Author Topic: Recalculate cap rate after property value goes up?  (Read 1794 times)

Bearded Man

  • Handlebar Stache
  • *****
  • Posts: 1142
Recalculate cap rate after property value goes up?
« on: September 07, 2015, 05:10:28 PM »
I bought a 3 bedroom 1 bath house on a large lot in Tacoma, WA for 65K with closing costs five years ago. I estimate the house is worth 130-150K based on other sales in within two block, most of which are on the 150K end of sale price.

The area is gentrifying. New houses are being built two houses one way, two houses the other way, and blocks around.

It's a paid off property that nets me $700 a month with no vacancies in the past 3 ish years, (since I've rented it out). It was originally bringing in 13% on my money not counting tax benefits or appreciation. Now that they value has gone up, it is more like 6-7% for what is essentially a part time job. Appreciation is about 10K a year right now, if I estimate conservatively. So $8,400 a year from rents after expenses, and 10K a year and counting on appreciation.

Right now I'm holding onto it with the though that, it's a paid off place to live with easy commute to high paying jobs. I lived there for 2 years before so I could do it again, especially since with taxes, insurance and maintenance, it costs me $200 a month to live there, should I move back in. It IS a great fall back position. Not my ideal place to live, but it's paid for and close to everything. 

I could probably earn a higher return elsewhere with my money, with less risk and less work. But that the same time, is there anything to be said for having a paid off place to live that I paid that price for years ago as a fall back position? Tenant is on a month-to-month lease so I could move in fairly quickly if I needed to.

Seems like it might be worth keeping for now. I can always decide to sell it later. If I sell it now, it is unlikely that I can buy back in at the price I got it for.

So should one recalculate the cap rate as the property value goes up? If so, is it always worth deciding based on return on investment, whether to sell a property and reinvest elsewhere? In this case, it does provide one hack of an advantage in life, having a paid off place to live, which I could either move back into, or rely on for income.

Ricky

  • Pencil Stache
  • ****
  • Posts: 842
Re: Recalculate cap rate after property value goes up?
« Reply #1 on: September 07, 2015, 05:36:05 PM »
In choosing whether or not to kick the tenant out and move in, you just have to run the simple numbers.

If you moved:
- Cash flow from rental ($700)
- Cost to maintain house once you move in ($200)
+ Current cost per month where you're living, rent or other ($???)
= ??? (difference per month between moving back in or staying where you are)

If the number is positive, you're better off doing this. If not, then I'd stay where you are as long as you're happy.

The other obvious analysis you could run is hypothetically selling the rental and putting the money in another investment somewhere else that returned higher. Then you could either stay or move somewhere else if there was excess cash flow per month or just move anyway. There's obviously some emotional decision based on whether you're happy at your current place or not.

Cap rate isn't really important unless you're evaluating a property you want to buy today. Cash flow and capital gains is really the only important metric here IMO. Your return on that property has been really good. Not only did you earn ~23% per year in (unrealized) capital gains but also collected a dividend each month (the rent).  Just like the stock market, $130-$150k could be the cap or it could keep going up ~$15k a year.

reklar

  • 5 O'Clock Shadow
  • *
  • Posts: 7
Re: Recalculate cap rate after property value goes up?
« Reply #2 on: September 08, 2015, 05:26:34 AM »
I'm in a similar situation and have been mulling options.  In addition to what Ricky said you could also consider doing a cash out refi on the property ... this would allow you to put that equity to (better) use without incurring capital gains.  Another option would be to sell and do a 1031 exchange so you defer the capital gains.

With or without 1031, selling would incur some costs (commissions, inspections, closing costs, repairs, etc) so you'd need to evaluate that.  Your tax bracket is what determines if you owe capital gains, so use that when considering 1031 if you decide to sell.

Bearded Man

  • Handlebar Stache
  • *****
  • Posts: 1142
Re: Recalculate cap rate after property value goes up?
« Reply #3 on: September 08, 2015, 09:07:55 AM »
In choosing whether or not to kick the tenant out and move in, you just have to run the simple numbers.

If you moved:
- Cash flow from rental ($700)
- Cost to maintain house once you move in ($200)
+ Current cost per month where you're living, rent or other ($???)
= ??? (difference per month between moving back in or staying where you are)

If the number is positive, you're better off doing this. If not, then I'd stay where you are as long as you're happy.

The other obvious analysis you could run is hypothetically selling the rental and putting the money in another investment somewhere else that returned higher. Then you could either stay or move somewhere else if there was excess cash flow per month or just move anyway. There's obviously some emotional decision based on whether you're happy at your current place or not.

Cap rate isn't really important unless you're evaluating a property you want to buy today. Cash flow and capital gains is really the only important metric here IMO. Your return on that property has been really good. Not only did you earn ~23% per year in (unrealized) capital gains but also collected a dividend each month (the rent).  Just like the stock market, $130-$150k could be the cap or it could keep going up ~$15k a year.


Good arguments. I really need to look at the hard numbers.

I'm just considering ROI, regardless of whether it is cap rate, cash-on-cash, etc. What I'm trying to find out is whether 1) one should re-evaluate the ROI as the value of the investmet goes up, even though that's not what you paid for it, 2) since it has gone up in value, could you earn more money by investing that money elsewhere?


reklar

  • 5 O'Clock Shadow
  • *
  • Posts: 7
Re: Recalculate cap rate after property value goes up?
« Reply #4 on: September 08, 2015, 09:54:32 AM »
There are two different concepts here ... return on investment while holding versus return on investment after selling.

However, my understanding is that ROI is ROI, i.e., you are calculating a return on the initial investment you made.  Whether the value of the property has gone up has no bearing on Cash on Cash or Cap Rate because you didn't invest at the appreciated price.  You invested in your property via original purchase price + plus closing costs (if not leveraged) or downpayment + closing costs (if leveraged).  The investment part is fixed, it's the return which varies due to associated costs/income generated. 


Ricky

  • Pencil Stache
  • ****
  • Posts: 842
Re: Recalculate cap rate after property value goes up?
« Reply #5 on: September 08, 2015, 10:00:54 AM »
ROI and cap rates are only useful in determining whether a deal is worth going for or not. ROI isn't static, obviously. There's always higher ROI out there. It just depends on if you think you can get higher. I'm sure you already know but appreciation is just icing on the cake. I wouldn't really count on it in the future.

Your annual ROI up till this point is simply ((total net rent collected / purchase price)/5). You could do daily, monthly, yearly, it doesn't matter. Your purchase price didn't change and never will. Then you could add back the unrealized 23% (annual) return for the total return thus far. Again, ROI is a snapshot and changes literally by the minute. ROI before you purchase something is simply a really good guess unless you're buying something turnkey and you know the income number upfront.

Compared to DOW's total return of ~9% over the past 5 years up till this point, I don't really agree with what you said in your original post about being able to find a comparable investment with less risk and less more return.

To whether or not you should cash in since your property has doubled in value seems to be a very personal choice. It's like predicting any market. It could keep going up or it could stay flat or it could go down. No one knows. I personally would leave it as is. I mean maybe you could find a cheaper market that would cash flow greater than the ~12% you're currently getting. If you can, maybe it's worth the headache and hassle of selling and finding something else.

Obviously if you're going to move back in then everything I just said is a moot point. I think you're comparing apples to oranges with simply keeping it around because it's a paid off house versus looking at your options from a pure investment standpoint. One can't really be quantified, the other involves numbers.

Quote from: reklar
Whether the value of the property has gone up has no bearing on Cash on Cash or Cap Rate because you didn't invest at the appreciated price.

Yes, exactly. What OP would be looking at now are the opportunity costs associated with holding this investment versus selling it and looking for higher returns.

Bearded Man

  • Handlebar Stache
  • *****
  • Posts: 1142
Re: Recalculate cap rate after property value goes up?
« Reply #6 on: September 08, 2015, 07:52:32 PM »
I will say that I'm still new enough to stock investing for the long term that I am going to keep the house at least until I find something else to put any sale proceeds in. VTSAX and REITS seem to be good investments, but I'm seeing a lot of info that only over very long periods of time do index funds crank out 10% average returns. My rental gets me that and then some every year, and has utility in that I can always move back into it if I need or want to. Heck, my gf and I were thinking of moving in recently. Alas, it looks like due to commute, it will end up being a move to another rental I own that is closer to work than the other house instead.