All Forum Posts by: Erik W.

Marc Rice nailed it. CAP rate compression is almost meaningless when you have virtually unlimited access to investment capital.

My real estate agent put it this way: even if this place only cash flows $100 and it costs $1,000,000... if it doesn't cost you anything (i.e. 100% financed or investment capital), in 15 years you have a paid off asset worth $3,000,000.  Why would you not do that?

This is clearly demonstrated in the formula: CAP = NOI/Total Capital Invested. So let's say you buy a 5 CAP...after ALL expenses, there's only enough cash left over to cover the mortgage. From a CAP rate standpoint, it stinks. From a Cash Flow standpoint, it stinks. And after 15 years, you own a $3,000,000 property for which you paid nothing out of pocket and did nothing in terms of management or maintenance.

$200,000 per year reward for doing not much other than putting a deal together.  Not bad wages.

Of course, this assumes everything works out just fine and a 5 CAP is enough to support the debt-service/equity partner payouts. But it illustrates the point that even at very compressed rates, as long as the property "pays for itself," it can still be very attractive to many investors.

Here's the fun thing though: this graph is an industry generalization based on limited data and survey responses. For example, I bought a property that penciled out as a 9 CAP this past year (it was vacant, $0 rents at the time) and since then I've turned into a 13 CAP. Other local agents said that the best deal one could hope for in today's market was a 6 CAP. But my agent and I did it. So....there's no reason to "settle" for compressed CAP rate properties. Find the property types that are exceeding official market data. They are out there, but they aren't being touted by gurus or on the front page. Think about abandoned retail strip malls, boarded up restaurants, and vacant automotive shops. Stuff that institutional investors won't touch because they are smaller ($500,000 - $1,000,000) and aren't multi-family residential.

That is not uncommon for a 30-year loan.  Because of the extremely long duration of the loan (30 years!) there is a lot of risk for the lender to be stuck at such a low rate for decades when it is clear that there are many inflationary pressures on the economy now, with Govt printing/giving away money like Halloween candy.  Most times, these loans are sold on the secondary market to institutional investors like insurance companies and/or Govt agencies (Fannie Mae, Freddy Mac), so the bank issuing the loan makes the majority of their profit off the up front lending fees rather than long-term interest payments.  4.5% actually is decent to lock in what are still historically low rates!  They've stuck around a long time, but I doubt it will remain this low another 30 years.

If you're willing to look at local commercial lenders, you can probably get a 20-year note for 4% and no points, so you're saving on loan costs too.  Keep in mind, though, that the rate will likely only be fixed for 3-5 years, but that's only a problem if you plan to hang on to the property for awhile.  If you're wanting to keep it forever, then the 30 year note makes some sense.  Over the long term, the rate difference will be immaterial because you have locked in a very low interest rate and can always refinance later if rates dip lower enough to justify the cost.

I encourage folks to look for ways to invest without debt (equity partners, lease options, etc), but if you're going to get a loan, go for long-term, fixed rate.  Those are the safest best, especially these days.

Depending on how large the asset is, you may be competing with intuitional money: think insurance companies with huge piles of cash from collected premiums that needs to be invested. They don't care about low CAP rates. They care about investing their cash to throw off enough regular cash returns so they can pay out claims. All cash deals cash flow just fine at 4 CAPs in those circumstances.

Some people are investing in bank CDs still, paying a meager 1%.  Some still have passbook savings accounts at less than 0.5%.  They consider capital preservation more important than making any return, which is ironic since inflation is eating up their purchasing power.  A wise investor might ask some of those folks if they'd rather earn 3% on an investment secured by real estate.  A spread of 2.5% (5 x what they're getting today) might look very attractive, and still leaves 1% for the deal maker.  

Then again, there are lots of people with cash right now looking to exchange up before the current administration tries to close down the 1031 exchanges.  You might simply be outbid by individuals who can put down 40% or more.

Consider looking at asset classes that aren't in a feeding frenzy right now.  Almost everyone on BP is gaga over MF units.  Why not look at something very "earthy" like automotive repair shops and/or warehouse space?  Less competition = better deals, I've found.

Hi @Robert Walters,

Okay, I'm not going to beat you up to hard as it's clear losing this deal would be fairly sucky and I'm sure that is already beating you up somewhat, but just to be 100% sure this base gets covered: this should have all been figured out BEFORE going under contract.  Real estate is reputation based, and Buyers who fail to close because they can't get financed soon develop a poor reputation among agents.  I'm actually kind of suprised your agent didn't do a better job ensuring your offer was on more solid ground before submitting the offer: real estate is flying off the shelf these days.  He who is not prepared loses the deal.

Anyway, enough about that.

What was / is your competition on this deal?  Were there other offers?  Did you have to bid and offer "highest and best?"  The reason I ask is we need to get inside the Seller's head and figure out what their options are if you fail to close.  Are they motivated Sellers?  If so, could you get more time in exchange for them not having to risk going out of contract?  That's a negative for them as well.  Buyers often looks at properties that have fallen out of contract and assume at least one of the following:

1) The Seller is now more desperate to Sell and will give more concessions on price, terms, etc.

2) There is something wrong with the property that caused the Buyer or the Buyer's lender not to want to deal with the property.  That's true in your case.

Anyway, I would try to "buy" some time. Ask for an extension, and if they won't do it, maybe offer more earnest money.  Show them you are EARNESTLY trying to close the sale.  Btw, still make it refundable if the financing doesn't happen.  But now it's your job to make the financing happen.

Option 1: Try hard money.  That is usually a quick, somewhat expensive solution to get control of the property so you can do your renovations done, then get traditional bank financing with all units having kitchens.

Option 2: Equity partners.  Find 3-4 people who have money sitting in a bank CD somewhere who will go in this as silent partners.  They provide money in return for a % of the profit.  You can make this short or long term.  Include an option to buy out there shares of the deal in the future at a predetermined price or at current appraised market value.

Good luck, I hope it can be salvaged.

Hi @Sawyer Smith!  I'm just up the road from you in Springfield, MO.

Typically, commercial building is anything over 4 units, at least in terms of loans.  I don't see anything hitting commercial as far as usage goes until your building requires fire suppression systems.  

For practical purposes, 4 units and under are almost always residential, especially if the primary use is for residential purposes only.  So I'm a bit surprised they're calling your building commercial.  But it could be a zoning issue.  The only way to really find out is to ask the Govt bodies in question.  Time for a call/trip to City of Joplin Office of Planning and Zoning to find out the ins and outs of your property.

@Dennis Perry, congrats on having 3 fully paid off properties!  

For your $110K house, you will likely need to do a cash out refinance at 80% LTV, so that will give you $88K to put toward the down payment on your 8-unit. That should do it, if you can get an 80% LTV first position mortgage on the 8-unit. The down payment will need to be 20% of $400,000 purchase price ($80K), so you'll have just enough to cover that plus closing costs on the SFH refinance and the 8-unit. Commercial/MF unit appraisals cost more than a SFH, so don't be surprised to pay between $1500 - $2000 for just the 8-unit appraisal. Then add in closing costs, etc. and you might walk away with a few extra bucks to plant new flowers at the 8-unit.

@Dennis Perry, hi and welcome to BP!

So it sounds to me like you're going to try to refinance 3 SFHs and pull out enough cash to purchase a small MF properties outright without getting a new loan on that property, correct? If yes, then yes that's doable and is done often. The loan against your three SFH's would be a "blanket" loan that is collateralized by the equity in the 3 properties. Be aware that lenders often won't go above 75% (maybe 80%) LTV when doing cash outs. So you'll have to add up the amount currently owed on those and subtract that from 75-80% of their total appraised value to determine how much cash you will receive.

Example: 

SFH A, owes $30,000. Appraised $100,000.

SFH B, owes $110,000. Appraised $220,000.

SFH C, owed $85,000. Appraised $170,000.

Total Appraised value: $490K.  Total owed: $225K.

$490K * 80% LTV = $392K, less $225K payoff of old loans = $167,000 to go shopping for your first MF property. Keep in mind you'll be paying appraisal & closing costs for the refinance as well. Probably around $1,500 or so per property. Subtract that out of your available cash as well.

As you can see, you may end up still having to get a first position mortgage to purchase the MF in addition to the cash out you receive.  Without knowing your precise numbers, it is hard to give a specific example.

Happy hunting.

@Anthony Jeffers, correct. Lenders/experienced investors will typically use comparable sales to determine how much they will lend you vs. using CAP rate to determine LTV. Remember: if you default the lender has to turn around and SELL it, and usually a default on a loan indicates the property is being run poorly and may be in a shambles or disarray. Their last desire is to own the property and manage it, regardless of how awesome the CAP rate is. Your boosting NOI $10,000 annually on an 8 CAP 10 unit complex won't increase the value to $1,100,000. Maybe among smaller Buyers some will look at it that way, but traditional lenders or institutional investor won't. They're concerned with, "If Anthony drops off the face of the earth, what can we sell this for quickly?" And since most small Buyers are going to need traditional lenders or institutional investors underwriting their purchase, they too will have to use those same guidelines for all intents and purposes. Which is why you want to look at bottom line cash flow as I mentioned in the final paragraph above.

@Reggie Desir, see the above paragraph. Per my original post, you can run a CAP rate analysis for your own personal, internal purposes comparing apples to apples on anything from a SFH up to a medium size MF as long as you properly account for all expenses, including your own donated labor, equipment and materials. But to reiterate: no lender or large investor who will underwrite this venture will value it that way. I learned this the hard way as I was running CAP rates for months to find good deals. I finally found one (20-unit MF complex, price $1,1 million), got it under contract, then the lender said, "Nope, comps won't support it." Institutional money wouldn't touch it either. Too small of a fish to get them excited.

I know, I know, I know...many folks on BP preach CAP rates and forced appreciation, etc. If you could dig into their smaller deals and see how they really happened, my guess is you would find CAP rates are a second or third tier concern behind comps. Either that or they have access to vast quantities of private capital from investors who only care about cash flow and the Buyer finds something that cash flows well that also runs a decent CAP rate analysis. This leads to conflating the two concepts and the Buyer thinks it's all about the CAP rate rather than the cash flow. The two are often positively correlated. Anything 9 CAP+ should cash flow well as long as it's not overleveraged or in terrible condition, but it's the cash flow, not the CAP rate, that makes the deal happen with these smaller properties.

My experience in the world of MF says anything below 50 units is considered "small".  Medium is somewhere between 50 - 100 units.  Over 100 units you're talking large....maybe 200 units in some markets.  Anything between 5-10 units is going to be straight comps and may be based on using multiples of single duplexes that have sold in the area.  Unless your market is considerably different than mine, 5-10 unit buildings rarely come on the market, so the appraiser will take 2 - 4 plexes and multiply by the number of units to get a reasonable guestimate of value.

As always, this analysis is brought from my market perspective and experience.  Others may feel differently or their markets may need numbers adjusted.  I'm from a Mid-West town of 170,000 people where real estate is relatively inexpensive compared to the coasts and other big cities like St. Louis or Indianapolis.  The thing you can buy here for $1.5 million might sell for $3 million elsewhere, and that changes the game with lenders.

@Reggie Desir, hi.

I'm going to repeat something I said in a recent post on a similar topic: CAP rate isn't really relevant until you get well over 50 units. Probably more like 100. the idea behind it is to give a high level analysis of how investment A compares with investment B....for example, an apartment complex vs. a diversified stock market portfolio. The formula for CAP rate includes all operating expenses such as taxes, insurance, maintenance, management, capital expense (CapEx) reserves, lawncare/snow removal, etc. You must fully account for all expenses for it to be a "true" comparison, which makes sense because a stock market portfolio doesn't take any maintenance at all, other than perhaps once a quarter you check on it and rebalance as necessary. If you plan on donating your time for maintenance and management, that will throw off your numbers.

One of the more commonly touted strategies on BP and other REI sites is boosting value by increasing Cap rate. That isn't going to work on a 5-unit. You can still run a CAP rate because the formula remains the same, but just be aware that no other investor or lender is going to take that as the true value of the property; rather, the value will be based on comparable sales.

Cash on cash / bottom line cash flow (after debt service and all expenses) is a more accurate analysis for smaller multifamily properties.  

$20K-$30K top line or bottom line?  Split among 4 people or that is your split?

The reason I ask is while some syndicators make insane amounts of money, if I were making $20-$30K net profit per month I'd say you have an excellent business model that has proven highly successful and I'd at least try to automate/outsource your secret sauce and keep that income as a baseline for the months (or years) it may take to grow your syndication biz. On the other hand, if 4 other people plus a VA are dividing up those profits, then that may not be sufficient to justify splitting your attention among two projects.

Either way, you've got to figure out how to pay the bills while you get your new venture running.  I recommend having at least 6 full months of living expenses (preferably a year) set back before jumping off the dock.