All Forum Posts by: Immanuel Sibero

@Phillip Rosin

IMO, generally reclassifying an expense as something else or omitting it altogether because the investor performs the service should not turn a bad deal into a good deal. A bad deal is a bad deal.

Whether or not you charge property management to a property should not depend on whether you perform the service or you pay someone else to do it. All properties need to be managed whether or not the service is paid for. If you manage your property yourself and not charge the property for it then you're just not valuing yourself. You may be okay with that but many investors are not.

The theory of cash on cash is how much cash is left during a certain period of time (month, quarter, or annual) in relation to the total initial "acquisition" cost of the property. The definition of acquisition here is important. IMO, I have NOT acquired a property until I have possession of it and the property is in normal "operating" conditions relative to other normally operating properties in the area. If I spent $1mil to purchase a property with non-functioning plumbing then I have not "acquired" the property because it can not yet operate normally. If I then spend $500k to fix the plumbing to get the property in normal "operating" conditions then my total acquisition costs is $1.5m, so $1.5m would be the basis for my CoC calculation.

Cheers... Immanuel

@Francisco Cruz

I would start by looking at the FOUR sources of return in rental real estate:
1- Cash flow
2- Loan paydown
3- Appreciation in value
4- Tax savings

Below are some examples of metrics used to measure the different types of return listed above:
- CoC (Cash on Cash) is a measure of net return generated by TWO sources (i.e. Cash flow and Loan paydown) on an annual basis.

- Equity Multiple (or ROI) can be used to measure the net return generated by ALL FOUR sources (i.e. Cashflow, Loan paydown, Appreciation, and Tax savings) throughout the life of the investment. Equity Multiple does NOT take into account the time value of money. In practice, the effect of tax savings is usually not included because it can be complicated to calculate.

- IRR (Internal Rate of Return) can be used to measure the net return generated by ALL FOUR sources (i.e. Cashflow, Loan paydown, Appreciation, and Tax savings) throughout the life of the investment. IRR takes into account the time value of money. In practice, the effect of tax savings is usually not included because it can be complicated to calculate.

Note that cap rate is not listed above as a measure of return/performance, and that's precisely because cap rate is NOT a measure of return or performance. Looking at the formula, cap rate makes use of NOI but NOI is not one of the FOUR sources of real estate return which is why cap rate is NOT a measure of return.

Cap rate is a measure of how investors assess the desirability of a certain market by looking at the demographics, economic prospect, and the associated risks of that market. I have seen cap rate described as a measure of 'investor sentiment" in a particular market. If investors are bullish in a certain market they begin to bid up prices which then leads to compressed cap rate in that market. Conversely, when investors are bearish and abandon a certain market prices will fall and cap rate expands. Also note that cap rate is generally only relevant in commercial real estate such as strip malls, warehouses, storage, apartment buildings (i.e. more than 4 unit), etc. Cap rate is not relevant in residential real estate such as single family homes, duplexes, triplexes, or fourplexes.

Cheers... Immanuel

I would contact local realtors in the specific area as they would have more intimate insights in to the property. I'm not an agent or realtor and nor do I live in the area but another poster is a realtor in Ohio, he might be able to help or refer you to someone. Although I would like to hear why he advises to ignore comps and use cap rate to value the property.

Cheers... Immanuel

OP means Original Poster... in this post, that means YOU... :-)

Cheers... Immanuel

@Ari Hadar

Duplexes are usually valued using "comps". I would check with local realtors to get a feel for home values in the area. If you are going to finance this then you can also check with the lenders in the area on how they would value the property. Residential loans would generally value residential properties using "comps".

@Stephen Brown

By ignoring the "comps" I'm assuming you are saying there are comps out there for this property but the OP should just ignore them? 

What if the OP's cap rate valuation comes up higher than comps? Should he offer higher than comps? That doesn't make sense. 

What if the OP's cap rate valuation comes up lower than comps? Should he offer lower than comps? That doesn't make sense either because the OP wouldn't be competitive with his offer.

Cheers... Immanuel

The formula for the cap rate of a property is Cap Rate = NOI / Value. Algebraically you can reshuffle the formula into Value = NOI / Cap Rate which is what you have done... so yes, algebraically it works. That's why you come back to the value of $3.4M.

But note that there is a lot of confusion about cap rate. Cap rate is a valuation metric in that it's only useful when a valuation of a property is needed. For example, valuation is needed when you are considering buying a property, or when you are trying to refinance a property that you already own, or when you're planning to sell a property that you already own. Another thing about cap rate as a valuation metric is that it is determined by the market, it is not a rate that you calculate from your property. While owning and operating a property, you can certainly calculate the cap rate but it's not all that useful. Many investors do calculate cap rate of their properties and use it as a performance metric which again is not very useful. Cap rate is not a performance metric.

So how then do you calculate value? Well... you would use "comps" (i.e. comparisons to other similar properties that have sold recently in the area). You would need the average cap rate of the recently sold similar properties in the area and divide it INTO the NOI of the property you're interested in buying. This would give you the probable value of the property. Note that the cap rate in this case is determined by the market, it's not a rate that you calculate.

Again, there is a lot of confusion surrounding cap rate. I might have opened a can of worms, but if you do a search on "cap rate", you will see lively discussions about cap rate :-)

Cheers... Immanuel

@Darin A. Scavella Jr

Cap rate is an annual metric, so it calls for annualized NOI. Your NOI of $18,936.25 is for a month. I believe your cap rate should be (18,936.25 x 12) / (2,000,000 + 1,000,000 + 400,000) = 6.68%.

The general rule is CoC should be higher than Cap Rate on a leveraged deal because without leverage CoC approximates Cap Rate. So, one of the primary reasons to use leverage (i.e. debt) is to, well... leverage (i.e. jack up) CoC, otherwise what's the point?

So when I see a leveraged deal where CoC is the same as Cap rate (i.e. as in your case), either it's a bad leverage (i.e. interest rate is too high) or there is an error in the calculations (i.e. as in your case).

Cheers... Immanuel

@Kate Andreeva

The cap rate formula is simple and calls for annual NOI divided by the original cost of the property so looking at the data you presented would be 20k / 400k. But cap rate is a valuation metric normally used in valuing a commercial properties such as office buildings, storage facilities, multifamily housing, etc.

Once you figure it out, what do you plan to do with the cap rate of this house? Are you trying to decide whether to sell this house vs. rent it out? Are you trying to decide if this house would be a good/profitable rental house? I ask because cap rate would not help with any of the above questions.

Cheers... Immanuel

@Mac Caspersen

You might just be missing some terminology and concepts. Valuations are always based on comparison (i.e. comps). That's how I decide where to buy milk at Kroger vs. Tom Thumb :-) My guess is that if you have sold a business, you would know that comparison of similar assets is a big part of the valuation process. Many investors in real estate (especially here on BP) have it ingrained in their heads that residential valuation vs. commercial valuation are so drastically different that they are two totally different investments. The reality is that valuations in residential and commercial properties generally use the same strategy... that is, comparison (i.e. "comps"). The thing is... what is being compared is different. For example, to value a residential home I would look at the "sales" amounts of recently sold comparable homes in the area. Similarly, to value an apartment complex I would look at the "cap rate" of recently sold comparable apartments in the area.

To answer your specific question, to calculate the probable value of an apartment complex (or self storage, etc.) I would obtain the NOI (i.e. T12) and apply the cap rate comps from recently sold comparables (i.e. apartments or self storages) to the NOI of the property I'm interested in.

Cheers... Immanuel

Although I don't see cap rate as a payback metric, this seems backwards to me.

Lower cap rate takes slower NOT faster to payback, doesn't it? Shouldn't higher cap rate produce more cash NOT less to service debt?

Cheers... Immanuel