All Forum Posts by: David Almeida

It's not a commonly used metric. Let's do some quick math to find out why:

If you buy 12 units for $1,200,000 and put 20% down, you're into the property for $240,000 plus closing costs and reserves. For the sake of brevity, let's stick with $240,000. 

Net cash flow after debt service of $100/door/month is $14,400/year, or a 6.0% cash-on-cash return. Because of closing costs and reserves, your true cash-on-cash will be lower. Of course, this doesn't tell the whole story: Are rents low? Will you be renovating units? Can you work into a higher return over time? What returns are other investors looking for in the same market? Do you have investors whom you need to pay an annual return to?

Most new investors I know make their offers by solving for a cash-on-cash return that they're comfortable with. It's the easiest metric to underwrite while also giving you an idea of your margin of safety. However, small multis--2 to 5 units--often have low cash-on-cash returns and it's thus all about capital preservation and paying down your debt over time. So, for those deals, take cash-on-cash with a grain of salt. In the end, it's market dependent.

I think Brandon's point is that you need to focus on how much cash is in your pocket at the end of the year. The cash-on-cash return accomplishes the same thing while giving you more information about the investment.

My two cents: you should pass. This is way too much work, especially in your financial situation and with your lack of experience.

My first gut rehab cost almost twice what I expected it to cost. Luckily, I had reserves and it originally penciled as having a high profit margin. I didn't lose money, but I cut it close. And it took 8 months...

In your situation, you should look for a light fixer-upper so you can get comfortable with the pricing and the process. You can then rent it out, refinance out your investors, and move on to the next one--with a lot less risk involved.

Congrats on turning it around! Those are healthy rent bumps for the amount of capital you're investing. 

Would it have made more sense for you to test the Airbnb unit yourself, rather than rent it to someone who's doing that?

As mentioned by a number of posters, relationships are of utmost importance. However, deal structure does matter. 

The old-school "country club" structure is:

Investor puts up 100% of the capital and Operator puts up 0%. Investor gets his/her initial capital returned, then a 6-8% preferred return, and then all profits are split 50/50 between Investor and Operator. 

The negative here is you'll often get push-back because the returns to the Operator are disproportionate to the risk they're taking (zero cash investment). Also, most lenders don't want an operator to have no cash in the deal.

A more modern private-equity structure is:

Investor puts up 90% of the capital and Operator puts up 10%. The Investor + Operator both get their initial capital returned, then both receive a 6-8% preferred return, and then profits are split based on hurdle rates (this is commonly referred to as a waterfall). As higher hurdle rates (returns) are exceeded, the Operator receives a disproportionate share of the profits. Thus, the Operator is rewarded for better returns to the partnership. The Investor should always grant incentives to the Operator so he/she works hard for great returns. 

The realty:

Smaller private deals (under $15MM) usually end up somewhere in between these two structures. Your goal as the operator is to negotiate the best deal for yourself while providing your investors with strong returns to keep them coming back for more. I've seen plenty of successful operators negotiate deals in which then end up with roughly 50% of the total returns; their investors were quite sophisticated, too. 

Larger deals often require more-sophisticated investors. These investors will negotiate harder and drive down your share of the upside.

Ultimately, the best way to raise money for an acquisition is to tie up a great deal! They are so few and far between that you'll easily raise money. And if you still struggle, call up an experienced market participant and partner with them.

Hi Davit:

In doing your due diligence, you should look at all approaches. 

For example, it's best to start with historical figures to determine how successfully the property has been operating. You can calculate the actual vacancy rate the current owner is experiencing and compare it to the rest of the market. If the owner is running at 99% occupancy and the rest of the market is at 90%, then maybe his rents are below-market or he's in a superior location, etc... 

Once you're more comfortable in your underwriting, you can then project income and expenses based on your knowledge of the market. Real estate value is ultimately determined based on the value of future cash flows, because that is what you're buying.

Point #3 in your OP is a conservative approach and won't work in all markets, but is useful for smaller suburban multifamily assets (say, under 10 units). It's best to underwrite as many deals as possible in your desired markets to get a feel for how properties are operating. To start, however, I think it's best make your offers based on trailing-12 numbers until you're very comfortable with the market.

Happy to discuss further!