All Forum Posts by: James W.

@Jason D. I can see how it would work in a value add situation but struggle to see the value in relation to the risk in a typical buy and hold that many investors do.  

I could be open to it, but would like the input from investors on how it worked out in the last recession if they were leveraged as there were many investors who flopped in my MN market which would suggest it did not work out for them.

Specifically, I am interested in how the recession affected vacancies and rent rates and if $100/mo would have weathered the storm.  I'm speaking a long term plain vanilla buy and hold, not a syndication with a value add and a goal to get out before interest rates rise again.  

I would think the lower the doors, the higher the risk.  For example, if you make $100 a door on a duplex and have one unit go vacant, you are paying out of pocket to service the debt.  If you have 100 units at $100/door, there is a little more flexibility as one unit being vacant will have a smaller impact on the investor.  With 100 units at $100/door, you can have vacancy increase by 10 units over the estimated before having to come out of pocket.  

Personally, I don't like the idea of coming out of pocket to support rentals with the thought that I will own them free and clear down the road.  I would want a good investment return-not the house as a savings account.  

In my first post, I was assuming after debt service and cap ex of  profit of $100/door.  

My last example in response to your post demonstrated a situation with no leverage to show it is not feasible and that it is not the same as what I was describing. With no leverage, NOI would be $10k/mo and would be the equivalent to after debt service cash flow which would mean a purchase price of $1.7 million for a 7% CAP.

It is not realistic to find $100 units for $1.7 million ($17k/unit which is what I was trying to point out as well.  100 units at $17k/unit leveraged would obviously look like a good return but you would need to show me a place at $17k unit not in a war zone to consider.  

At $80k/unit ($8,000,000) with 25% equity, that is a loan of $6,000,000 and a payment of $36k/mo at 5.5% on a 25 year amort.  After this, if you still pull away $100/door=$10k/mo ($120k/yr).  If we look at the return over 5 years, this would be $600,000 in profit and $643k in principal amort=$1,243,000/5= $249k/yr total return=12% total return.  It doesn't look as bad from this standpoint, but the numbers would need to be solid to the point where $100/door will always be achieved.  Vacancy estimates would need to take into consideration a worst case scenario and rents would need to remain feasible in a down economy.  

In the last cycle, I did see an increase in rents on my single family homes as people strategically defaulted in my area and needed space, but when prices for housing are low, I could be wrong, but I would think that might also drive people out of apartments and into their own homes too.  

I am assuming the opposite-high leverage.  The items I discussed in the first posts are the risks of doing $100/door with high leverage.  I don't feel there is much cushion in that scenario considering the risks involved.  I don't agree with no leverage, but think there needs to be some balance of equity and more than $100/door profit to be safe in a recession.

Low leverage would be impossible to get any return on your money at $100/door in the current market.  $10,000/mo *12 months =$120k year.  At a 7% cap rate, you would need to be able to buy a 100 unit building for $1.7 million ($17k/unit).  You are not going to get anything for $17k/unit unless you can somehow find something in a war zone.  This shows a cash deal or low leveraged deal does not work at $100/door if you want any return on your money.  

I see a lot of discussion with people saying they want at least $100/door but I don't really understand how it can be a good metric unless there would be a big value add opportunity with a big cash out (limiting the investment) and/or a reliance on appreciation (which I don’t like).

I think there is agreement that $100/door is not a good metric for a limited number of doors, but I struggle to see how it is reasonable even at 100 doors.

I would be interested in hearing from people who agree with the $100/door and those who do not agree with the metric. For those that do agree with the $100/door metric:

1. Have you been investing since before the last recession?

2. If so, how did that work out?

3. If you have not been investing that long, what do you have in place to protect you if we run into another recession like the last?

Below are some of the reasons I do not agree with the $100/door metric and why it is not attractive for me. I would like some good discussion on how I should be open to it as it is easy I can be missing something in my analysis.

For the purposes of the discussion, we will assume 100 doors and that the $100/door factors in PITI, all expenses, property management and a reasonable level of Cap Ex for the property. That is $10,000/mo coming in after expenses and reserves.

Some of the limitations I see with it on the surface are below:

Limited investment returns without relying on appreciation or a big value add

$100/door is only $1,200/yr per unit. If we assume $100/mo in principal pay down per unit as well, that would get the total return to $2,400 per unit per year. Assuming an investor would be ok with a 10% return (I wouldn't invest in this personally), the price per unit would need to be $24,000 which usually means you would be in a warzone or more of a rural area. Even if we assume principal pay down on the high side of $300/mo per unit ($30,000/mo) a 10% return would be $48,000/unit which is still low.

At $100/door, you need to assume minimal equity as the total return would be even lower if the borrower had any significant amount of money down.

At $100/door, this needs to account for a worst-case scenario

Unexpected changes in expenses, vacancy and Cap Ex can have a significant impact and any expense increases need to be passed along to tenants to maintain the $100/door metric. This might not always be possible if the units are already at market rents or are at above market rents. If the units are below market rents, increases can and likely will lead to additional vacancy when rents are increased. You would need an experienced property management team in place as well since there is not much room for error.

Limited ability to withstand changes in the economic cycle

100 doors at $100/door is a return of $10k/mo. If we say the average market rent is $1,000 (a little low for where I am at in MN) and market vacancy is 4% (lower in some areas now) that already factors in 4 units vacant at a given time. With 4% vacancy, the actual profit/door is really $104.16 to make up for the 4 units vacant at a give time but to make things easy we will assume $100/door.

If we enter a recession, we could see higher levels of vacancy and rents declining. The $10,000/mo income relates to additional vacancy of 10 doors to get to break even (86% occupied) or a rent decrease of $104/mo across the board. It seems feasible that either if not both could happen in a recession which means this investment at $100/door could easily cost money every month for as long as the recession lasts. If both happened, the investor will need to have deep pockets to cover $10,000/mo out of their own pocket. $120k/yr is a lot of money to put up for an investment that is losing money. I surely hope the investor would be diversified or has a large outside income source because if their sole source of income is rental real estate in a local area, income from multiple properties will likely drop at the same time limiting the investor’s ability to cover a property that is not performing. Selling it likely will not be feasible either unless the borrower has a lot of equity.

If the rent/unit is greater than $1,000/mo, the investor would have less flexibility in withstanding vacancy and changes in rents than a building with rents lower than $1,000/mo as each additional unit of vacancy will have a larger hit to the investor’s profit. Investing in lower class areas with lower rents would seem to be much more attractive in weathering changes in the economic cycle, as lower rent units are less likely to have large fluctuations in rent as well. At the same time, these investments may take more work to manage too but we can assume you have a strong management company.

Scalability options seem limited

In order to scale, you will need to be able to maintain a minimum DSCR of 1.25. If you have minimal cash equity in the deal above to get a decent Cash on Cash return, it may be difficult to find deals that will meet this metric in the current climate where most deals are overpriced for the level of income they generate. Absent a good value add opportunity with private pre-funding and a cash out, it seems like it might be hard to find many deals in strong areas that could provide a good return at $100/door and would meet the minimum DSCR requirements.

There is more to this and several variables to consider (unit count, avg rents…), but in a situation of 100 units at $1,000 or more a door avg rent, it seems tough for me to call $100/mo per door a great investment unless this a pre value add or is a worst case scenario number that factors in the performance in a declining economic cycle.

Summary

I would be curious to see the thoughts from others whether they agree or disagree as my primary purpose in posting this is to understand how this metric can be a good metric (in any situation) to base an investment decision on. I understand metrics are what they are and cannot be used in every situation, but I fail to understand how this metric can be a good one to use at all and want to clear things up in my mind as I see it being brought up every day on the forums-likely by people who have never even used it, let alone investors that have weathered an economic cycle.

Thinking this through more makes me start to side more with @Jay Hinrichs on his philosophy that wealth is the accumulation of free and clear properties not a bunch of high debt properties providing monthly cash flow as these are the ones susceptible to big problems in the downturn. 

I do not think the properties need to be owned free and clear, but they need enough equity and strong cash flow to protect against the next downturn.  $100/door would be a poor investment return in a deal with a lot of equity and does not lead to a strong level of cash flow in some situations.

@John Woodrich has done my taxes the last 10 years which has included, flips and buy and hold investments.  He is a manager at a local CPA firm and can do everything you need.  

I agree that it can work with a lot of doors like your example, but the OP was saying 10-20 doors which is only $1,000-$2,000/mo.  That is not much money and does not lend much room for error in his situation.  That is 1-2 vacancies away from losing money each month in this current high rent environment.  

I'm small time, but I probably over analyze most deals looking at the conventional cap, Cap with Cap Ex, DSCR, Fannie/Freddie impact, COC and Total return with amort. I usually run several scenarios with different vacancy levels, decreasing rents, operating expense increases and varying cap ex levels as well.

I believe they are only open to accredited investors from what I remember.  Something to take into consideration if you were not aware of that.

Seems hard to make any money on $100/door to me unless it is with really conservative numbers (high vacancy and high cap ex estimates).  There would need to be strong upside in increasing cash flow for it to be something I would consider myself.  

$100/door does not lend to much cushion in a downturn where you could have decreased rents and a high level of vacancy.  Good luck covering costs in that scenario.

I've had three on a lease and done it without issue.  I just make them send me one payment so I don't get it from each of them separately.  I'm not sure I would say it is high risk unless you are dealing with young kids that will be partying all the time.  My people are IT professionals that do not want to buy a place and are too cheap to get their own place.  

I'm not sure how big the property is but it might be a bit much depending on the size of your units.  I did it with a 6BR 3BA house.