All Forum Posts by: Account Closed

Thanks.  I'll continue figuring my Capital Reserves above the line on offers I make.  If it's a mistake, then I'm fine making that one.  By keeping it above the line in my offers, it lowers the price I'm willing to pay.   I also realize that when I do my taxes after I own it, I'm not going to try to claim it as an above the line expense each year.  I'll change the name of this to "buffer" if I ever post on this part of BP again.  

In my example where I used "CapEX" it is the same as what you are calling "Make Ready." You'll have to excuse my lack of using the right lingo as I was self taught and mentored by other self taught men.  My bad on that one.

On market CAP rates, I'm merely playing devil's advocate. More than half of the Mobile Home Parks in the US are transacted off market and a great number of them are also financed by the seller. Appraisers and Brokers don't even have data for half of the sales in that asset class. So, in our industry, you have a group of brokers/appraisers who claim that prices are set on a per lot basis and some who say that the prices are set on a CAP rate. As far as what the market CAP rate is, you'll hear anything from 7-10 depending on who you talk to. I deal in a very fragmented (maybe the most fragmented) sector of real estate and this has been my overall experience.

We can agree to disagree that CAP rate has no place in underwriting an acquisition. I might be wrong, but it's a wrong I can live with. If it is wrong then I'm wrong along side a number of very successful people and I'll enjoy that company. If CAP rates have no bearing on underwriting the buy then why are you using them to determine what to sell it for. What is your reasoning for not pricing/presenting your property in a way that is in line with how someone should underwrite it when they buy it from you?

Bob, you must be trolling or something.  That's the only explanation I can come up with for what you are writing here.  

1. Show me a reason why you would need CAP rate comps to calculate a CAP rate. Explain this in detail where a CAP rate comp helps you calculate NOI/purchase price. Furthermore, where in the hell are you getting CAP rate comps from? Please tell me because I've never shared the P&Ls a seller has given me with anyone when I've completed an off market deal. Plus, who exactly is determining this. Brokers, Appraisers?? Ask two different appraisers what the Market CAP rate is in a particular market and prepare yourself for two different answers. Sometimes wildly different.

2. Vacancy loss can be calculated by analyzing the market you are in vs. your own portfolio performance (or a mentor's performance).  I know my business model and I know the markets I invest in.  My gut will tell me what is appropriate to write in on that based on the features of the property and I will test the market in diligence to confirm my theory.

3. CapEX is included in the CAP Rate calculation. Here's how, NOI/(Purchase Price+CapEx). You can also build in future capital reserves by including a line item called "Reserves" on the P&L. In fact, if you aren't including that line item, you are over-paying for a property because it should be removed from your return. If you've ever seen a banker model your property for financing, then you'd know this isn't a crazy concept. My banker went through his internal refi model with me in December and guess what, Reserves were in the P&L he entered data into but they weren't in the P&L I handed him. I'll be sure to tell him Bob said we're doing it wrong the next time I see him though.

4. I didn't read enough of the last post to address this one.  Sorry

A post like what you've put here leads me to believe that you aren't out in the market place actively buying deals. If you require this type of data to make a move, then I'm sure you are sitting there in vapor lock all day trying to accurately use whatever it is you think a CAP rate is.

For everyone else, apologies for the post but this misinformation just rubbed me the wrong way. It's hard enough to start out in this business without having a bunch of BS thrown in the mix. Best advice I can give is that you use the evaluation method that is appropriate for the asset class. If you are in multi-family, then a CAP rate (Capitalization rate) will be used to build a picture of your "minimum deal requirements." Then you compare deals that come into your funnel against that. If you are in 1-4 family, just understand that CAP rates aren't used to determine price. You can still use them internally as part of your evaluation if you'd like, but don't base your buy or your exit on them.

Just to clarify the use of CAP rate in my own example, it is nothing more than a tool that I use to quickly evaluate a property. For example, if I have 20 P&L's on my desk from 20 different properties, I'm not going to sit there all day and do long division. So, my process is this:

1. Calculate the purchase price against the NOI.

2. Examine each line item in the expenses and then adjust the NOI to reflect how I feel the property should be performing.

3. Calculate the purchase price against the adjusted NOI.

I can do this in about 2-3 mins. After an hour or so, I can have my stack of 20 down to the 2 or 3 that I'm interested in. By using CAP rate, I can go from a stack of 20 unvetted leads to 2-3 LOIs in about an hour.

I can do this because I've defined this clearly in my investing criteria by saying that I want to buy properties that provide an upside NOI that is at least 13% of the purchase price (13CAP). The only upside that will be considered as "easy" upside is rent increases and normalizing management expenses, insurance expense, ect. Billing back utilities, leasing will not be considered easy upside in my evaluation. Again, this is just me but it suits me just fine.

This is about as far as CAP rate goes for me. After getting an accepted offer, there is about a million other things that need to be looked at and the ultimate financial formula at this point is cash on cash. I like 20+% for this metric and it's very dependent on the financing I can get.

So, basically it's semantics is what you are saying. I'm not staying within the box of the defined definition of CAP rate according to you guys, but you can still understand what I'm talking about. It's funny, if I had this same conversation with other active CRE investors in my space, there would be no confusion. If you don't assign a CAP rate in the scenario I listed above, what metric are you going to use to evaluate the effect of upside across one property vs. another. For example:

Property 1
$26,000 NOI
$650,000 purchase price
$114,000 upside NOI

Property 2
$47,000 NOI
$470,000 purchase price
$75,000 upside NOI

If you know a quicker way than using the upside NOI/purchase price to get upside CAP rate, I'm all ears.

Anyways, we've gone wildly off track. To provide an answer to the original question, do not use a CAP rate on your 4 unit building. Calculate the Cash-on-Cash return and then evaluate your exit on comparable sales. example: If this is a D-class area where similar buildings go for $25k per door, then this is likely not a great buy. If it is a C/B class area where similar buildings go for $50k per door then it is a steal.

If your returns and exit meet/exceed your criteria, tie it up and begin diligence to confirm your assumptions.

The CAP rate won't give you any indication of the strength of your deal because the capital markets and future buyers aren't going to use it to evaluate your property Christos.

I never said anything about a market CAP rate. The market CAP rate in the industry is 8-10 for Mobile home parks. I'm saying that the CAP rate on the purchase was $26,000/$650,000=4 and the adjusted CAP rate due to the value add component/normalized operations is $114,000/$650,000=18.

I'm not sure where you are getting that the market CAP rate in this market is 18, but it isn't. I can assure you that I'm not calculating this incorrectly. You are reading it incorrectly and do not understand what is being discussed here.

Hmm, not even sure what you're asking here Bob. My work was sending out a letter to increase the rent and then NOT hiring 3 employees at closing time. Here's the CoC on that property. Keep in mind, this is from day 1 to 365:

Downpayment & Reservers: $175,000

$114,000 year 1 NOI
 $41,337  Mortgage payment
 $72,663  Cash available for distribution

Cash-on-Cash return: 41.5%
Current value at a 10CAP: 114,000/.1 = $1,140,000

I'll buy this deal all day long over a 10CAP with no upside.

Jeffrey's explanation of CAP rates was just fine and very indicative of how you buy turn-around properties. I'll say it another way to avoid confusion by using a property I purchased.

Purchase price: $650,000

NOI at purchase: $26,000

NOI under normalized operating conditions: $114,000

CAP rate at purchase: 4

CAP rate under normalized operations: 18

This deal only required a 7% rent raise and also required me to not hire 3 of the 5 park employees at closing. It was the equivalent to an 18CAP purchase from day one.  Had I been rigid with my 10CAP requirement, my offer would have been $260,000 which is almost equal to the yearly revenue for this property.  Clearly, the seller would have never sold it for that.  

Placing emphasis on existing CAP rate is a very small piece of the the picture. If you are buying properties that are in distress, then you need to throw out the CAP rate at purchase and base your offer more off of what the CAP rate/CoC/value would be if the property was running properly.

The ease/difficulty with which the upside is realized determines how close to either end of those values you'll be willing buy at and what financing terms you're willing to accept.

Lincoln,

If you have a lot renter, the process is exactly the same as any other rental.  You evict the person.  Once that person is evicted, they are required to move the mobile home off of your property.  If, after a certain period of time that person does not move, you can go back to court and take possession of their home through abandoned property laws.  Typically the lot renter does not move the home and you end up with the home to resell.

Now, as for the business reasons to steer your community into a lot rent only position.  Land is much easier to maintain than a bunch of mobile homes.  People who own typically have pride of ownership and also have much lower turnover.  More than half of the turnover you do get with lot renters is the lot renter selling their home to someone else, who then pays you lot rent.  This type of turnover provides no break in income for you.  

I know you see the dollar signs on renting those mobile homes but you really need to understand that there isn't much money in that side of the business even with the spread you likely have over your lot rent.  Ten homes shouldn't drive you too crazy, but the types of people who rent mobile homes are very different from those who own.  I suspect that if you wind up owning this park, you'll agree with that statement within 6 months and change your business model.

First thing I see is that Texas can be a little nightmarish with private utilities, especially septic.  Most recent horror stories I've heard on septic have come from those who own parks in Texas.  Additionally, you last paragraph suggests that this park has homes that share septic tanks.  You should understand that you are taking on more risk with this configuration than the typical septic park.  Ask yourself, if I lose one septic, how many homes are affected?  

Second thing is that the "unofficial formula" is pretty accurate and a great way to stay out of trouble in this business.  If it were me, I'd go one step further for this park and call it a 50% expense ratio on the lots.  I would also require much better than a 10CAP to deal with the homes, septics, and economies of scale.

Based on current operations, I would place the NOI on lots at around $7,200 ($300 lot rent). The park/homes are realistically worth about half what you have it tied up for at best. My take may be slightly pessimistic, but I can absolutely promise you that this park will not cash flow $50k per year.