Investment property and cap rate

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jcw
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Investment property and cap rate

Post by jcw » Sat Jun 08, 2013 11:02 am

Hello,

I have a single family home that I bought in 2009. I moved away for the last couple of years and have been renting it out. My tenant has been great so it's been easy to landlord the property, even from the other side of the country. However, my tenant is about to move out and I'm trying to figure out if I should sell it or rent it out to a new tenant:

Bought price: $695,000
Current market value: ~$880,000
Loan: 30 year fixed at 3.375%
Loan amount: $520,000
Mortgage: $2480/month
Rental Price: $3300/month
Property tax: ~$700/month
Property Manager: $200/month
Gardener: $50/month


My question is, should I sell it and take out the equity or should I continue renting it? I've been reading about the double digit cap rate on investment properties. I bought this house at the bottom of the down turn, and I still can't get a double digit cap rate on it. It's more like 5-6%. I don't understand why we can only look at the cap rate when valuing an investment. If real estate is a hard asset, it should move with inflation over the long run. If inflation is 2% and I put 20% down on the house, I am 5x leveraged. This means my return is 10% just from inflation + leverage. In addition, the renters are covering my mortgage/principal so there is an additional benefit of about 3-4% per year over 30 years. FInally, rents should also increase with inflation right while my mortgage stays fixed, so I should make additional cash flow in the long run (even if it is 10 years from now).

FYI, this property is in one of the most expensive cities in the SF bay area. There are houses worth 2-5 million just a mile away. So I'm renting to affluent people who should be taking better care of the house.

Please advise.

Valuethinker
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Re: Investment property and cap rate

Post by Valuethinker » Sat Jun 08, 2013 3:19 pm

I think the days of cap rates of 10% must be gone in most localities. They made sense if your mortgage rates were also 10%.

5-6% seems fine to me in that it is is a positive 'spread' over your cost of borrowing.

However what I have observed from people who own rental properties:

- they don't plan for much, if any, price appreciation. They make their money by a rental yield > cost of financing, and when the mortgage is repaid they have their equity in the house

- they have quite a holdback for contingencies, I have heard 20% of rents for voids, maintenance etc.

If you look at Shiller's data, or Neil Monnery's 'Safe as Houses: 800 years of housing prices' you'll see that the assumption housing prices match inflation is only broadly true at best, there are plenty of times and places where they do not.

If you are prepared to be a long term investor and to take the rough with the smooth, owning residential property can be a good way to 'get rich slowly'.

YttriumNitrate
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Re: Investment property and cap rate

Post by YttriumNitrate » Sat Jun 08, 2013 3:24 pm

deleted.
Last edited by YttriumNitrate on Sat Mar 12, 2016 12:25 pm, edited 1 time in total.

jcw
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Re: Investment property and cap rate

Post by jcw » Sat Jun 08, 2013 6:57 pm

Thanks for the thoughtful replies. I'm currently living rent free for a while and have at least $10k/month gross income and low monthly expenses (~ $1000). I can use this cash to backstop any vacancies, repairs, etc. Other than that, I would use the money to build up a 12 month safety net to cover all costs and invest it in equities/bonds. If all goes well, will eventually get a second property.

If I cash out for $300k, what will I do with the money? Even if I invest in the S&P 500, the expected return is about 7% going forward. So, I have 25 years left on the mortgage. Even if it appreciates 0% in the next 25 years and the rent never increases, my return/CAGR is 6.8%. I didn't calculate vacancies and repairs, but let's say its 15% of yearly gross rent. My return would still be 6% in what I'd expect is a worst case scenario. If I get even a 0.5% CAGR in the next 25 years, I will have beaten the S&P 500.

I already have a substantial amount (> $100k) invested in the simple 3-fund portfolio and I really enjoy the simplicity but it seems like I could get a better return on the property.

dodonnell
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Re: Investment property and cap rate

Post by dodonnell » Sun Jun 09, 2013 9:01 am

jcw wrote:... I've been reading about the double digit cap rate on investment properties. I bought this house at the bottom of the down turn, and I still can't get a double digit cap rate on it. It's more like 5-6%. I don't understand why we can only look at the cap rate when valuing an investment ...
Higher "Cap Rate" yields a lower current Value.

Holding all other things constant a "Cap Rate" of 5% will yield a Sales Price twice as high as a "Cap Rate" of 10%.

Value = (Net Operating Income) / (Cap Rate)

"Cap Rates" are at currently at historical lows ... meaning income properties are selling at their highest valuations in history.

I am confused, it appears you own an income property, but don't understand this ? (maybe i misunderstood OP)

eddiejov55
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Re: Investment property and cap rate

Post by eddiejov55 » Sun Jun 09, 2013 9:39 am

I was under the impression that cap rate is NOI/purchase price. It does not appear that OP has any operating income since mortgage is $2400, property taxes are $700, property manager is $200, and gardener is $50. That adds up to roughly $3300 and rental price is $3300. So operating income is $0? If the mortgage price quoted is all-in with taxes and insurance, then we are talking more like 1% cap rate currently. Once house is paid off then OP would be in the 5% cap rate range...

Regardless, this does not appear to be a rental income producing property, but rather a long term resell play.

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Frugal Al
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Re: Investment property and cap rate

Post by Frugal Al » Sun Jun 09, 2013 11:40 am

Other than the gardener expense I see no vacancy reserve or maintenance expense. The OP really needs to do a proper accounting for these contingencies and do proper cash flow projections. It seems like there might currently be some after tax net income. I don't know the SF market, but the rents seem low even given the original purchase price, let alone the current value.

It appears that the deal on the property was buying it right. I'd probably take the gains and be happy.

travellight
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Re: Investment property and cap rate

Post by travellight » Sun Jun 09, 2013 1:06 pm

The numerator on the cap rate calculation based on what I read, should not factor in the mortgage cost. So, it would be net annual income minus operating costs not including mortgage = $2400/month x 12 months, divided by purchase price of the property which gives a cap rate of 4.8% for this property.

You can improve the cap rate by managing the property yourself. I did the calculation for my worst property and got 6%. My best property is at 8.2%.

I would probably keep this property. It is covering its cost and will be a significant equity for retirement. Once it is paid off, it will deliver $3300/month minus costs to supplement your retirement income.... at a fairly low cost since it is about cost neutral. I am not savvy enough to do well with the money I would cash out anyway. I agree that it is a "get rich slow" method that is more plodding and predictable for me than the stock market.

jcw
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Re: Investment property and cap rate

Post by jcw » Sun Jun 09, 2013 1:09 pm

To clarify, I am not an experienced real estate investor and this was not intended to be a rental property. I am an "accidental landlord". This purchase was intended for a family and kids. Based on unfortunate and fortunate circumstances that did not happen and I moved across the country. For the last 2 years, I rented to a good friend who was a really easy tenant and made being a landlord very easy. Those tenants are moving out at the end of the month and I am trying to figure out what I should do with this property. I am just starting to read up on real estate investing and will model everything in excel once I understand this.

Ok, now that being said, my original question basically boils down to valuing the real return of a property and not just the cap rate. Wikipedia is much more articulate than I am so I will just quote it:
The cap rate only recognizes the cash flow a real estate investment produces and not the change in value of the property.

To get the unlevered rate of return on an investment the real estate investor adds (or subtracts) the price change percentage from the cap rate. For example, a property delivering an 8% capitalization, or cap rate, that increases in value by 2% delivers a 10% overall rate of return. The actual realised rate of return will depend on the amount of borrowed funds, or leverage, used to purchase the asset.

To calculate the change in asset value, divide the appreciation rate by the percent of investor equity in the property. For example, if the property appreciates 3% this year, and I have 25% equity in the property, my profit is .03 / .25 = .12 = 12%.
So the question, put succinctly, when valuing an investment property, why do most people (including posts here) only look at cap rate without taking into account change in asset value (See wiki quote above)? Put another way, for finance people, in my cash flow model, what is a safe value for the growth rate and terminal growth rate. My previous posts basically try to make a case that inflation (~2%) is a safe terminal growth rate and this is what is typically used in financial models. Other posters seems to indicate a 0% growth rate, which didn't seem realistic to me.

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deanbrew
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Re: Investment property and cap rate

Post by deanbrew » Sun Jun 09, 2013 3:18 pm

It's not true that a cap rate doesn't incorporate any change in income or value. Those are built into the cap rate that an investor is willing to pay. The reason direct capitalization is used is because it is so simple and universally known and calculated. That doesn't mean it's the only analysis an investor or owner should consider.

It is true that the cap rate ignores debt, leverage and debt service. It is a simple calculation of NOI divided by purchase price. There are other investment calculations that consider leverage, such as cash on cash return, leveraged IRR and others. In the end, it appears that you have a very large investment in one asset. That's not necessarily bad, but it does warrant a better understanding of the risks and returns.
"The course of history shows that as the government grows, liberty decreases." Thomas Jefferson

dodonnell
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Re: Investment property and cap rate

Post by dodonnell » Sun Jun 09, 2013 6:28 pm

My previous post assumed that "Cap Rate" was short for "Market Capitalization Rate" (for comparable properties).
The rate that an appraiser would use to perform a direct capitalization method for an income valuation (NOE/caprate=Value).

For this purpose the growth rate is incorporated into the Cap Rate. Cap Rate = Required_Return - growth_rate.

This tutorial explains it better than i can (skip to Direct Capitalization):
http://www.analystnotes.com/notes/subject.php?id=2340

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deanbrew
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Re: Investment property and cap rate

Post by deanbrew » Mon Jun 10, 2013 8:12 am

Using the OP's numbers in the first post, the way an appraiser or investor would look at the property is:

PGI (Potential Gross Income) = $3,300 x 12 = $39,600
Less: Vacancy/Payment Allowance = Assume 7% (2,772)
EGI (Effective Gross Income) = $36,828
Less Expenses - Taxes (8,400)
Insurance (estimate) ( 800)
Gardener ( 600)
Management (2,400)
NOI (Net Operating Income) $24,628

So, if the property is really worth $880,000, the current investment yield (cap rate) is only 2.8%. If you use the purchase price of $695k, you get a cap rate of 3.5%. Both are very low, indicating that the price is too high for an investor. This isn't uncommon with residential homes in owner-occupied neighborhoods.

The bottom line is that the rent is very low compared to the value of the property. An old rule of thumb is monthly rent should be one-hundredth of the value. In your case, that means the property should rent for $8,800 per month, more than double what you're getting. Now, that rent is unrealistic, which again indicates that home prices in this neighborhood are set by home owners, not investors.

Many small investors look at the cash on cash return, rather than the unleveraged return. In your case, your cash flow after debt service is negative, so you have no cash on cash return. Again, this indicates that rent is too low compared to debt service (mortgage payment) and expenses.

As for whether to sell or keep, you clearly will not be making money by renting it in the near term. Any investment gain will have to come from price appreciation when you sell. I don't know your market, but if the value has gone up since you bought it, I would be mighty inclined to sell rather than rent at a loss and hope for further appreciation.
"The course of history shows that as the government grows, liberty decreases." Thomas Jefferson

jcw
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Re: Investment property and cap rate

Post by jcw » Mon Jun 10, 2013 3:03 pm

Deanbrew,

Thank you! That was a super helpful and constructive reply. I see now that the cap rate is really low. Also, if I add in potential maintenance costs of 20%, it will be even worse. I will definitely consider selling in the next year. I still have about a year to get the tax free exchange.
That is amazing that I still have such a low cap rate. I bought at the bottom of the market in 2009 too. I don't see how it's possible to make money in real estate, at least in the SF Bay area. I would have had to buy this house for 330k, which is like 1995 values to get a double digit cap rate. In today's short sale's wouldn't go for that price.

One other question, how would I think about rental appreciation in the future? It should grow by, at least, inflation right?

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deanbrew
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Re: Investment property and cap rate

Post by deanbrew » Mon Jun 10, 2013 3:56 pm

jcw wrote:I bought at the bottom of the market in 2009 too. I don't see how it's possible to make money in real estate, at least in the SF Bay area. I would have had to buy this house for 330k, which is like 1995 values to get a double digit cap rate. In today's short sale's wouldn't go for that price.

One other question, how would I think about rental appreciation in the future? It should grow by, at least, inflation right?
As I posted here, as well as in other real estate threads, the owner-occupied and rental markets are really two separate markets, populated with different sets of buyers having different motivations, knowledge levels, expectations and emotional investments. The users - owners vs. renters - also tend to be far different. Even the nicest, newest apartments sell for FAR less than $500k per unit, since the price is set by willing buyers who base the value on income.

As for rental appreciation in the future? I don't know your market, so I'm unqualified to answer or even guess. From my experience in markets I know, however, rents tend to track inflation over long periods of time, but do not do so steadily or evenly. Rents jump when demand exceeds supply and usually stagnate or even go down when lots of new rental inventory is added in a market. Over a short to medium period, you can't count on rents growing by at least inflation.
"The course of history shows that as the government grows, liberty decreases." Thomas Jefferson

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Hub
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Re: Investment property and cap rate

Post by Hub » Mon Jun 10, 2013 3:57 pm

Great post deanbrew. I've modeled my spreadsheet based on the set of numbers you illustrated. My local market is not nearly as out of whack of the SF Bay area, but still, you can't get investment property to cash flow in single family residence neighborhoods where home ownership is common. The rents just aren't high enough.

For my home value appreciation estimates I just use a flat 2%, but that's not based on anything other than an effort to be conservative while still accounting for the appreciation. Though depreciation expenses factor in here too.

jcw
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Re: Investment property and cap rate

Post by jcw » Mon Jun 10, 2013 4:12 pm

Deanbrew,

Would you mind sharing the other real estate site you use? I find that this site is great for index investing advice, but the general population here is very against owning real estate so it's hard to get constructive feedback.

Thank you!

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deanbrew
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Re: Investment property and cap rate

Post by deanbrew » Mon Jun 10, 2013 4:24 pm

jcw wrote:Deanbrew,

Would you mind sharing the other real estate site you use? I find that this site is great for index investing advice, but the general population here is very against owning real estate so it's hard to get constructive feedback.

Thank you!
I meant other threads (in the past) here at bogleheads. I can't think of any decent real estate message boards, but I'll give it some thought.
"The course of history shows that as the government grows, liberty decreases." Thomas Jefferson

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Hub
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Re: Investment property and cap rate

Post by Hub » Mon Jun 10, 2013 4:45 pm

jcw wrote:Deanbrew,

Would you mind sharing the other real estate site you use? I find that this site is great for index investing advice, but the general population here is very against owning real estate so it's hard to get constructive feedback.

Thank you!
Here are three links I bookmarked to come up with my investment property spreadsheet.

Boglehead ProForma thread:
http://www.bogleheads.org/forum/viewtop ... 52#p426352

Depreciation Calculation:
http://homeguides.sfgate.com/calculate- ... -7940.html

Cash Flow Quick and Dirty:
http://johntreed.com/positive.html

bkslainte
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Re: Investment property and cap rate

Post by bkslainte » Mon Jun 10, 2013 4:55 pm

Would you mind sharing the other real estate site you use? I find that this site is great for index investing advice, but the general population here is very against owning real estate so it's hard to get constructive feedback.
Here are some you might find useful
Biggerpockets.com

Redfin.com
The Bay Area forum is probably the most active

Fatwallet.com
Some real estate threads in the forum

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Clearly_Irrational
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Re: Investment property and cap rate

Post by Clearly_Irrational » Mon Jun 10, 2013 5:25 pm

Hub wrote:For my home value appreciation estimates I just use a flat 2%
I usually model it as Inflation + Population growth, over the long term this tends to be the trend.

jcw
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Re: Investment property and cap rate

Post by jcw » Mon Jun 10, 2013 7:48 pm

Yes, this is how I modeled it and was my original question! See the first post.

If I model 2% growth and I'm leveraged 5x (your standard 20%) down. Then I'm getting a 10% return just from inflation. Example: The house costs $10000, you put 20% down, so your equity is $20000. Then, you rent for cash flow neutral (in net income) so you don't pay anything else. At the end of year 1, if the house appreciates 2% (inflation), you made $2000. That is a 10% return on your 20k down. Compounding makes that return increase even more. Also, at the end of your mortgage, your renters pay down your principal, which increases your return.

If this logic is correct, and I have a 30 year time horizon, then my money can either go into the S&P and get 7-8% or I can continue with real estate and get 10+%.

ge1
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Re: Investment property and cap rate

Post by ge1 » Mon Jun 10, 2013 8:24 pm

You ignore that by paying the mortgage your equity increases and leverage goes down.

I'm just starting out doing investment properties, but as others mentioned your rental income seems very low. As a comparison, we are in the process of buying an apartment for 140k and should get 1200 per month in rental income.

I don't see how you can make money on your house once you factor in repairs and vacancies, assuming price appreciation is limited to inflation. Don't forget that real estate taxes, repairs and management fee will increase with inflation too.

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steadyeddy
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Re: Investment property and cap rate

Post by steadyeddy » Mon Jun 10, 2013 8:35 pm

I found this article interesting. It might make me pause before becoming an "accidental landlord" in SF for risk management considerations.

jcw
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Re: Investment property and cap rate

Post by jcw » Mon Jun 10, 2013 8:47 pm

ge1 wrote:You ignore that by paying the mortgage your equity increases and leverage goes down.

I'm just starting out doing investment properties, but as others mentioned your rental income seems very low. As a comparison, we are in the process of buying an apartment for 140k and should get 1200 per month in rental income.

I don't see how you can make money on your house once you factor in repairs and vacancies, assuming price appreciation is limited to inflation. Don't forget that real estate taxes, repairs and management fee will increase with inflation too.
hmm, that is true. Do I need to take into account the decreased leverage if I'm calculating return on my originally invested capital? That is a nice rental property you have.

Also, I just modeled this whole thing in excel taking into account a depreciation tax shield over 27.5 years at a 40% (state and federal) tax break. Given the cash gained from the tax shield, it's cash flow positive. Given the following assumptions:

Rent increase: 2% per year (inflation)
Appreciation 2% per year (inflation)

Vacancy: 7% of gross rent

Maintainance : 30% of gross rent
Property Management: 6% of gross
Gardener+Insurance: ~4% of gross
Total operating expense: ~ 44% of gross rent

I would have ~9% CAGR. In my net income, I take into account principal per year (amortized over a 30 year fixed). If I adjust the appreciation to 5%, which is what it has grown at for the last 5 years, the CAGR is 11.4% (although I don't think that scenario is reasonable).

I can see why the double digit cap rate is important. If I had a 10% cap rate, I would have a 10.22% CAGR even if I never increased rents and the property never increased in value.

travellight
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Re: Investment property and cap rate

Post by travellight » Tue Jun 11, 2013 12:37 am

It is difficult to make it in real estate in locations like SF, or where I live in San Diego. This is why I have invested elsewhere, in another state. I would likely sell this place jcw and if you want to invest, find a place where the numbers work out better. As a comparison, one of my properties rents for $2550/month and I paid 381K for it. Another rents for $2200/month and I paid 256K for it. These are both nice upscale SFRs in great neighborhoods, not multi-units.

WhyNotUs
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Re: Investment property and cap rate

Post by WhyNotUs » Tue Jun 11, 2013 8:00 am

Cap rate is more useful in looking at whether to pursue a deal rather than the decision that you need to make IMO. If you are correct and have seen a couple hundred thousand in increased valuation since purchase, then the numbers will look worse since one uses current valuation in decision making. That is one of the limitations to using the tool in areas of higher appreciation, of which SF may be one. Since the formulas typically do not suggest assuming appreciation greater than inflation, they will not produce great results for Manhattan, the Mission district, Aspen, or other places that might be reasonable investment opportunities. A cap rate analysis would have probably not suggested to buy your property at $695k but it appears that you stand to make a profit. Low cap rates are only one indicator, but a useful one for comparing opportunities and critical if one moves into apartment complexes, commercial real estate, etc.

Your comments about leverage are generally consistent with my own thinking and the rationale that some use to invest in sfh's. In addition, assuming that you are locked at 3.375%, then you are leveraging at historically low rates. Without knowing where your property is in SF, it as a whole has been a pretty strong market and there are no obvious reasons to suggest that changing.

The challenges to keeping it as I see it is that you have an expensive property that has low cap rate, live too far to keep an eye on it, have had a friend as a tenant who may have given an unrealistic view of managing tenants ("I'm renting to affluent people who should be taking better care of the house"), and may have already enjoyed the "cream" of appreciation on the property. Selling would be pretty attractive to me unless I thought I might return to Bay Area. If you lived in it long enough to qualify for the gains exclusion for tax purposes, then it would be even more attractive to sell for me. Not many chances to capture that kind of gain tax free.

If you have been bit by the real estate bug and are stable in your new location, you could use a portion of the proceeds to buy a duplex or triplex and live in one unit for a while to get a better feel for land lording. Who knows, it could be something you love. From a distance, it is really hard to deal with bad tenants and/or maintenance issues so one ends up paying extra to deal with everything.

The real estate investment websites previously listed could provide additional info but please be aware that many of the deals described there are not likely to be found in an area with tight supply or high appreciation. The trenches of hard core investing- mfh, apartments, and commercial are not for the faint of heart. There is money to be made in mfh in working class neighborhoods with marginal housing stock but that has not been my calling. The other info out there that I would be aware of is the "leverage" venders. The are coming back after a period of relative silence after the financial/real estate crisis. The elixir of compounding and leverage has created wealth and bankruptcy for those attracted to its nectar, the only sure thing over time has been selling the elixir.
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Leemiller
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Re: Investment property and cap rate

Post by Leemiller » Tue Jun 11, 2013 8:10 am

Would you buy this property now as an investment from across the country? I doubt you would and based on that alone I would sell. I also think it is possible that prices will go down as interest rates go up and baby boomers downsize.

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deanbrew
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Re: Investment property and cap rate

Post by deanbrew » Tue Jun 11, 2013 8:42 am

A couple of comments.

First, leverage doesn't work quite the way the OP indicates. If you borrow half, that doesn't double your return, because you have to pay the mortgage (debt service) during the holding period. Leverage works if the overall return is greater than the mortgage interest rate, and the greater the disparity the higher the positive leverage. If values go down, leverage works against you, and you not only multiply the value loss, you've also paid interest during the holding period.

Second, you can adjust cap rates for anticipated value and/or rent increases greater or less than inflation. A "normal" cap rate in a market typically assumes that rent will increase similar to other properties of the same type. If you're looking at residential rentals, most investors assume that rents will go up by roughly inflation. If you have some reason to believe rents will go up faster, you reduce the cap rate by the differential. The more frequent situation is one where an investor knows the rent will not go up the same as the market. For example, if I'm buying a Safeway supermarket or CVS store and the lease is written where the tenant has flat rent for the next 15 years, I would adjust the "normal" cap rate UP by 2 or 3 percentage points. So, for this investment, I would not be willing to pay, say an 8 percent cap rate, I would want a 10 or 11 percent cap rate to allow for the flat rent.

As to the OP's situation, I would echo the thought that now is a good time to sell, since the value has gone up since you bought, and especially since you now live across the country. It's much easier and less expensive to invest in real estate near where you live. Like Leemiller, there are signs interest rates are going up. If they do, prices will stagnate or go down due to affordability.
"The course of history shows that as the government grows, liberty decreases." Thomas Jefferson

WhyNotUs
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Re: Investment property and cap rate

Post by WhyNotUs » Tue Jun 11, 2013 9:29 am

deanbrew wrote: Like Leemiller, there are signs interest rates are going up. If they do, prices will stagnate or go down due to affordability.
While I agree with deanbrew's post, I would offer the following to confirm my lack of knowledge about what will happen to OP's valuation when rates creep up.

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deanbrew
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Re: Investment property and cap rate

Post by deanbrew » Tue Jun 11, 2013 9:45 am

^^ I should have more cautiously stated that "prices will have downward pressure due to affordability". I can't predict whether prices will go up or down, particularly in a market I don't know. But there is little doubt that if interest rates rise, so do monthly payments, which will have a negative impact on affordability and home prices. Most home buyers look at monthly housing cost, including mortgage payments and taxes. If monthly costs go up due to interest rates, that's an anchor on home prices.
"The course of history shows that as the government grows, liberty decreases." Thomas Jefferson

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Re: Investment property and cap rate

Post by Valuethinker » Tue Jun 11, 2013 10:06 am

deanbrew wrote:A
As to the OP's situation, I would echo the thought that now is a good time to sell, since the value has gone up since you bought, and especially since you now live across the country. It's much easier and less expensive to invest in real estate near where you live. Like Leemiller, there are signs interest rates are going up. If they do, prices will stagnate or go down due to affordability.
Leemiller and deanbrew have hit a key point. Unless OP plans to live in this house some day, having a property far away magnifies the potential hassle quite a bit (plus having to deal with tax returns in 2 different states?).

FWIW I think US housing prices are still in an 'up' phase. 5 years of not building enough inventory plus frustrated demand will mean demand comfortably exceeds supply. What was needed was 1). confidence 2). spending power arising from easier home mortgages (and banks are now making money, so they will be looser lenders) 3). a reduction in negative equity (allowing buyers to begin to 'jump up the ladder' again).

I also expect GDP growth to be strong enough from here to lower unemployment, and again that means previously frustrated buyers coming back onto the market.

And of course rising prices beget rising prices, as people start panicking to get on the housing ladder, again.

Here's the tricky part. A large part of the sharp rise in US housing prices last 12 months has been an entirely new force-- private equity type buyers investing in single family residentials (historically institutional investors have stuck to apartments). They have mopped up a lot of the excess stock, and the IPOs are coming. What happens when those investors want to sell? Have they driven valuations to levels not justified by fundamentals? the 'rebound' cities have been the ones which were worst hit, and that seems to signal that housing prices are catching up to 'where they should be' at which point they will probably make steady but entirely unspectacular progress for a few years. Remembering that the younger generation of Americans has spectacularly bad balance sheets-- student loans, plus careers that have been stalled. It will take them a long time to get to prime home buying position.

Also there are structural changes to the US mortgage market eg the plans to wind down Freddie and Fannie. No one really knows what that will do, but likely it will make mortgages more expensive in the long run (no implicit Federal subsidy).

So to what extent are we again in 'overrun' mode? I don't know.

FWIW an asset on which someone has made money, a long way away, sounds like an easy asset to sell and walk away. Exception might be if I thought that would mean I could never buy back into that area (and I expected to have my career back in New York or Silicon Valley or wherever).

BTW to deanbrew and others the discussion of how real estate investors look at cap rates, calculate them etc. has been most illuminating- the UK is similar but with its own quirks. Thank you.

jcw
Posts: 56
Joined: Fri Nov 23, 2007 2:37 pm

Re: Investment property and cap rate

Post by jcw » Tue Jun 11, 2013 9:47 pm

Thanks for the replies. My personal situation is that I have finished grad school on the east coast and will be taking a job back in the bay area, starting in July. So I will be local again in about a month after some travels through Europe. Sounds like most here would sell if they were me. I'm leaning towards that too but will wait it out another year or so to see where things go.

From a yearly cash flow perspective, if I include the depreciation tax shield, I make a couple of thousand in cash per year. Without the tax shield, I am cash flow negative several thousand per year. I am not even sure if I should include that in my analysis but logically, that is cash in my pocket, so I have included it.

My own cash flow model shows a > 10% year over year return already. Much of that from market appreciation, which has been about 5% per year for the last few years. The location of this property is in a high end area (think Nob Hill, Woodside, Atherton, Cupertino) with great public schools. It's hard for me to see any significant decrease in value but it may be flat for a while.

Valuethinker
Posts: 35015
Joined: Fri May 11, 2007 11:07 am

Re: Investment property and cap rate

Post by Valuethinker » Thu Jun 13, 2013 6:22 am

jcw wrote:Thanks for the replies. My personal situation is that I have finished grad school on the east coast and will be taking a job back in the bay area, starting in July. So I will be local again in about a month after some travels through Europe. Sounds like most here would sell if they were me. I'm leaning towards that too but will wait it out another year or so to see where things go.

From a yearly cash flow perspective, if I include the depreciation tax shield, I make a couple of thousand in cash per year. Without the tax shield, I am cash flow negative several thousand per year. I am not even sure if I should include that in my analysis but logically, that is cash in my pocket, so I have included it.

My own cash flow model shows a > 10% year over year return already. Much of that from market appreciation, which has been about 5% per year for the last few years. The location of this property is in a high end area (think Nob Hill, Woodside, Atherton, Cupertino) with great public schools. It's hard for me to see any significant decrease in value but it may be flat for a while.
yes you should include the tax effects.

If you are going back to the area, then this is a hedge against rising property prices in a high demand area-- no bad thing.

I am not convinced of the economics of it as a rental investment, but as a hedge? Well it's a good one, the best in fact-- a place you might have cause to live in someday.

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