintenance:	$3,921
Taxes:	$8,496
Insurance:	$1,000
Utilities:	$2,402
Total Expenses:	$15,819
Net Operating Income:	$27,006
Expenses/Unit:	$3,955.00

thank you
GoldMin3

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mikeoh,

can you explain how you came to those numbers?

i understand there is a tool here...but i would like to UNDERSTAND the concept of getting those numbers....if you could, i would appreciate it

BJ

Joshua Dorkin · Answer

Mike uses a formula of Operating Expenses=0.5 X Gross Monthly Rents.  There has been much debate on the site about this number, but it is a safe formula to use.  Many respected experts will typically advise using a multiplier somewhere around 0.45 and 0.50. By using this multiplier for calculating NOI, you end up covering all the expected & unexpected things that actually come up when running rental properties.

Richard Warren · Answer

The S&P does NOT average 12% EVERY year.  You will have up years and down years.  You should not be investing in any equity based securities unless you have a long enough time horizaon 3-5 years or more.

8)

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And "S&P" is not a money market account. I'm talking about investing in mutual funds that invest according to the S&P 500 index. These are usually trivially easy to invest in, some will have a minimum investment but will waive it if you set up for automatic monthly investments. Vanguard, Fidelity, etc. I'm sure all have them. Fees are typically charged as a percentage, but with index funds the fees should be trivially low (fraction of a percent).

Rehab's point should be taken well to heart. These funds go up and down (ulike your money market which has probably always gone up). Most investors feel these stock funds pay off a lot better in the long run and thus are worth the risk, but a year from now you could be looking at a negative return and be cursing the day you left your secure 5% return.

Also, many mutual fund investors feel that diversity is important, and while a mutual fund itself is a form of diversity, a typical plan would be to pick several funds that target different types of companies, not just a single fund that only targets the S&P 500 mix.

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Try out the "Property Analysis Tool" in the left column under "Interactive" here at Biggerpockets. It will help you play around with numbers so you can get a feel for how different assumptions affect your bottom line.

A couple of things jump right out at me when I look at what you posted.

(1) I would always factor in at least 5% if not 10% for vacancy (here they did a lot less, but sellers always try to convince you that vacancy is lower than it really is, and there's just a physical amount of time it takes to turn over a unit, even in a place that is easy to fill). So I would up that value to about twice what they listed.

(2) The expenses total must assume that you go are getting one of those great places that never needs repairs and requires no maintenance. These are great if you can find them, but unless you are buying in Fantasyland you better factor in about 10% for each.  Some people here advocate a 50% rule (that is, assume all expenses total 50% of income). The theory is that you can never predict exactly what many of the expenses will be, and that 50% comes closer than any number you could come up with on your own. If you use the property analysis tool, though, you'll have to put in your own estimates.

(3) Even if you ignore 1 & 2 above and assume the listed values are correct, this deal would be terrible at a 3% cap rate. The cap rate is the return you would get if you made a cash purchase (i.e., it is the return not counting your financing expenses - in this case the net operating income divided by the purchase price). It can be a useful way to compare a real estate investment to a non-real estate investment. Think about what a 3% cap rate means. I'll assume you would need a loan to pay for this place. What interest rate will you be able to get, maybe 7%? That means you'd be borrowing money at 7% for a return of 3%. That's a quick way to go broke. Even if you paid cash, as your friend pointed out, you can do a lot better than 3%. Whenever I think about how to invest money, I don't compare to a money market, I compare to an S&P index fund, which will average 12% return with zero time or effort on my part, and relatively little risk over the long haul. With real estate, where I have to also invest time and effort, and potentially take on more risk (though that's debatable), I want to see a much better return.

But all this talk is nothing compared to how much you learn by playing with the property analysis tool. Try it out, make some assumptions, and see what you get for different types of properties. What you are looking for will partially depend upon your goals (immediate cash flow, long term asset build-up, some balance of the two, high maintenance for better returns vs. less work for less return, etc.).

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speaking of S&P, how do you get into S&P investing...is there a fee?  my money market is paypal 5%....but i would like to invest in S&P because it avergaes 12% every yr....

how can i get started in that with a small fee?

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what are some places that help ou to INVEST in S&P?

i am 26 so i can plan on putting money for 3-5 years...is there a fee for that and if so, what is the normal fee for S&P investing...i have most of my money in money market but it seems too little...only 5%

Michael Rossi · Answer

Here is the way I see this "deal".

Purchase Price:  $799,000
Gross Rents:  $42,739 per year or $3,562 per month

Operating Expenses (the real ones):  $1,781 per month
NOI:  $1,781
Mortgage Payment:  (30 yr, 6.75%):  $5,182

Monthly LOSS:  $3,401  OUCH!  Better dial 911 with this one, it would be PAINFUL!

Mike