Potential Investor with $150,000.00

[jarrettvaughan]

I have an investor that is interested in investing $150,000.00 with my on a JV. I currently own in Chilliwack and Red Deer and would prefer to stay in these areas as it is what I understand.

They need as much cash flow as possible.

Should we buy multifamily (4-8 plex), buy a house or townhouse with a very small mortgage or pay cash for a very cheap condo? Maybe a couple houses or condo with $75,000.00 down on each? Which city? Any other options?

Any advice would be very helpful as I want to ensure that I can offer them a deal with cashflow of $800.00 -$1000.00 per month.

 

[Thomas Beyer]

Cash flow in real estate works with high CAP rates and low mortgages only !

So: an apartment building 50% levered (at most) .. or a retail centre .. but likely not a single family house or condo !

8% cash-on-cash ROI is VERY VERY HARD to realize .. unless you over distribute like some private or public REITs and tap into mortgage paydown !

 

[Nir]

Thomas, Jarrett wants to maximize net income and cash on cash ROI for his partner - both are increased with an increase in LTV!

Therefore, look for high CAP (you got that right Thomas) AND high LTV. what probably confused you Thomas is the following:

You are correct saying cash flow is improved with a lower mortgage WHEN TALKING ABOUT THE SAME BUILDING. BUT.. what higher LTV allows you to do is buy more with the same down payment amount ($150K), meaning you buy a bigger building!* --> as a result you get a higher cash on cash ROI and higher net income.

Bottom line Jarrett, Yes, look for a 4-8 plex with a good CAP and 25% down (even 20% if possible).

Good luck!
N.

* "bigger building" means a more expensive building, most likely with more units, that generates MORE REVENUE/RENT!

 

[housingrental]

investmart: There are some things that should be taken implicitly from Thomas`s post:
1) Your are paying more interest on a larger mortgage. If there is an adequate spread between cap rate and mortgage interest rate this might allow for higher cash flow - HOWEVER - there is an increased risk from this as there`s only increased cash flow if performance from operations hit the planned numbers - This is not a 100% given - So for stability of return your comparing apples to oranges - If you need an X% return to use the cash flow to live off aiming for an X+Y% return might not be the best route - as you`ll sometimes end up with an X-Y% return instead!

2) You are paying down principal from the mortgage - so although higher return potential this isn`t cash in the investor pocket - so no mortgage has it`s benefits.

3) For certain investment properties lower interest rates are available with lower loan to value - so 40% LTV might be 1.5% cheaper money than 70% LTV, ETC...

Jarrett: In these posts Thomas`s years of experience shine through, he has provided good advice.

 

[Thomas Beyer]

QUOTE (investmart @ Oct 2 2010, 08:28 PM) .. as a result you get a higher cash on cash ROI and higher net income.
..
Actually that is INCORRECT !

The higher the leverage the LOWER the cash-on-cash ROI !!

The only thing higher is the TOTAL ROI assuming flat or positive asset value growth .. but at the expense of cash-flow (or cash-on-cash ROI) !!

 

[Nir]

Adam, the debate is not about risk but rather the expected cash on cash ROI, net income etc. if you want to minimize risk we can put the money in the bank.

Thomas, reminding you of the formula I developed: ROI*= {(CAP-i) /d} + i
As you can see, the less you put down (d) the higher the cash on cash ROI(%) is.
Obviously, the more you put down the higher the net income will be in $, on that building, because you reduced your mortgage payments. But not the ROI(%)!
ROI(%) is lower/worse when you put more. (as long as CAP higher than mortgage interest of course. otherwise, you have negative cash flow regardless of the leverage)

Example:

2 possible purchases with 100K down:

1. buy one 4-plex 200K 50% down. Net income $500/mo
OR
2. buy two 4-plexes 200K 25% down each. Net income $300/mo x 2 = $600/mo

In option #2 you increased your net income to $600 from $500 by putting less down and as a result buying more with the same total down payment amount of 100k.
you also increased your cash on cash ROI from 6% to 7.2% (500x12/100K --> 600x12/100K)

[note: same result %-wise when looking at it per building: an increase in ROI(%) from 6% to 7.2% (500x12/100 --> 300x12/50K)]

Am I missing something?

so minimize your downpayment and maximize leverage if maximizing net income is your goal.

Cheers,
N.

 

[Thomas Beyer]

QUOTE (investmart @ Oct 4 2010, 09:55 AM) ..Am I missing something?
..
yes, the formula is incorrect !

cash on cash ROI = (CAP - mortgage payment) / downpayment

so TWO times 3 scenarios:

A) 6% CAP RATE (say an apartment building or 4-plex)

a) one unit

100K per unit in your example .. say 6% CAP rate and 4% interest rate

100K down = no mortgage = 6% ROI = $6000 / year

b) 2 units

2 * 50K down = 50K mortgage each for 2 100K units = $12,000 income - 6410 mortgage payment (using 25 year amortization) = 5590 income = 5.5% cash-on-cash ROI .. i.e. LESS

3) 4 units

4 * 25K down = 75K mortgage each for 4 100K units = $24,000 income - 19200 mortgage payment = $4800 income = 4.8% cash-on-cash ROI

you will make more money if values are at least flat in 5 years as mortgages have been paid down 10% each .. but AT THE EXPENSE OF CASH FLOW !!

B) a single family house (5% CAP rate)

a) one small house

100K per unit in your example .. say 5% CAP rate and 4% interest rate

100K down = no mortgage = 5% ROI = $5000 / year

b) 2 small houses

2 * 50K down = 50K mortgage each for 2 100K units = $10,000 income - 6410 mortgage payment (using 25 year amortization) = 3590 income = 3.5% cash-on-cash ROI .. i.e. 30% LESS

3) 4 small houses

4 * 25K down = 75K mortgage each for 4 100K units = $20,000 income - 19200 mortgage payment = $800 income = 0.8% cash-on-cash ROI i.e. over 80% LESS

it gets worse as most houses do not have a 5% CAP rate (worse usually) and there is closing costs that can`t be mortgaged !

Thus: decide what you want: cash-flow or 5 year total cash-on-cash ROI assuming an exit in 5 years .. as you cannot maximize both !

 

[bizaro86]

The difference between your two opinions (I believe) hinges on the difference between interest rates, and mortgage pyament factors.

For example, on a 4% interest, 100,000 mortgage with 25 year amortization, the monthly payment is 528, or an annual payment of $6336, which is 6.33% of the mortgage. Thus, in this example, the mortgage payment factor is 6.33%.

For cash flow to increase with leverage, the cap rate must be higher than the mortgage payment factor, not the interest rate.

Example: a 100,000 property with a 10% cap rate, (obviously high, but used for illustrative purposes).

NOI is 10,000 per year, at 100% down, you have cash flow of 10,000 per year. If you buy 2 of these properties with 50% down, you have used the same 100,000 of your cash and 100,000 of the banks cash, for which you pay them 6336 per year.

NOI: = 10,000* 2 properties = 20,000
Mortgage = 6,336
cashflow = 13,664

As you can see, with increased leverage, cashflow goes up. This is because the cap rate is higher than the mortgage payment factor, so every dollar of the banks money you substitute for your money increases your cashflow.

As Thomas shows above, with 4% interest and a 6% cap rate, the cash flow goes down as borrowing goes up, because the mortgage payment factor is greater than the 6% cap rate.

Michael

 

[Thomas Beyer]

QUOTE (bizaro86 @ Oct 4 2010, 10:43 AM)
..



For cash flow to increase with leverage, the cap rate must be higher than the mortgage payment factor, not the interest rate. ..


That is true .. IN THEORY.



A 10% CAP rate in a decent area with good economic fundamentals does not exist in Canada .. especially if counting the necessary, but usually forgotten R&M expenses that tend to creep up from time to time ! Add the capital expenditures like a new roof or a new boiler or a new carpet that is rare but also has to be counted and is usually not included in CAP rate figures .. and even a 6% CAP rate is tough to achieve !



Having said that the cash-on-cash ROI is just ONE of 3 metrics one needs to consider:

a) one being the ROE or as Don Campbell calls it: the cash-on-cash PLUS .. namely the cash-on-cash ROI PLUS the mortgage paydown, and

b) the third one being the total return assuming some equity growth that is not guaranteed, of course, but prudent to assume in any healthy real estate market over a 5 or 10 year period !



More here on these calculations to make money in RE: http://myreinspace.com/public_forums1/Real_Estate_Discussion/62-10711-Equity_is_not_the_only_way_to_make_money_in_real_estate.html

 

[bizaro86]

QUOTE (ThomasBeyer @ Oct 4 2010, 12:12 PM)
That is true .. IN THEORY.



A 10% CAP rate in a decent area with good economic fundamentals does not exist in Canada .. especially if counting the necessary, but usually forgotten R&M expenses that tend to creep up from time to time ! Add the capital expenditures like a new roof or a new boiler or a new carpet that is rare but also has to be counted and is usually not included in CAP rate figures .. and even a 6% CAP rate is tough to achieve !



Having said that the cash-on-cash ROI is just ONE of 3 metrics one needs to consider:

a) one being the ROE or as Don Campbell calls it: the cash-on-cash PLUS .. namely the cash-on-cash ROI PLUS the mortgage paydown, and

b) the third one being the total return assuming some equity growth that is not guaranteed, of course, but prudent to assume in any healthy real estate market over a 5 or 10 year period !



More here on these calculations to make money in RE: http://myreinspace.com/public_forums1/Real_Estate_Discussion/62-10711-Equity_is_not_the_only_way_to_make_money_in_real_estate.html




Absolutely 10% isn't realistic, as I mentioned above. I used it more for computation convenience than anything else. Interestingly, a 4% mortgage with a 35 year amortization gives a mortgage payment factor of 5.32%, so even with a 6% cap rate property cash flow would be improved by buying more property with higher leverage.



Cash flow is of course not the end-all be-all, as you mention above, but it seems like for the investor involved in this project, its a pretty important point. Which (to belatedly bring the thread back on topic) would mortgage investments make sense for this particular investor? 1000 per month on 150,000 investment is 8% interest, and I suspect that mortgage investments at that yield could be found by anyone, and could be done safely by someone who looked carefully.



Regards,



Michael

 

[Thomas Beyer]

QUOTE (bizaro86 @ Oct 4 2010, 11:52 AM) ..1000 per month on 150,000 investment is 8% interest, and I suspect that mortgage investments at that yield could be found by anyone, and could be done safely by someone who looked carefully.

..
namely where ?

8% is NOT easy to deliver !

Some MICs do that .. but with construction mortgage or 2nd mortgages ..

Show me 2-3 examples of commercial firms (publicly traded or private) that deliver a safe 8% cash flow and I`ll shut up and/or invest even !

REITs ? Syndications ? MICs ? JVs ?

8% per year is doable, of course, over a 5+ year horizon with some modest value growth assumptions but NOT as cash-flow .. unless it is a vehicle that essentially pays you back your own money (or that from new investors) such as many of those dubious 10%+ advertisements out there !!

 

[bizaro86]

QUOTE (ThomasBeyer @ Oct 4 2010, 01:07 PM)
namely where ?



8% is NOT easy to deliver !



Some MICs do that .. but with construction mortgage or 2nd mortgages ..



Show me 2-3 examples of commercial firms (publicly traded or private) that deliver a safe 8% cash flow and I'll shut up and/or invest even !



REITs ? Syndications ? MICs ? JVs ?



8% per year is doable, of course, over a 5+ year horizon with some modest value growth assumptions but NOT as cash-flow .. unless it is a vehicle that essentially pays you back your own money (or that from new investors) such as many of those dubious 10%+ advertisements out there !!




I said 8% could be done by anyone, by investing in one of the many MICs that offer such a yield. I specifically didn't say that it would be safe, because as you mention they invest in 2nds and development loans. I met a gentleman this weekend who was collecting rents on his apartment style condos in a building I own a condo in. He had a bunch of them, which he foreclosed on when the prior owner went bankrupt. Obviously that investment had risk.



As for a lower risk 8%, I was thinking of direct mortgages to REIN members, when both they and the deal have been thoroughly vetted by the investor. Obviously that takes both hard work and some cleverness. Deals of this nature regularly pop up on the REIN classifieds, the most recent one is here: http://myreinspace.com/classified_ads1/Joint_Ventures/74-18264-Wanted_-_Short_to_Medium_Term_Private_Money.html.



I make no comment on the nature/quality of this specific offer, but am using it for illustrative purposes only.



Michael

 

[Nir]

Hi Thomas, Michael from Calgary is correct: just plug in CAP 7% in your own example and you will get a higher ROI% when buying 2 units than when buying one.

Also, you are correct Thomas - the formula I developed includes principal reduction. However, since you can take out equity after 5 years, this formula is probably the more relevant one for most investors than any other.

Regards,
N.

 

[Thomas Beyer]

QUOTE (investmart @ Oct 4 2010, 03:44 PM) Hi Thomas, Michael from Calgary is correct: just plug in CAP 7% in your own example and you will get a higher ROI% when buying 2 units than when buying one.

Also, you are correct Thomas - the formula I developed includes principal reduction. However, since you can take out equity after 5 years, this formula is probably the most
relevant one for most investors, than any other.
except for those that run out of cash due to overleverage when vacancies occur !!

OF COURSE more properties are better IF
a) you can carry them (through cash-flow or cash at hand), and
b) they don`t drop in value

Hence I trademarked the term: Cash is King - Cash-Flow is Queen !!


Since CAP rates and interest rates are closely related I used a 6% CAP and 4% interest rate .. a differential of about 2% which is a common occurrance ! So when interest rates are 5% a 7% CAP rate is more common too !

 

[Nir]

QUOTE (ThomasBeyer @ Oct 4 2010, 05:57 PM) Since CAP rates and interest rates are closely related I used a 6% CAP and 4% interest rate ..

Thomas,

Actually correlation is pretty poor: interest rates are the same everywhere in Canada. Average CAP changes from city to city. 6-plex for example:
Toronto around 5% Hamilton: around 7%, Sudbury maybe 8-9%. CAP is also a function of the amount of work needed to renovate or/and manage the building: a neglected building will require more work and therefore cost less and generate better CAP (to compensate for the additional work needed). A building in a great condition will require less work, be more expensive and therefore generate lower CAP.

Sincerely,
N.

 

[jarrettvaughan]

I appreciate this very deep and complicated debate but I would like to bring the topic back to the original questions and get some clarification on some other questions I have.

I have a couple elementary questions:

Is there a minimum down payment required on a multifamily building? If so, what percentage?

What type of interest rate range can be expected on a 8 plex (appox)? Of course, I understand that each property will be different.

At what point does a property become a multifamily building? 6, 7 or 8 units?

What type of cap rate would you consider looking at in Chilliwack or Red Deer?

Thank you for your help.

 

[bizaro86]

QUOTE (jarrettvaughan @ Oct 5 2010, 08:25 AM) I appreciate this very deep and complicated debate but I would like to bring the topic back to the original questions and get some clarification on some other questions I have.

I have a couple elementary questions:

Is there a minimum down payment required on a multifamily building? If so, what percentage?

What type of interest rate range can be expected on a 8 plex (appox)? Of course, I understand that each property will be different.

At what point does a property become a multifamily building? 6, 7 or 8 units?

What type of cap rate would you consider looking at in Chilliwack or Red Deer?

Thank you for your help.

Hello,

You can access information about CMHC insurance for multi-unit properties here. It`s recommended to allow you to access a more competitive interest rate. http://www.cmhc-schl.gc.ca/en/hoficlincl/m...-Purchase_E.pdf

I should not that they say they`ll do 15% down, but that`s off their appraisal, so don`t plan on putting down 15% of the purchase price, it`ll almost always be higher.

Michael

 

[jarrettvaughan]

Thank you for your help.

QUOTE (bizaro86 @ Oct 5 2010, 07:44 AM) Hello,

You can access information about CMHC insurance for multi-unit properties here. It`s recommended to allow you to access a more competitive interest rate. http://www.cmhc-schl.gc.ca/en/hoficlincl/m...-Purchase_E.pdf

I should not that they say they`ll do 15% down, but that`s off their appraisal, so don`t plan on putting down 15% of the purchase price, it`ll almost always be higher.

Michael

 

[Thomas Beyer]

QUOTE (jarrettvaughan @ Oct 5 2010, 07:25 AM) Is there a minimum down payment required on a multifamily building? If so, what percentage?
15% in theory .. 25% in most cases these days .. often 30% !

QUOTE (jarrettvaughan @ Oct 5 2010, 07:25 AM) What type of interest rate range can be expected on a 8 plex (appox)? Of course, I understand that each property will be different.
with CMHC around 3% today .. 4% for conventional .. changes daily !

QUOTE (jarrettvaughan @ Oct 5 2010, 07:25 AM) At what point does a property become a multifamily building? 6, 7 or 8 units?
5-plex or bigger usually ! .. some bansk lend residential up to a 6-plex but that is not so common.

QUOTE (jarrettvaughan @ Oct 5 2010, 07:25 AM) What type of cap rate would you consider looking at in Chilliwack or Red Deer?

7.5% Chilliwack .. 5.5% Red Deer