Posted by Nate(DC) on January 08, 2003 at 15:36:01:
“try” what with it?
NT
Buy a CASH FLOW STREAM, not appreciation - Posted by Marc in Portland
Posted by Marc in Portland on January 05, 2003 at 12:35:21:
From a post I made in another forum which might be of interest:
Those of you who follow the market have no doubt witnessed a decline
in cap rates across the country. I think the reason is twofold:
1.) The number of ex-stock market investors who have read they should
be in real estate are driving prices up beyond reason. At least half
of my “clients” for 8+ unit apartment buildings, who responded to my
ads here in Portland or web site, are brand new to investing. That’s
fine, of course…there is nothing wrong with being an INFORMED
newbie. But, these folks haven’t read any real estate investment
books, they typically don’t have experience managing anything larger
than a duplex, they don’t know expense statistics, and they don’t
have the necessary financial tools (like a property analyzer software). As a result, they fall for what brokers are saying and end up paying too much. For example, they see an 10% cash return and think, “Sure beats the stock market. I’ll take it.”
2.) Interest rates. The majority of even experienced investors seem
to mainly want the magical 10% cash-on-cash return, i.e., they won’t
consider buying a property that doesn’t offer this level of return.
They don’t know how to use cap rates and internal rate of return, nor
do they care because they think 10% is “da bomb.” Well, with interest
rates of 5.5% for a 5-yr. ARM and 80% LTV, it turns out you only need
about a 7.5% cap rate to get a 10% return on an apartment building
with a 40% expense ratio. So, what do we brokers do? We play with our
property’s price until it offers that level of return…cap rate be
darned! Amazingly, in the Western states, the appraisers and banks
appear to be going along with it. After all, as long as a property
has at least a 1.25% Debt Coverage Ratio and positive cash flow,
price is relative, right? If you say so.
But I ask THIS question. Five years from now, the investor wants to
sell. Interest rates are now 7.5%, more of their historical average.
When she bought the place, Ms. Investor was willing to pay a 7.5% cap
rate, since it gave her a 10% cash return. Her broker told her he
thought she’d be able to sell it at a 7.5% cap rate then as well.
SUCKER! Actually, if you use a 7.5% interest rate, it takes an 8.8%
cap to get the magical 10% cash-on-cash return for the same building,
and an 8.4% cap rate just to get the 1.25 DCR the bank will approve.
Meanwhile, in 5 years, the stock market has perhaps started to be
able to offer a decent return, so the pool of available buyers for
investment real estate declines: Fewer buyers + same number of
buildings = lower demand = lower prices.
All I’m saying is: Appreciation is NOT a given…there are
macro-market forces which effect our purchases that you can’t
forecast or plan around. BUT…as long as we plan for all this and keep our appreciation variables conservative, we can at least avoid surprises.
As usual, my advice is: BUY A CASH FLOW STREAM, NOT A FUTURE VALUE.
Take care,
Marc Coan
Re: Buy a CASH FLOW STREAM, not appreciation - Posted by Mike Blount
Posted by Mike Blount on January 08, 2003 at 22:14:13:
Marc
I am missing something if I am making 10% cash on cash return and I hold the property for 10 years that would equal $50,000 based on $50,000 invested. So if I sold the property exactly what I paid for it 10 years ago I still made $50,000 not including tax depreciation and mortgage payoff(which would be quite less than original buy price)
Re: Buy a CASH FLOW STREAM, not appreciation - Posted by JJT
Posted by JJT on January 05, 2003 at 22:27:22:
Marc,
I’m a newby and need your help. With a no money down scheme, how do I get the cash on cash return? Does that mean chances are the bank won’t let me get the mortgage for my 80/10/10 deal if I could not show them that number?
As I mentioned in my other post, for 80%/7%/20 year loan, with 8.5%/5 year balloon/20 year loan, I’m looking at the GRM of 4.35 and Cap rate of 11% for a particular 8-plex in town. I have verified the NOI around my target area, and take into account the 48% of expense, 10% vacancy rate. What did you see I miss here if I go ahead and offer the 75% of the asking price with all the excape clauses added to my offer?
Thanks,
JJT
Re: Buy a CASH FLOW STREAM, not appreciation - Posted by Tjent
Posted by Tjent on January 05, 2003 at 19:42:05:
I agree. I’m in Los Angeles where prices have skyrocketed. I have always sought good cash-flow properties in low income areas. There was a time when I first started investing - in 1997 - when that’s the only type of property I could afford. Yet now that I have the ability to buy higher-end units, I’m still committed to the strong cash-flow properties i.e. older buildings that need work in “questionable” neighborhoods. When I started seeing people paying for stabalized apartment properties in the good part of town with cap rates of only 3 and 4% I new something was wrong. These folks are speculating on appreciation. Although I think you should always buy with an eye to a potentially higher future value, I still say follow the cash.
Great Post! - Posted by ray@lcorn
Posted by ray@lcorn on January 05, 2003 at 19:34:12:
Marc,
Thanks for a great post. Your thoughts are right on the mark. When the room is full of people with more money than sense, the people with sense have two choices: Either figure out how to give them what they want, or wait in the hall until they’ve had their fill. Bankers call these investors “hot money accounts”, because they will move large amounts of cash for nominally increased returns with little regard for fundamentals.
But there is a bright side to the folks that are overpaying for property. They are lending a stability to the commercial real estate market that is rarely seen. Prices are holding in spite of a whole host of negative indicators regarding corporate tenant strength, job contractions and slumping sales. That bodes well for those of us that are in this game for the long haul.
Couple that flood of money with the now huge presence of Wall Street in the RE financial markets, and the large amount of properties owned by REITs, (> 20%), and all of a sudden commercial real estate is no longer the “drunk driver of the economic highways”! (quote from Dean Starkman, WSJ, 2 April 2001)
For exactly those reasons we made a decision not quite a year ago to “monetize our assets and redeploy the capital.” We’ve sold four large properties this year, all for premium prices. We also were able to piggyback one sale into an acquisition with a deal structure that is providing returns in the high teens from credit tenant assets.
So bring on the hot money. I love the stability, and I especially like the prices my properties have been bringing this year. I hope there is at least one more hot money buyer out there, because I’ve got one more property to sell!
ray
Re: Buy a CASH **********P.S. - Posted by Mike Blount
Posted by Mike Blount on January 08, 2003 at 22:23:37:
I am a Vice President of a Multifamily Developer that Developes, Builds and keeps Apt. Complexes for 15 years(Tax Credits) In other words I am just on the building side of the Apt. Complexes and know nothing about the finacial side except I know we make a bundle on development fees and construction fees and sell the tax credits to some large investors (First Union, Sun America etc)and they love these kind of deals.
Re: Buy a CASH FLOW STREAM, not appreciation - Posted by Marc in Portland
Posted by Marc in Portland on January 06, 2003 at 11:35:01:
> With a no money down scheme, how do I get the cash on cash return?
If you have no money into it, then your return is INFINITE, isn’t it? Whatever positive cash flow you get is good.
> Does that mean chances are the bank won’t let me get the mortgage for my 80/10/10 deal if I could not show them that number?
Do you have a bank that will let you buy an 8-plex with no money down? If so, please tell me who it is as I could buy HUNDREDS of buildings that way. Remember, financing for 5+ unit apts. is quite different than I’m looking at the GRM of 4.35. Cap rate of 11% for a particular 8-plex in town.
I like those numbers! Around here, you’d see a GRM of 8.0+ for a 8-plex, with a cap rate of maybe 7%. What part of the country are you in?
> 48% of expense, 10% vacancy rate
Wow! You get that kind of a cap rate with these numbers plugged in? Jeez, what’s wrong with this property or neighborhood that they would be willing to sell it so CHEAP? I’ll take one!
> if I go ahead and offer the 75% of the asking price with all the excape clauses added to my offer
Nothing, except that my question is: What’s the cap rate at 97.5% of the asking price? Most properties (in this current marketplace) sell within 3% of their asking price. Why would this seller take 75%? (Sorry, didn’t see your other post.)
Marc
Re: Buy a Cash Flow Stream - Posted by Mr. C
Posted by Mr. C on January 05, 2003 at 21:52:01:
So how do you see all this affecting the investors who pick-up the mortgage notes on commercial properties?
Great to be a seller! - Posted by Marc in Portland
Posted by Marc in Portland on January 05, 2003 at 19:46:39:
Ray,
Thanks for the compliment on my post. I also have been able to move some properties this year to folks who might not have the experience in the marketplace that they should. However, now I have to figure out where to put the money!
Take care,
Marc
Re: Buy a CASH FLOW STREAM, not appreciation - Posted by JJT
Posted by JJT on January 06, 2003 at 12:09:40:
>Nothing, except that my question is: What’s the cap
>rate at 97.5% of the asking price? Most properties
>(in this current marketplace) sell within 3% of their >asking price. Why would this seller take 75%? (Sorry, >didn’t see your other post.)
>Marc
Marc, the GRM is 5.65 and Cap Rate is 8.52 for 97.5% of the asking price. I plugged in the 75% because all the books I read suggested to use that number as the starting point. The only trouble is, with no money down, there is nothing left for the debt service, since DSCR goes to 0.77. 
That was based on 80%/7%/15yrs and 20%/8.5%/15yrs/5yrs balloon. Just got off from the phone with two banks. The first one ask for 75%LTV, 15yrs/5yrs balloon, and the second one 80%LTV with the same term. One of the mortgage broker promised that they could find a 30 to 40 yrs loans from private investor, but I have to wait and see. I think for this particular property, the owner just tired of managing it…Still wonder is there any other way to get this deal without lossing my shirts. 
Do you have any suggestion?
Thanks for your time.
JJT
Re: Buy a Cash Flow Stream - Posted by Nate(DC)
Posted by Nate(DC) on January 05, 2003 at 23:10:13:
I sure as heck wouldn’t want to be holding a note with a 5 year call, written at 5.5% today at 80% of today’s “value”. I might find that 5 years from now when rates are up I would be holding a note at a much higher LTV and lower DSCR, even if the property kept performing.
As Marc said, it’s amazing the lenders are making these loans so readily. But I guess they have money burning holes in their pockets the same way the buyers do…
NT
Re: Great to be a seller! - Posted by ray@lcorn
Posted by ray@lcorn on January 05, 2003 at 19:51:07:
Marc,
Don’t get me wrong… I don’t think everything is peaches and cream on the horizon. Don’t put that money somewhere just to be doing a deal. There is much to be said for being liquid in uncertain times.
I’ve got an article coming on my take for the next twelve to twenty-four months. Stay tuned… I think we’re in “interesting times”, as the old Chinese proverb warns.
ray
Re: Buy a Cash Flow Stream - Posted by Mr. C
Posted by Mr. C on January 06, 2003 at 24:04:26:
So how would you feel about a $2MM note at 7% with 30/10 terms on a commercial property at 50% LTV? …how do you think one of these “hot money” investors would feel about it?
Re: Buy a Cash Flow Stream - Posted by Nate(DC)
Posted by Nate(DC) on January 06, 2003 at 17:33:57:
The problem with that is, your money is stuck there for 10 years at 7%. Sure, it’s better than a T-bill, but not as safe, even at 50% LTV. Most people I know of that do private lending are savvy enough to command at least 12% interest, and often a lot more. Don’t know that there’s a big number of people who would be interested in private lending on something as long term as 10 years.
NT
Re: Buy a Cash Flow Stream - Posted by Mr. C
Posted by Mr. C on January 07, 2003 at 11:28:57:
Try this one…
Fixed-rate, 10-year loan for $2.5MM at an interest rate of 5.98% on a 7% cap property… underwritten by a commercial lender this morning.
Re: Buy a Cash Flow Stream - Posted by Mr. C
Posted by Mr. C on January 07, 2003 at 10:45:49:
The P&I is over $14k a month ($175k+ a year), with a balloon of $1.9+ million… at 54% LTV.
I know a few bankers that would climb all over that.