Deal Analysis I don't get it am I missing something?

Question

fourplex with gross rents of 23,760 (10% vacancy) Total expenses: Property tax 5,592, insurance 1,200, maint and repairs 2,400, legal professional 100, auto 200,electric 360, water 960, other (includes plow and lawn) 600

Total annual expenses 11,412

We tend to be conservative in our numbers too.. we were planning to finance this property 25% down closing cost of 10,100 (prepay tax insurance etc + actual cost to close) total cash outlay of 38,850

So NOI would be 12,348 
with a cash flow of 630 a month (7,555) annual  Cash ROI of 19.45%
Cap rate of 10.74 %
GRM of 4.84
Total ROI of 23.53% (includes appreciation and equity)

The property is an a B neigborhood near the highway but with lots of competition from other rentals near by ( I think it would be difficult to increase rents)

That being said this was a short sale property... they had 9 cash offers for above LP which was 115,000.. I guess I am surprised that this would go for more than LP. Especially considering I see this property being good if you finance it by why would someone want to pay cash for it ? that is a lot of capital to tie up all at once for this property. I would consider this properties return to be less than ideal compared to some of other properties we currently own.

What do the numbers tell you guys ?

Mike

Account Closed · Answer

Hi Tom Goans,

Can you explore on this a little more if you don't mind?  "my father will not consider a deal unless it has an annual 4 to 1 ratio ($4 for every $1 invested)"

What you're saying is that if you invest $100k on a property, it has to give you a $400k return annually, or it has to gross $400k annually?

TIA.

Tom Goans · Answer

Yes, when my father considers an investment, he first uses simple math to determine if it will provide a minimum of 4 to 1 return the very first year.  He once rejected doing a deal with me that would have given a 3 to 1 return in less than 60 days.

The investments I have been making since 2001 give me 8-10 to 1.  For more than 20 years, most of my father’s investments are like this ... buy a large chunk of land for $100 per acre, subdivide it into 40 acre tracts (extremely low development and holding costs with No Babysitting) and then sell the 40 acres for $25,000 ... this is $625 per acre.

My father generates his sales leads from cheap print advertising and the Internet.  100 percent of my sales leads come from my websites.  CHEAP.

Our work is easy and requires little time.  This brings me back to 2 things my father always told me ...

1)  K.I.S.S.

2)  If it is not lucrative, easy, and fun, just don’t do it.

These have been excellent and successful philosophies.  He owes no one and has not for many, many years.  Plus, he has a net monthly cash flow greater than the average household annual gross income.  All his money comes from real estate investments.  The monthly income is derived from collecting loan payments.  His big tasks each day are scanning checks received the previous day, entering them, filling out a deposit slip, ridding one of his motorcycles to the bank to deposit the payments, then riding around for pleasure.

One of his favorite books is “The Millionaire Next Door”.  I highly recommend the book.

Michael Sherwood · Answer

well I found another item of note folks. looks like this property was bought in 2006 at 149k... which means someone really screwed this one up! No wonder it was a short sale! Tom Goans thanks for the KISS analysis. I agree that the numbers are not everything. You cannot look at them in a vaccuum because pretty sure you might end up purchasing rental property in a less than ideal area.

Wendell De Guzman this is a good point, it is like they are getting an 11% return more or less and that seems to be decent. Some of the properties we own get returns of 20% or higher (some are riskier though ) some are not. Thanks for the continued insight friends.

Mike

Tom Goans · Answer

If I may offer another thought, the old pros and my almost 50 years of experience have taught me that if a “deal” relies upon tax benefits or structuring for the best tax savings for it to be considered a good “deal”, then it is not a “deal” at all.  The old pros and I will not even consider an investment unless it has a minimum fast return of capital and very large return on investment risk ... this includes any loans or anticipated debt.

Simple grade school math is what we use for determining if a deal is an investment.

For example, my father will not consider a deal unless it has an annual 4 to 1 ratio ($4 for every $1 invested).  Why should he.  For decades, his return has been closer to 8 to 1 and greater.  I have some investments that provide a 10 to 1 return.

Another tip that my father also drilled into me is there are more buyers for Chevys than Caddies.  In all economies, there are more buyers for Chevys.  Therefore, your investments are less affected by the economic us and downs.  Plus, since the capital investment is returned so quickly, and in many instances, you own the property free and clear, you are not sweating bullets and losing sleep.  You are still enjoying life.

K.I.S.S.

Consider this, a very large and prestigious hotel in my area (a former Crowne Plaza Hotel) recently sold for $14 million.  The buyer bought the hotel from the bank.  The previous owner bought the hotel in 2007 for $30.8 million.  The new owner is making a living off other’s mistakes.  This is the 9th hotel property they have bought in during the past 5 years.  The surrounding neighborhood is excellent.  In fact, it is within a half mile of the large convention center and many restaurants and shopping centers.

Think of it this way, the previous owner put his spin on the numbers and manufactured a positive result.  This was sold to a bank.  But, it failed.  I would bet blue-sky and “massaging the numbers” were used instead of simple grade school math and the goal of a true return on the risk.

Wendell De Guzman · Answer

Michael Sherwood, on your question...why would anyone pay cash for it, the reason is there's a lot of cheap money floating around nowadays. With a cap rate of 10.74%, that's the return on investment they get from an all-cash deal. That's better than the measly 1% a certificate of deposit is giving investors.

I agree that the numbers are not that exciting.

Tom Goans raised several good points.
1. Keep it simple
2. Look into the area or location also. I bought a 36-unit apartment in a bad area but the numbers are stellar (cap rate of 15%, infinity ROI - got it for $1 down and I took over the loan...which is only $565K for a property appraised for $1M). It turned out to be my worst investment ever.

Tom Goans · Answer

While there have been many books and seminars on real estate investment using many tricks and computations to try to turn nothing into something, including getting money from credit card cash advance or excessive financing, my almost 50 years of experience always reverts back to K.I.S.S.

Have you ever been around an old-time investor?  They never refer to all the numbers and computations you used when analyzing this particular investment.

I am a third generation real estate investor with almost 50 years of personal experience.  Neither my grandfather or father ever use those computations, yet, they were extremely successful.

One thing my family, and other old-time investors taught me over they years is to take the potential gross cash flow and reduce it by 40 percent - 20 percent for maintenance and repairs and 20 percent for vacancies.  If the numbers still suggest an acceptable return on the risk (this includes all debt liabilities), then analyze the costs and liabilities, including deferred maintenance and repairs.  If the numbers are still good, analyze the community and a large scope of the neighborhood.  Realistically determine the future as you own this property.  Many times, unexpected things completely change an investment, especially rental.  If there are few employment opportunities and one large employer, what happens to the area, jobs opportunity, and the values of ALL real estate in that area should the one employer leave the area?

The numbers you quoted do not factor in this type of extremely critical information.

For example, I know of an area of in the second largest city in the state that was booming during the 1980s.  In come the “pros” to build large shopping centers.  Jobs did not materialize, the income of the people living in the area became some of the poorest in the city.  Several years later, the pros went broke.  The shopping centers lost tenants and then the shopping centers sold at foreclosure auction.  A similar thing is currently happening in a neighborhood that was prosperous and desirable during the 1970s and early 1980s.  Now the neighborhood is in great decline, the people living in the area are aging with very limited income, schools are closing, and now the huge shopping centers are sitting empty.  Apartment complexes are filled with very low-income families and huge drug and crime problems.  This once beacon of a neighborhood is now turning into the place where there are many crimes on a daily basis.

A prudent investor looks beyond the numbers when considering an investment.  Blue sky will turn an investor into an employee.

Steve Babiak · Answer

Looks like two quick "rules" that say that this was worth looking at: GRM was less than 5 (the lower the GRM the more likely for it to be a deal), and it looks like it fits the 2% rule.  The other investors might be so used to seeing 1% deals that when they see one near 2% they jump on it.

William Brace · Answer

The numbers are by no means stellar as in I just must have it, so all I can figure on the cash offers above list price is they are planning on purchasing it and trying to flip it for a profit or do the cash offer, which is always more appealing to the seller/lender, then doing a cash out refinance. Just my $0.02

Deal Analysis I don't get it am I missing something?

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