I’m wrestling with this. I hate renting my old house, but I don’t want to sell cheap. I’ll lay out the stats and my intrinsic value and leave it up to you geniuses to rip me a new one: if any of you BSD’s have the nuts to pony up and provide an opinion. (I really do appreciate the insight, all prodding aside).
Rental income 1495. Property manger takes 7%. 200 a month in propery taxes. Figure another 150 in maintenance. Growth rate figured to be 2%. Avg cap rate of 7% (compressed right now) in my area.
so I figure the intrinsic value is (1495-((1495x(1-.93) - 200 - 150))/.07 - 02. = 249,684.00
edit( L1 mistake) d sub 1 = 1068.16 / .05 x 12 = 256,357.00 = intrinsic value.
the rental offer of 1495 is on the table. We also have an offer of 210,000 net to seller.
Ive got the placed leveraged to the hilt (owe 185k at 3.25%).
My gut says dont even think about selling for less tha 256k less the PITA cost of having a rental.
My back of the napkin math says you should be making about $500-600 per month but most of this will go to pay down your debt which I assume is amortized over 15 years at that rate. You may have some phantom income which may result in negative cash flow but you will have a debt-free property if you can keep it rented. Your tenants are basically paying down your mortgage for you, so I would rent it out.
Also, if you are paying a management company it should not be much of a PITA. That is why you pay them. If it is a PITA, you need a new property manager.
agreed, thanks. And thank you for the response. I showed your profile pic to my wife and said this is the smile of a man who is done with the program, she said your wife (presumed) smiling says even more! Parting comments as I head out to the office to study.
It’s very subjective. I’ve been through a few rounds of appraisals at my office building and it blows me away what they use for cap rates. I mean given the sensativity of the value given a discount rate you would think it would require a great deal of thought. Not the case. Typically tends to be what recent transactions (comparables) have gone for. Quite a bit of this in current version of L2. The problem as I see it, is every investor has his or her own discount rate.
For this property though, and where I got my cap rate, I did a search to find out what the current avg. cap rate on like properties in my market.
knowing how to derive a cap rate is what separates the rulers from the droolers in the RE world. if you don’t already know, no one is going to tell you.
i know how to derive a cap rate. as a friend once said: “I’m chevy chase and you’re not”. good luck applying market average cap rates to your building.
I think cap rates should be viewed more as an output like an earnings multiple is used with companies which makes sense because a cap rate is just an inverted multiple. Using either as an input is dangerous. To arrive at a cap rate, I think you typically need to run a DCF analysis with all of the required assumptions, including the taxes and debt… The only place where cap rate is an input in most of my models is in the terminal value calculation which is typically 15 years out with minimal impact on cash flows. I tend to use a conservative estimate inline with historical cap rates for this input (ex. 10% in a lot of cases). If you need a real estate model in Excel, shoot me a note and I will send you what I typically use.
Cap rates in real estate are highly dependent on the cost of debt for a specific property so predicting cap rates is basicaly predicting interest rates. If I had to guess, I would guess flat for the next 3 years because there is an obscene amount of cash in the market with few options. There is still excess capacity in the economy and technology will prevent wage inflation so rates will likely be in a similar place 3 years from now, maybe slightly higher if the fed runs out of money for its bond purchases.
ok pdx914 level II candidate. i’ll tell you what you should do but first i need some info. how much do you have into this property and what do you expect for an unleveraged yield if you sign this lease? Above routine maintenance, you should have an idea of what your capex will be over the next few years and you should take a reserve out of cash flow for this. also, if you’re going to hold this for several years, chances are you’ll be sitting vacant for a little while so you may want to reserve a little for carry while you’re empty.
my guess is you’ll be barely covering debt service on a cash basis, so your only real source of return is growth in value on the back end. in between expect your tenants to destroy your house. i’d be focused on the quality of tenant you have on the table. get a really good security deposit.
Unless you really think you can lease it at an unleveraged yield above market cap rates, then you’re not adding value by renting it out and the only thing that will bail you out is value growth. to get to that value growth, you need to surrender your property to tenants who may destroy it.
TFergy - Property debt is 185k. Gross rent is 1495, debt service is 1400.00. 1000 of that is primary mortgage, 400 is HELOC I used to get another project going. I’ll call it unrelated debt and honestly my cash flow is sufficient outside of this property to where I have little concern about not covering (I am afterall a BSD, L2 candidate)… Lets say I’ll have the HELOC paid off in two months. What I’ve got in the property then is purchase price of 140k plus 20k of capital improvements. The property just came out of a rental five months ago. Its been vacant since but listed on the market for sale. After the last renter we did 10k of improvements that should last 5 years. This was the third renter in the last five years. Property Management is 7%. Property Taxes is 150 month. I figured maintenance at 200 a month in my estimation of intrinsic value. Cap rates in the area on average are 7% and the pundits expect rental increases to grow at 2% a year for the forseeable future.
I used the avg cap rate because I wanted to know how close the offer price of 210k net was to market value. It wasn’t close (apprx 250k).
Im not sure about the unleveraged yield. Not familiar, perhaps should be. Not a concept addressed in L1or2, probably intuitive enough to figure out. Similar to calculating going in Cap Rate I’d imagine? If that is the case, thats how I derived Intrisic Value, see original post.
cross collateralizing…not a good idea in my experience. anyway, your total costs (regardless of source of funds) are $160 and your NOI from what I calculate is about $965 per month (before any reserves). so your return on cost is about 7.25%. If you can sell it at a cap rate below this rate, you’ve created some value for yourself. If it’s a 7% exit cap, then you’ve created 3.5% of value by entering into the lease (you’ll be able to sell it for $165 and you’re into it for $160).
Nobody factors long term growth of income in a direct cap valuation so your intrinsic value calc is off, unless you can comp it out at a 5% cap rate, which is what you’re effectively assuming in your calculation.
Anyway, sounds like a lot of time and brain damage to get this thing to a value above $210 on an investment sale. your NOI will have to go up by about 21% to get there, assuming the same 7% market cap rate.
Sorry to ask, but could you provide a little math behind your numbers? I don’t follow your logic but that’s ok. There are plenty of opinions on a public forum and I appreciate hearing a contrary one. Yes, I’m anxious to understand.
Regarding cross collateralizing, I’d guess a lot goes into that statement you made but for me using all resources available has proven to be very helpful and the best alternative. A Heloc, established at a time with this was my primary, has been a very low cost source of financing.
The math don’t lie, it’s not an opinion. If you leased it and your NOI is $965 per month then you are going to be able to sell it leased for about $165 if comparable properties are selling at a 7% cap rate. Perhaps your NOI will actually be higher, but you need it to be 21% higher to be able to sell it for $210. Seems like a no brainier to sell.