All Forum Posts by: Immanuel Sibero

@James Kojo

@Joshua Simon

The OP specifically states that no cash was paid and that this was all 100% financed. My interpretation is that the OP is not out any cash at all but offers the equity of another property for 75k. This is different from a cash out refi (i.e. no cash actually changes hands). The OP does not "borrow" (i.e. takes out cash) from property A to partially pay for property B.  

If this assumption is correct, then Cash on Cash can not be computed... many investors would say Cash on Cash is "infinite". I prefer the term "undefined" or "can not be calculated". The OP can however calculate ROE (return on equity) but this is a metric that's less commonly used.

Cheers... Immanuel

@Adam L.

Hi Adam,

After quick glances of the spreadsheet:

- To me there is a difference in analyzing a property before or after purchase. I'm assuming you are analyzing to determine whether the property meets your investment return goals (i.e .before purchase). I would have a section of independent metrics, and dependent metrics. Independent metrics are variables that affect the property's performance such as increases in rent and expenses due to inflation, growth, etc. Other important independent variables are vacancy, capital expense, and financing terms. Dependent metrics are variables that tells me how I'm doing with the investment (i.e. Cash on Cash, IRR, DSC, etc). They can also show me what circumstances would put me in a bind (i.e. what vacancy rate would affect my ability to make debt payment). From a worksheet design perspective, having sections of independent and dependent metrics makes it easy to run "what if" scenarios. So the drill would be 1. enter assumptions such as rent/expense increase and vacancy, 2. observe the impact on the dependent metrics.

- I would also reformat the income/expense worksheet to the standard rental property format which makes it easier to analyze. For example vacancy items such as rent concessions, vacant units, etc should be right up there after rent income. Similarly, debt payments and capital expenditures are not normally included in the expense section.

- Looking at your worksheet, your NOI is really your net cash flow. NOI should not include capital expenditures, nor should it include debt payments. From there, Cap Rate = NOI/Price, while Cash On Cash = Cash Flow / All cash paid out at purchase.

Cheers... Immanuel

@David Jackson

By definition (i.e. NOI/Price) cap rate is a metric associated with the operation of a property. The O in NOI is short for operating, so it follows that cap rate should not include NON operating items such as capital expenditures, debt service.

Cap rate is not meant to be inclusive of all expenses (i.e. even the large ones). It's just meant to include OPERATING items only.

Note that taxes are operating items so they should be figured into cap rate. Debt service payment that represents the repayment of loan principal is not an expense let alone operating expense so it definitely does not belong in NOI and therefore not figured into cap rate. Debt service payment that represents interest on the loan IS an expense but NOT considered operating expense so it is not figured into cap rate either.

Cheers... Immanuel

@John D.

Depends on the interest rate you're paying, obviously the lower the interest rate the higher your return would be. The usual scenario is to leverage your return higher by borrowing at interest rate lower than your cap rate.

In your example, assuming no capital expenditures, loan costs, closing costs, etc... a 7.7% CAP and 80% loan, rough estimates of your CoC return at different interest rates might look like below:

As you can see the lower the interest rate on the loan the higher the return.

Cheers... Immanuel

@John D.

If you pay $2M for a building valued at $2M at 7.7 cap, then your cap rate is... well... 7.7 (i.e. never had to say it this way but...)

Your down payment would not affect cap rate, it would however affect annual return.

Cheers... Immanuel

@Kyle Brown

A different perspective...

While 3-unit properties are multifamily, they are still considered residential properties. Cap rates are of limited use in residential properties and are more relevant in analyzing 5+ unit properties. When doing any kind of valuation analysis on residential, multifamily properties (1 to 4 units), cap rates are irrelevant as the valuation is normally based on recent sales comparables as opposed to cap rate comparables.

The approach I take in analyzing a property is the same as when I analyze any other investments and that is to look at it in its entirety, even if it means I would have to assume the length of time I plan to hold the investment, and the proceeds I would receive when I exit (i.e .at sale). The metrics that are my usual suspects are IRR, CoC, DSC, LTV.

I use IRR to see if I'm even interested in the deal (i.e. the deal is highest and best use of my capital compared to other investment opportunities that are available to me at the time). Once I'm interested I then use CoC, DSC, LTV to stress test the deal under various what if scenarios. I want to know what circumstances would put me in trouble with cash flow (CoC), with my ability to make loan payments (DSC), and with going underwater with the lender (LTV).

Notice that cap rate is nowhere in the analysis, but know that you need to understand cap rate and how people are using it. They use it to entice and advertise, it's a marketing tool. It also establishes rapport with brokers and other investors at meetups and gatherings because when you mention cap rate somehow people know you're in the biz :-). I recommend you do a search on "cap rate" right here on BP, you would discover some level of confusion surrounding cap rate.

Cheers... Immanuel

Interesting... I'm a newbie investor. I recently refinanced two different properties with the same bank around the same time. My observation was that it was very important to the bank to have independent appraisals. The appraisers who showed up at my properties were from different companies and they were not affiliated with the bank. I expected this to be the case since if I was a lender I would think it would be in my best interest to get independent value appraisals. I find it troubling that banks would dictate the "independent" appraisers to come up with different values from an otherwise "actual market value appraisal".

But then again I'm a relative newbie, I'm learning something new everyday. Does this happen often?

Cheers... Immanuel

So far cap rate has been defined as some measure of return of a specific property. But cap rate is more than just a measure of return. As a matter of fact it is a rather poor measure of return.

Consider another look at “cap rate” from a valuation perspective (i.e. also called “market cap rate” which @Brent Coombs casually mentioned above). As a valuation metric, cap rate is a measure of how many dollars of VALUE each dollar of NOI can fetch. Stated another way, cap rate is a rate that converts a dollar of NOI into x dollar of VALUE. For example, we all understand that when buying an apartment building we are essentially buying the income (i.e. NOI) of the property. But we also know that the property generates NOI every year. It is painfully cumbersome to pay the seller every year for the NOI that's generated every year. Well there is a solution... Meet "Cap Rate". The established consensus is to apply cap rate to first year NOI to come up with a single value so a buyer can just pay the seller ONCE. This is known as capitalization. This is where the CAP (i.e. short for "capitalization") in "CAP RATE" comes from. So cap rate is a rate that "capitalizes" or "converts" NOI into VALUE.

A quick google search of “cap rate”:

Investopedia defines cap rate as a return/performance metric.

http://www.investopedia.com/terms/c/capitalizationrate.asp?lgl=myfinance-layout-no-ads&ad=dirN&qo=relatedSearchNarrow&qsrc=6&o=40186

While Wikipedia defines cap rate as a valuation metric.

https://en.wikipedia.org/wiki/Capitalization_rate

For some reason Investopedia’s definition of cap rate is the one being perpetuated here on BP… maybe because it shows up first on the search.

Cheers... Immanuel

@Bob Romano

How do you calculate YOUR ROI when you're financing the deal using all "his" money (i.e. your lender)?

You realize that your investment would be zero, so your ROI is undefined (i.e. most people call this "infinite", a result you would get from dividing a number by zero. To me "infinite" almost sounds like you make all the money in the world as in no limit... which is not the case... just my terminology hangup). The point is, on a deal with 100% OPM you would be making something out of nothing... and that's a better ROI than 10%, 100%, or 15,000% and on up...

Cheers,

Immanuel

At that price you would be overpaying. Two quick ways to lose money in real estate:

- overpay for a crappy property

- overpay for an excellent property

So... never overpay!

Cheers... Immanuel