Posted by Nate(DC) on December 12, 2003 at 10:43:09:
From your perspective as the buyer, it should be as low as possible.
NT
another derived cap rate question - Posted by jason
Posted by jason on December 08, 2003 at 17:10:19:
16 units, 60k each. Asking price 960k. Requires 20% down, seller to carry balance at 7%. Annual gross income 106k.
So, if I manage it myself and buy this so that I can buy me a “property manager’s job”, I make 106k gross. By the way, then if I take 7% (interest only) approx 55k is interest. That leaves me with 50k and bunch of property expenses. The 20% that I put down (i.e. 192k) is costing me around 8k per year by me not putting that money in a CD.
Now that leaves me with 47k and bunch of expenses (tax, insurance etc.) I would expect those to be at least around 25k. So, my derived income rate comes to :
a full time property manager’s job that pays 22k after putting 192k of my own money down!!!
Unfortunately, this seems to be the case with most listings. Did I miscalculate anything here? Or maybe there are properties out there with a gross cap rate of 20+ % ??
New question - Posted by Alex
Posted by Alex on January 14, 2004 at 20:51:59:
Hi, I know that that cap rate is NOI/price, where NOI is the income after substracting the expenses. But what happens when the leasing is a triple-net, where all the expenses are paid by the tenants? Do we still have to consider the expenses to calculate the NOI to estimate the cap rate?
Re: cap rate - Posted by Paul Ness
Posted by Paul Ness on December 11, 2003 at 08:07:10:
Assuming your assumptions are correct…
Gross $106,000 - Expenses $25,000 = NOI of $81,000
NOI $81,000 / Price $960,000 = 8.4% cap rate.
The cap rate seems somewhat low and the gross income multiplier high at 9.0 (Price $960,000 / Gross $106,000), both of which mean a high price. How does this compare to other offerings in your market? Is there a lot of potential for increasing rents and appreciation which would warrant a low cap rate?
And all this assumes no vacancy unless your $106,000 already has vacancy deducted.
Re: another derived cap rate question - Posted by Walter
Posted by Walter on December 09, 2003 at 13:24:57:
Jason,
Be careful, Cap rates are based on Net Operating Income (NOI), not gross income. Furthermore, gross income may encompass more than gross rent, which some people discount with the vacancy rate. consider true Cap rate (NOI/Sales Price) and Cash-on-Cash [ROI] (NOI/cash outlay for acquisition). For me, a Cap rate & Cash-on-Cash rate of 12% & 30% for an Apartment would be a minimum requirement. For triple net long-term lease arrangements I would relax my requirements by 2% - 5%, depending on a few other factors. Before I settle for less, I would invest in tax liens, where my annual return starts at 20% & goes upon exponentially, depending on other factors outside the scope of your question.
8.4% might sound right - Posted by jason
Posted by jason on December 11, 2003 at 16:28:39:
If gross 106000 - expenses 25000 = 81000 NOI comes to 8.4% cap rate, should I not also factor in the debt service? Ray’s article says I should. And if I do factor in debt service of 55000, the net income comes down to
81000-55000 = 26,000 per year.
Assuming that I didn’t do any of this and instead just took my 20% i.e. 192000, put it in a 5 year CD, I would easily make 8k per year in interest. So if I stick my 192000 in this property, technically speaking I am losing the 8000 per year.
That brings my final net down to 26000-8000= 18000$ per year for buying myself a “property manager’s” job.
Is it worth it? Is this how people make it in real estate? Maybe if I had 10 of these properties I would be doing good. But that would mean having 2 million dollars in down payments. And if I had that, I would be retired, not looking for a property manager’s job.
There’s got to be a better way. I would be shocked if this is how Ray or some of the other experts here have made it. Something bites in this deal and just doesn’t sound right.
whew!! walter gets the medal - Posted by jason
Posted by jason on December 12, 2003 at 16:11:30:
Ok, I banged my head around and now I seem to make some sense out of all this. First of all, the idea bulb went on after re-reading all the replies and particularly, this one from Walter.
The key seems to be his method of setting THE MINIMUM requirements to 12% cap rate and 30% cash on cash or ROI, which in turn makes life much better.
That would bring the price down to
NOI (81K) / CAP RATE (12%) =675K
The seller would never come down by 300k but thats ok, at least this has been a learning lesson.
If this could be pulled off at 675k, 20% down payment, 7% interest only loan, debt service would be 38525$ per year.
Final numbers would look like
Gross 106k
Expenses 25k (This is really low but thats what we assumed all along)
Debt service 39k
Net take home property manager’s pay = 42k which is decent enough.
Even if I took the 675 x 20% =135k and put it in a CD, I would get 5k interest, which brings the property manager’s pay down to 37k, but I think thats still acceptable.
Thanks again Walter!!!
12% !!!??? - Posted by Jason
Posted by Jason on December 10, 2003 at 18:03:31:
Where do you find such listings that have 12% cap rate?. To begin with, allmost all the listings I have come across seem to be in the 10% rental gross income of purchase / asking price. So, for example if the gross rents are 100k, the asking price is 1 Million, if the gross rents are 20k, asking price is 200k. Forget about making 10 or 12% NOI / Sales price. Either such an animal doesn’t exist or I havent found one becaoz I am looking in all the wrong places?. The best is 5% NOI / Sales price cap rate. I don’t know whats triple net long term lease arrangements?
Walter , Tax liens question? - Posted by James in NC
Posted by James in NC on December 10, 2003 at 12:03:19:
Walter, could you elaborate some more on investing in tax liens? This is something I have not heard much about. Thanks, James,
Re: - Posted by Paul Ness
Posted by Paul Ness on December 12, 2003 at 07:20:14:
By definition, the “overall” cap rate is net operating income divided by price (or value), which means you do not deduct debt service before calculating. To make sure you are comparing apples-to-apples in disussion with others, this is how the “overall” cap rate is calculated.
To calculate your “annual” return on your equity, you deduct the debt service from net operating income to come up with net cash flow, which is then divided by your equity investment. HOWEVER, the resulting rate is only the annual cash return and does not consider the favorable impact of the investment over time, which is what you are missing when you compare this to a CD alternative. Your overall return on your cash equity invested over the entire time you hold the property is what you really what to look at in comparing it with other investments. The other benefits that increase your equity return over time include appreciation and the fact that you are paying down your debt, so that when you sell the property, the price is higher due to appreciation and the balance of the loan is lower. Hope that makes sense.
I think you misunderstood Ray’s article with regard to considering debt service. He was probably talking about your annual equity return as I explained above.
You can build an “overall” cap rate to determine what you are willing to pay based on your mortgage and your required annual return. You can use the following formula, called the simnple band-of-investment.
(LTV x mortgage constant) + ((1-LTV) x annual equity return) = overall cap rate
example assuming 7% mortgage for 15 years and 80% LTV with 10% required annual return…
(.80 x 0.108) + (.20 x .10) = 10.2%
FYI - The 0.108 is called the mortgage constant which is a factor (from a calculator or financial tables) that is the factor you multiply the principle by to get the monthly debt payment.
Back to your original example - if you paid $960,000 and all your other assumptions are correct, and you get an 80% mortgage at 7% for 15 years, your net income of $81,000 would not even be enough to cover your debt service of $82,836. This would be acceptable ONLY if there is great potential for increasing rents and appreciation over time. Remember, your overall return on investment in real estate comes not only from annual cash throw-off (return on investment) but also from net reversion when you sell the property (return of investment) as I explained above. Bottom line is that the asking price is too high. If your available mortgage was as stated in the above band-of-investment and you require 10% annual return, then applying the 10.2% cap rate to your net income of $81,000 means you personally would only be willing to pay $795,000. If you paid this price you would be able to cover your debt service and get an annual 10% return (but don’t forget your overall return will be higher by the time you sell as the value goes up and loan balance goes down). I’m not saying this is necessarily the value of the property, but it would be what someone would be willing to pay based on the stated requirements. Sorry to be so long-winded, I’m typing fast…
Re: 8.4% might sound right - Posted by Nate(DC)
Posted by Nate(DC) on December 11, 2003 at 16:39:03:
What bites is, the price is too high.
NT
Re: 12% !!!??? - Posted by Paul Ness
Posted by Paul Ness on December 11, 2003 at 08:13:27:
I’m seeing cap rates on sale prices (not list prices) for nice suburban apartments approx. 8-12 units down in the 8.5%-9.5% range. Older city properties may have 12%+ cap rates. Triple net lease terms refers to leases where the tenant pays all operating expenses, including pro-rata share of real estate taxes, insurance, utilities, and sometimes even the management fee. These are not found in apartments but often found in retail, office and industrial properties.
Thanks!! - Posted by jason
Posted by jason on December 12, 2003 at 15:18:49:
Paul,
Thanks for the detailed calculations. It confirmed the numbers I have. There are 2 things you did differently. One is you assumed a 7% 15 year loan that pays principal and interest. The true case is that I can find a lender that would do a “interest-only” loan at 7%. That brings the debt service to 55k, and the
mortgage constant to = 55000 / 768000 = 0.072.
This in turn brings the cap rate to
(0.8x0.072)+(0.2x.10)=7.76%
Price = NOI / CAP = 81000/7.76% = $1043814
So, that might mean I am getting a great deal at 960k i.e. the property is being sold at 83k below value (?). Or maybe not. If we go back to the original scenario, here’s what I have.
Gross =106000
Debt service =55000
Expenses = 25000
Final and true net income = 106-55-25= 26k
Agreed that the property will appreciate and a CD won’t but then, regardless of by how much the property appreciates, a CD is guaranteed to yield 4% per year. Thats why I took 8k off the final 26k figure to come to an income of 18k per year for buying me a property managers job and yes, if I go with the 7% principle + interest method, I am never going to find a good deal. Becoz as you can see, even with the relaxed interest only loan, 18k per year or 26k per year for a property manager’s job just doesn’t seem to be ok.
I have ran countless listings thru such formulas and just don’t seem to be finding one that works. And I have not even looked at the tax returns, balance sheets etc of these properties, just the numbers don’t make sense so why bother? Surely, there are going to be situations which might sound like they would click - only to later find out that the balance sheets say something different.
Thats why I asked how do the pros do it? Or is it that the good properties never get advertised just like the good jobs don’t get advertised? Maybe there’s a better way but I haven;t found it yet. There’s no way I would pay 192k, work full time and make only 18 or 26k. I don’t think anyone would do such a thing, definately not the seasoned pros.
so what shud the price be? NT - Posted by jason
Posted by jason on December 11, 2003 at 17:26:14:
nt
Re: so what shud the price be? NT - Posted by Nate(DC)
Posted by Nate(DC) on December 12, 2003 at 10:43:55:
And I should add that, at a minimum, it should be low enough that you earn your desired rate of return, whatever that is.
NT