Originally posted by @John B.:
@Jason Chen
First of all, thanks for your reply, answers like yours are exactly what pushes me towards wanting to learn more.
May I ask what is terribly wrong, in technical details, with this deal? Yes, cap rates in this area are extremely low so the deal is not looking too favorable in terms of cash flow. However, the debt terms are very favorable and the sponsor is planning to significantly increase the NOI (~250$/month per door) through internal and external budgeted renovations. This in itself should bring the value of the property from $5,600,000 to $7,200,000 (and this is considering a more conservative exit cap rate of 100 bp above the enter one), so at the end of the day the increased value would make the investment IRR in the 15-20%.
I have a considerable amount of my portfolio in the stock market and believe me, no 2.5% dividend yield stock is going to deliver that performance over the next few years, especially considering the current inflated P/E ratios in the market, unless we gamble on ridiculous appreciation, so I fail to see how your comparison is fair.
Please notice that I am absolutely not trying to argue with you and I just genuinely want to understand what is your point: are you saying that, in order for this to be a good deal, I should be completely ignoring the exit value the increased NOI will bring to the property, and just focus on the actual increased cash flow the increased NOI will bring me? Because that would indeed mean that the only way to achieve a better performance, regardless of the value-add strategy, would be to buy at a considerable discount (not really feasible in this area of CA).
As a novice, understanding this would be priceless.
Thanks!
Yes, I give answers the same way I would verbatim to a friend. You were right in the the deal doesn't cash flow right.
I trade a lot. In fact, trading is #1 for me, followed by real estate. The thing is that I happen to be a lot better at real estate than trading. I wish it were the other way around.
So to answer your question, let me explain. I did not even look at the technical details at all that much, because all i had to see was the asking price, and how many units the complex had total. For over $130,000 a unit, everyone involved in the deal better be getting a new Ferrari along with the purchase. The asking price is just a pie in the sky type of number that the seller is hoping to nab. There is no "deal" to be had here.
The only plus to the property is if appreciation continues to rise a lot, but let me ask you this - if appreciation in this area is what you're looking for, then why not get some real estate that is being relatively undervalued while you're at it? There should be better alternatives.
In order for this to be a good deal, there is really only one thing that needs to improve, and that is how low the purchase price is. It's all about the PRICE. There's not going to be an issue with the rentability of this property or it's NOI. It's simply the price.
If you think it will sell for $6.5 million easily after you guys improve the property, and you only had to pay $5 million total, then you have a great deal. If you only had to pay $4.5 million, then you just gave yourself a $500,000 cushion.
Successful real estate all boils down to two things - common sense, and how big of a CUSHION you are able to ensure for all of your deals.
