Author Topic: Property Buying Parameters  (Read 3306 times)

frugally

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Property Buying Parameters
« on: July 03, 2014, 05:17:53 PM »
Hey Folks,

I'd like to get a sense of what the community is using for their KPIs when evaluating properties.  Right now I'm just using cash-on-cash return to evaluate and would like to get a sense of what others are doing.  Do you use cap rate?  Do you see what it would cash flow at 100% financing and try everything in your power to extract your leverage?  Thanks for the input!

jk

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Re: Property Buying Parameters
« Reply #1 on: July 06, 2014, 11:54:59 AM »
This is a question much on my mind too.

I am very much an amateur but in my opinion the measure that gives the best indication of whether a property is an investment that will work is the cap rate.  If the net return from a property as a % of its price meets your requirement then your safety margin should be satisfied.  This assumes, of course, that your are being honest with yourself and accurate on both the calculation of the return and your own safety margin.


KBecks2

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Re: Property Buying Parameters
« Reply #2 on: July 07, 2014, 11:10:40 AM »
What is a KPI?   I am considering getting started this fall and I want to look at properties that have a 1.5% to 2%+ rent to purchase price ratio.  I am hearing over and over that a 2% property will cash flow well.  Capital expenditures are a concern but I will also take that into consideration in choosing a property.

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Fishingmn

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Re: Property Buying Parameters
« Reply #3 on: July 07, 2014, 02:10:46 PM »
KPI = key performance indicators

I think normally the biggest number to focus on is the cash on cash return for most investors.

For many cap rate is something to somewhat look at but not nearly as important (unless you are a 100% cash buyer where cap rate and cash on cash return are the same).

Using the 1.5-2% rule is good if you can find markets where they work. Certainly use the 50% rule for estimating expenses when doing a pro forma to estimate cash on cash return as that is how I would find out the expected return.

johnhenry

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Re: Property Buying Parameters
« Reply #4 on: July 07, 2014, 03:33:20 PM »
I look at, in this general order:

Cap Rate
Cash on Cash Return
Breakeven occupancy
operating expense ratio
debt coverage ratio

  Also factoring in:
expected capital cost and timeline required (new roof/HVAC expected in 12 years or 2 years?)
general feel of neighborhood (is it swinging up or down)
value of this home vs others in the neighborhood
school district
how it complements my existing portfolio concerning diversity in different towns, neighborhoods, sizes, etc....


  Fishingmn is right about most investors focusing on cash on cash returns.  And I'm in that camp.  All other things equal, I'll usually take the deal with the best cash return.  But... the reason I like to use the cap rate is to compare potential opportunities with other potential deals and other current investments to see how they stack up against each other.  Even though I'm not (usually) a 100% cash buyer, to me, the cap rate is a good indication of the quality of the investment compared to others.  Your cash on cash return on new opportunities will change over time with interest rates and will also be affected by your down payment.  And I've run into situations where, on a certain property, banks were requiring 25 or 30% down instead of the 15% I'd been doing with them. That naturally lowered the cash-on-cash metric for that property, but the cap rate was very favorable compared to other options that required only 15% down.

  Cash return is a valuable metric because it accounts for financing costs/leverage, but cap rate is valuable because it ignores them :)  In either case, the most difficult part is accurately estimating the income/expense numbers that go into the equations.

  I would agree though, it's hard to go wrong with a property that meets the 2% rule. 

arebelspy

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Re: Property Buying Parameters
« Reply #5 on: July 08, 2014, 02:18:53 PM »
Your criteria depends on your goals.

Real estate is local, and I have different criteria for different markets.

All of the above things that people mentioned (ROI/cash on cash/etc.) are things to look at, yes, but it will vary by market and by goals, so you need to set targets based on your goals.

Do you see what it would cash flow at 100% financing and try everything in your power to extract your leverage?

You should always make sure it cash flows at 100% financing (otherwise you are forcing cash flow), but that doesn't mean you need to take as much financing as you can get.  You may want 100% financing, or you may want to put down 20%, or 50%, or 100% (pay all cash).  But you should still run the numbers and make sure it cash flows (typically 100-200 per door minimum) at full financing.
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frugally

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Re: Property Buying Parameters
« Reply #6 on: July 08, 2014, 03:23:14 PM »
Your criteria depends on your goals.

Had a feeling you or someone else would say that. :)

Based on a 15-year ownership horizon, it would seem my order of importance is as follows:
  • 100% Financing Cash Flow > $100/door/month
  • Cash on cash return > my target
  • Cap rate > target

This seems to be in line with how the rest of the community thinks.  Thanks for the sanity check!

arebelspy

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Re: Property Buying Parameters
« Reply #7 on: July 08, 2014, 05:29:37 PM »
Your criteria depends on your goals.

Had a feeling you or someone else would say that. :)

Heh.  Only cause it's true.  ;)

Some of my investments I'm targeting a 15% cash on cash return.  Others I'm targeting 5%.  It really depends, and it's because of the various goals I have, the markets they are in, etc.
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with three kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

JayKay

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Re: Property Buying Parameters
« Reply #8 on: July 09, 2014, 04:29:32 PM »
Generally, I look at:

* COC return (I like to see 10-15% depending on the interest rates and the area)
* Age of the building (the newer the better)
* # of bedrooms (Usually at least 3 is what I like to see)
* rents about 1% of the purchase price
* follows the 50% rule, generally
* property and insurance costs
* high avg income, good jobs and low crime rate in the area (think "nice quiet suburb")

I'm also seeing more the benefit of getting multifamilies rather than SFHs, mostly to get the most bang-for-the-buck out of your loan.  I've found smaller mortgages are more costly, more trouble to get, and can quickly max you out.

Generally, I'm suspicious of homes that rent out for 2% of the purchase price.  To me, this often means a less desirable area, less potential for appreciation, more vacancy, etc.  A cheap deal doesn't usually mean a good deal.

I have a couple of condos, but I definitely wouldn't get more, mostly because HOA fees tend to be unpredictable and they cut into profits too deeply.  Also, HOAs can be unfriendly to landlords.

Basically, all of this list is geared toward creating steady retirement income, so I want as much "hands-off no-hassle" as I can get.