All Forum Posts by: Samuel Eddinger

Thanks for letting me know. I have never seen it in the literature so I thought I was on to something. I agree 3% is generally my spread target or possibly higher depending on the area. This is also why I buy properties with 30 year notes as I can still get less than 4% mortgages. I'm still trying to get 8% CAP rates where I can.

Thanks for the feedback. I like that it is pretty simple but has flexibility because it has the affect of financing rates. People should buy a higher CAP rate in a higher interest rate environment so it helps to normalize that (whereas CAP rate has no impact on debt service).

I tend to think of myself more as a CAP rate guy but I hate that people are buying for cash on cash with terrible CAP rates. I figured this is an easy way to normalize it and make sure that you are not overleveraging.

I appreciate your feedback.  I own 20 properties but am an engineer by training and now own a property management company so I'm hyper analytical but definitely not an analysis paralysis guy.  I just think in areas that are not speculative plays like New York City, this may be a better approach.  I get it if their is some other intangible about an investment, all evalutation methods go out the door.

People are generally in one of two camps on real estate, it's all about CAP rates or it's all about cash flow and the cash-on-cash return. It seems that neither is exactly correct, and neither is exactly wrong. When interest rates are really low or you can buy with close to no money down, cash on cash return seems to be how people evaluate real estate and when interest rates are high, it is all about CAP rate. I always wondered why combining both isn't a better approach to use.

As an example, is a CAP rate of 8% or 12% or whatever number you use always a good investment? I'd argue that in 20% interest environments, buying a 12% CAP rate would cause you to go bankrupt if you are using debt service in any way. I'd also suggest buying a 12% CAP in cash is probably not appropriate as you would not be competing against anyone that has to use debt service. Based on all of this, is there a better way to evaluate real estate?

I would propose a better way of evaluating real estate and that is to take the difference between the CAP rate and prevailing interest rate and use that to evaluate whether something is a deal or not.

D = CAP - %APR

This would allow you to calculate the spread which is directly related to your debt assisted profitability (like a cash on cash return).

You can vary what "D" you will accept based on the normal factors you would consider when thinking of the CAP rate (location, building type, number of units, financing, deferred maintenance, etc).

You could also rearrange the equation to calculate the CAP to search for opportunities and how to offer for property:

CAP = D + %APR

In this case, you can actually figure out the CAP by knowing the "D" you want to get for a given location, building type, etc and understanding the financing available to you and other investors for the opportunity.

Any reason this is an inferior approach to CAP rate or cash on cash return?

I have heard many people say that inflation in our housing market will lead to higher interest rates which will ultimately lead to an affordability crisis and a significant drop in housing prices. I have not seen anything to quantify this so I decided to do just this; determine for a given interest rate, what the purchase price has to be so that the payment is unchanged. It really is a straight forward exercise, vary the purchase price for a given interest rate, such that the principal plus interest payment for a loan is the same. The purpose of this post is to understand the following:

1. What changes to the purchase price for each annual rate will need to be to get the same principal plus interest payment.
2. The impact on the loan term (15 year versus 30 year) and how it impacts the purchase price for the same principal plus interest payment.
3. The impact on purchase price as the government raises treasury rates to combat inflation.

1: If interest rates decrease to 4% for a house, worth $200,000 when prevailing rates are at 5.00% for 30 years, that person can pay $224,885 for the same property (an increase of 12.4%) without an increase in the principal plus interest. Alternatively, if interest rates rise by 1% to 6%, that same house would sell for $179,074 (a decrease of 10.5%) without an increase in the principal plus interest payment.

2: If a person chooses to use a shorter rate term (15 years instead of 30 years), the impact on affordability is reduced because the total number of payments are reduced. For this reason, when the population of people generally use a 30 year loan, that defines the worst case scenario for housing affordability. For situations where loan terms decrease in duration, the impact on changes in housing prices (higher and lower) is muted.

3: If inflation is tracking at something like 6% year over year and if we believe that housing will keep up at the prevailing inflation rate (new builds are affected by labor, energy, and materials), a 1% increase from 5.00% to 6.00% will only go down in relative value by something like 4.5% (-10.5% - 6%). If inflation tracks at 6% for two years, housing should be above our current rate in two years. For this reason, long term inflation will significantly increase property prices faster than the temporary drop due to affordability. This does assume that wage growth tracks with the inflation rate which may or may not happen.

I recognize that inflation occurs differently for different groups of products and services/labor.  With that said, am I missing something about why a relatively small drop (as compared to the gains we saw) would lead to a huge crash in the housing market due to an increase in interest rates?

Thanks in advance.

@Dave Jones - you need to decide what the correct margin of safety is for you and the investment. I'm buying a pro forma 6 CAP in Middletown right now (mostly because of a 1031) but my 6 CAP is a super conservative 6 CAP (vacancy, bad debt, property management, CAPEX, etc included in my numbers). If I can get the insurance and taxes down ($8k for a 4 family), I think I could push it to an 8 CAP.

Ultimately, with interest rates so low, CAP rates will stay low. If interest rates go up, CAP rates should go up bringing prices down. It ultimately doesn't matter as long as you get long cheap money now.

I tell all of my investor clients (I'm a broker) to buy anything you want to hold long term and sell anything you don't.  We cannot predict which way the market will turn but over the long term, housing prices will go up (inflation is ultimately our friend).

A nice bigger pockets guy, @Filipe Pereira, is very familiar with that area.  I'd reach out to him and he may be able to help you determine if it is a prudent investment.

If you are buying in Arizona, I would look for an attorney that can practice in that state. Unfortunately, this is A Connecticut Real Estate Forum you posted to.

Hey CT group.  I have successfully received $245k in UniteCT funds working with a bunch of case auditors but about 3 or 4 in particular that worked a lot of my cases.  None of them are still working on UniteCT and I have no good case auditors and many of my cases are unassigned.  Does anyone have any good case auditors that are willing to pick up some cases?  Thanks in advance.

@CJ S. - Liberty Bank has a good neighbor program where you can get rates as low as 3.5 to 3.625% for non-owner occupied property if the location is in a low to moderate income area (most of meriden is I believe).  

DM me directly for me to send you a name.  My wife and I have done 6 to 8 loans in the past two years.  They are backed up so it does take a couple months.

@Sam Slivinski - I use Dave Lake for my CT taxes. I can send you his contact information if you would like.  Lots of people on Facebook talk about Ted Lanzaro but I think he his busy and not taking on new clients.