All Forum Posts by: Account Closed

Hi guys, I'm still looking into this if any of you know :)

@Joe Villeneuve Forgot to mention you for my previous answer. My bad !

Thanks for your feedback, much appreciated. The 1% rule makes sense as a preliminary screening tool.

For your sourcing, does it mean you came to the point where you don't look at the MLS / other websites (Zillow, Trulia..) anymore at all? Do you still use them for other purpose though? (rent estimate, comps, market dynamics, statistics, etc)

For capex estimate, it make sense too, but I believe you're only able to do that at a later stage of the process? (You don't have access to this kind of info at first). So in terms of process, do you jump directly to asking specific questions (such as to estimate capex, etc) when a property passes your 1% test? or do you use other tools / criteria to further filter the results?

Thanks again

Nobody screens investment opportunities? :)

Thanks for your feedback.

I'm not sure to follow the first point: Why can't we compare two investment vehicles (such as stocks and RE)? or at least compare potential returns? Also, I'm surprised that you consider IRR irrelevant in RE. It would appear to me that, on the contrary, IRR is a great tool (but not the only one) to assess an opportunity as a whole as it benefits from many advantages: it values time and takes into account leverage, cash flow, debt repayment, inflation, appreciation, etc..

Regarding the second mistake, indeed for a certain initial equity, the size of the investment is significantly different. REI is the only asset where you can borrow 80% of the funds, unlike stock investing. And that's why you can manage to get great return on you investment even if conditions are not ideal (i.e. cash neutral property where bank debt is still being paid down).

Regarding the compounded return, the IRR does assume cash flows (if any) are reinvested at the same rate of return as the project itself, so this aspect is also included in the calculation (and that's why people use MIRR if they want to adjust this reinvestment rate)

Again, thanks for your answer!

I’ve been analyzing my market for quite some time now and I was thinking it would be interesting if BP members shared their investment screening routine (i.e. not the criteria of analysis, but the platforms and strategies), more specifically:

• What is your day-to-day routine to screen your RE market in search of potential investments? (e.g.: looking through MLS, contacting certain people, sending direct mails, etc.)
• What % does screening the MLS (+other websites such as Zillow, etc.) represent compared to other strategies you may use to find deals (such as direct marketing, etc.), both in terms of # of analyzed properties and # of purchased properties?
• When performing a quick preliminary screening on those websites (i.e. to exclude obvious bad deals), do you usually use the 50% rule (or similar % rule) to estimate expenses? I would assume it would be too time consuming to try to assess more specifically the operating expenses of each particular house?
• In relation to my previous question, why do most sites and books recommend estimating certain expenses as a % of rent? It doesn’t seem very intuitive to me. I mean, the replacement cost of a window, or painting a room has little to do with how much rent I expect to get from the property. I would believe it would make more sense to estimate certain costs relative to sqft2 for example (bigger house = more windows and more walls to paint for example). Do you guys use such type of estimate?

I would agree. Although the 4.5% IRR is the base case scenario with no inflation at all, a bet I wouldn't want to take on the general economy. In the second example, the return is 9%, which is not a bad number in absolute terms. And in these circumstances, locking a 9% returning asset for 30 years doesn't seem a bad deal at all when I compare it with other potential investment opportunities

Also, tying up money is relative here. First, the asset starts generating CF after year 1 (but let's assume a few years) due to the depreciation of the loan, so it's not like I'm living with a complete burden. Second, even without selling the property, I could still refinance and tap in the equity to do other things, so I'm not completely blocked here either.

What do you think? In any case, thanks for the feedback, I appreciate the discussion !

If I were to modify the initial question, it would be: Why is cash flow at closing so important? Obviously you wouldn't have any cash on cash return at closing, but if you expect the property to cash flow in the next few years (which is the case if you're neutral at Year 1 and inflation kicks in), I really don't see the issue

What do you guys think?

Thank you for your answer Elenis.

Regarding your first point. I understand life happens, but everything that you’ve listed initially are costs that have been included and accounted for in the example (vacancies, evictions, capex, maintenance). Obviously, I don’t have a magic crystal ball so I cant perfectly estimate the cost of such expenses when they pop up but I can at least budget for them (which is the case in the example above).

Regarding your second point, if the market is down, I could still hold the property. Let’s remember that I’m talking about a property that has zero cash flow at inception. It doesn't mean that 30 years from now, that would still be the case (I assume it would not). Of course, we can also assume that over 30 years, we will face 0 inflation or even deflation, but then REI as a whole would become very challenging.

Final point, I do not include "appreciation over inflation" in my calculation: the only reason why the sale of the property in the second example is higher than the purchase price is due to compounding inflation. The exit cap rate multiple used is the same. So I'm not really betting on any positive market trend that would lead to better-than-inflation appreciation (so no icing on the cake I believe)

Thanks again

Why is positive cash flow mandatory in a real estate investment? I understand looking for positive cash flow is a good proxy to avoid making bad deals when you’re a beginner, but if you’re careful in your estimates and run the numbers properly, I would believe you can still enjoy a decent return on your property even if your initial cash flow is inexistent.

Let's take the example of a zero-CF property (i.e. it's zero after opex, capex, vacancy, PITI, property management etc..) in the following situation:

• I put down 20% as down payment for a 30 years loan, at 4.5%
• The property doesn’t appreciate over the years and I sell the property after 30 years for the same price
• I incur 5% closing costs at purchase, and 5% selling cost when exiting
• I assume no inflation (hence selling price = acquisition price)

In this context, my IRR would be 4.55%. I agree it's not that great but it's not a pure financial loss either (it would become only if you lack sufficient liquidity to operate the asset as planned over the period). The definition of "bad deal" here would relate more to the opportunity cost of such investment compared to other investments (financial markets), than a real financial loss for the investor (i.e. ending up with less cash than originally invested).

Let's now modify a bit our assumptions by including some inflation in our model (say 2%, in line with historical average). The direct consequence is that our initial cash-neutral property just became CF positive in Year 2 and it will keep improving year after year (as long as you can increase rent in line with inflation, and that expenses also follow the same pattern). In this scenario, our IRR rises to 9% (assuming an exit cap rate of 4.9%, in line with the acquisition cap rate). Again, this number may not seem like much but I don't think it looks that bad: this investment basically gives me the opportunity to put to work an amount at an annualized rate of 9% for 30 years. And if I decide not to sell the property after 30 years, I would still enjoy significant positive cash flow (due to the full debt repayment), and owe a property with 100% equity in it.

So, I know that a vast majority of you guys preach the importance of cash flow, and I’m not trying to convince anyone of the opposite (I’m just a beginner trying to truly understand things). I’m just trying to figure out why we don’t want to look at the overall picture when making such investment? I understand the importance of cash flow if you plan on living from it, but for someone with other sources of income (main job), I don’t see why CF would mean more than other sources of return?

Thanks!