From the listing for 555 4th Street #715 in The Palms:
Solid investment property, already rented $2800/month…Property virtually rents and manages itself…No eviction control, no rent control…Low maintenance since the property is almost new…Hoa dues paid through december 2009.
We’ll let you confirm that’s a sustainable market rate rent, run your own numbers, and draw your own conclusions about how solid this investment might or might not be.
We will note, however, that focusing on being “cash flow positive” is rather naïve in terms of investing. In a down market the loss of principal can quickly offset any carry. And being “cash flow positive” doesn’t speak to a rate of return.
∙ Listing: 555 4th Street #715 (1/1) – $605,000 [MLS]
∙ The Palms (555 4th St.): Secondary Market Slowdown And Short Sale [SocketSite]
HOA paid through 12/2009 can be accounted for as a price reduction of about $5000. So the property is priced at $600,000. With rent per month of $2800, that’s a rent maultiple of 215. A 1/1 is very hard to justify as an investment above a multiple of 150.
I come up with a Cap Rate of 3%. Too low for investment IMO.
May make sense for owner occupier… maybe someone will do the number from that angle.
Good luck trying to maintain that rent level! This is not going to be a normal downturn, and we’re just getting started.
Not rent controlled I get, but eviction? Can someone confirm?
Uh, rent of $2800.
HOA is $428 which leaves $2372
Monthly taxes of $650 leaves $1722
A 30-year fixed mortgage of $480k at 6.25% costs $2955/mo
Leaving you with -$1223/mo in “cashflow” assuming you put ~$120k downpayment.
You get a credit for depreciation of the structure (over 27 years) which you would have to factor in. I’ve heard that rentals also need periodic maintenance.
Tell me again how this is cashflow positive? I don’t think it would be truly cashflow positive even at half the price.
“We will note, however, that those who simply focus on being “cash flow positive” are rather naïve in terms of investing. In a down market a loss of principal can easily offset any carry. And of course being “cash flow positive” doesn’t speak to any actual rate of return.”
Least insightful paragraph ever written? Just maybe.
As a renter I’ve self-taught myself a lot about the real estate market, but I still don’t understand what a Cap rate is. I’ve tried to research it online with limited success. Would anyone care to give me a one paragraph explanation or point me to a good source on it? It would be greatly appreciated.
I should add that I am asking because I just can’t fathom why anyone would say $2,800 rent on a $605,000 apartment is a good investment. Even with tax credits, HOA suspensions, etc. I don’t see how it works.
Let’s see….a 3% cap rate when Citibank is offering FDIC-insured CDs at 4% for 6 months.
Purchased for $634,500 in February of last year. So roughly a $60K loss assuming it sells at asking (and 4% commission).
This is one of five 1-bedrooms for sale at the Palms, and 3 are cheaper than this place. Plus #401, which is a 2/2, is on the market for $634,200 (roughly what #715 sold for last time). And is probably negotiable.
Finally, as Jimmy points out, this is NOT cash flow positive. Not even close. Prediction: short sale in the making here.
I feel sorry for the renter in this unit about to get evicted due to forclosure.
I think renters need to asses the risk on “mom and pop” landlords who are all underwater. I would stick with a corporate-owned complex as they are more stable.
Why risk renting a condo from someone takig a loss each month?
I would also add that a LL underwater would give you very crappy service -that and try to nickel-and-dime you to death on the deposit just to make that little extra money back he/she needs.
@ Jane:
The purpose of a capitalization rate (cap rate) is to figure out the rate of return on an investment property. Appraisers use cap rates to determine the value of an investment property.
There are different methodologies to calculating a cap rate, but the most commonly used is the OAR (or the overall rate).
To figure out the rate using the OAR method is easy. You divide the sales price by the net operating income. The sales price is self-explanatory. The net operating income = gross annual income (all income generated by the property), less income lost due to vacancies, uncollectible rents, and operating expenses (such as maintenance and property management fees).
Once you divide sales price by net operating income, you get the Capitalization Rate. This is the rate of return (or percentage used to convert income into is value equivalent).
So why does it matter? Because using the cap rate, you can determine a property’s value at a specific rate of return. For example, a property earning $40,000 per year at a rate of return of 10% can be said to have a value of $400,000.
The way appraisers use this info to determine the value of a particular property is to analyze cap rates of comparable investment properties, and using these rates, come up with a value range for the property in question.
Are you lost yet??
Excuse me, you divide the net operating income by the sales price. (had it backwards)
@Jane
The capitalization rate is a yield calculated by dividing one-year’s net operating income by the purchase price. Net operating income is rents collected less operating expenses. It’s basically the inverse of a price-earnings ratio.
Rents collected would include a deduction for reasonable vacancy/collection losses.
Operating expenses include taxes, insurance, maintenance, management fees, leasing, and any administrative costs. Even if you manage it yourself for “free”, you have to include a market-level management fee (as if you were paying yourself for the work you’re doing).
Operating expenses do not include any debt service payments or depreciation.
If a property throws-off $5,000 in annual net operating income and the purchase price is $100,000 then the cap rate is 5.0%.
It gets a bit more complicated but those are the basics. I hope this helps.
1 – No square footage. Anyone knows how big this unit is?
2 – This is not a good price point for rental investments. Of course, had the prices gone up another 15% per year they’d be sitting on a pile f equity, offsetting the losses on this rental.
3 – 2800 for a 1BR is a bit steep. Wait for the same 1BRs to go under 500K and you’ll see your renters rushing out the doors to buy their own place.
My estimate, as a rental investment (based on high HOAs and location): it belongs in the high 200s segment (for 600-800sf) or 300s if it has more footage. The landlord should offer it to his gem of a renter for 550 or more.
I understand how a renter with a MTM lease would be SOL in event of a foreclosure.
If the tenant has a lease, I don’t believe that would be negated in the event of a foreclosure. Worst case scenario for the tenant, the buyer would take title subject to the lease and would have to wait until lease expiration to raise the rent or evict the tenant?
Are there any lawyers, property managers, or leasing agents out there who can verify this?
I agree with SausalitoRes. The lease would likely survive foreclosure and/or change of ownership. Regarding an earlier question, properties built after 1979 are not subject to rent or eviction controls (ie the just cause limitations).
When a bank takes over a property, the lease is erased and the tenant generally evicted -with no notice or short notice.
Banks are not required to honor previous leases once the LL’s property is seized.
Regarding capitalization rates, it is important to understand that loan interest is not included as an operating expense, even though most buyers would in fact take out a loan to finance the purchase.
Here is a quick, simplified example of the indicated capitalization rate for a hypothetical investment property with a $2,800 monthly rent potential and a $600,000 purchase price.
Potential gross income: $33,600
Less (say) 5% stabilized vacancy loss: ($1,680)
Effective gross income: $31,920
Less operating expenses:
R.E. taxes @ 1.163%: ($6,978)
HOA fees @ $428/month
(includes insurance, reserves): ($5,136)
Allowance for maintenance @ 3% of EGI: ($958)
Property management fees @ 5% of EGI: ($1,596)
Net operating income (NOI): $17,252
Capitalization rate = NOI divided by price = 2.9%
Note: this is a simplified, hypothetical example of the derivation of a cap. rate and does not constitute investment advice.
Are you guys sure about that? I thought there was a new law that required 90-day notice to a tenant if their landlord got foreclosed? Maybe it was suggested but never implemented.
In any case, don’t cry too much for the tenant here. They can save $150/month by moving down the hall:
http://sfbay.craigslist.org/sfc/apa/900669201.html
F,
1 – You’re including insurance in the HOA. Is that a homeowner’s insurance or just the HOA?
2 – What about repainting the place, carpet, appliances that will need replacing. 3% for maintenance seems really low based on my experience. On 9 rentals I had at least 2 places that required sizable work done each year. About 10% of the rent went into repairs or building work.
From the 14 years I have been a landlord, I found out you get a better ROI than government-insured CDs only when your buy/rent ratio is under 100. And cash flow is always an issue for small time landlords. Cash flow is what kills most mom-and-pop rental businesses.
wow. that looks like the cheapest kitchen I’ve ever seen before. I’m sure it’s high end or whatever (I often can’t tell the difference between high end and cheap, especially when it’s laminate stuff), but my goodness it reminds me of the 1980’s… and not in a good way
and you know it’s bad when it only has 2 pictures of the unit. (I don’t count 2 extreme closups of the floor and countertop to be a pic of the unit).
they have more pics of surrounding buildings than they do of the unit. And more views of the lobby than the living space.
horrible listing. horrible unit.
THis would have to be priced below $400K to buy it as a successful rental investment
Thanks for the explanations of what a cap rate is. So, my landlord is getting about a 16% cap rate on my place based on F’s rates for taxes and maintenance and such. Sigh. He’s doing even better because I’m low-maintenance and have been here a while.
(Interestingly, if he had paid today’s Zillow estimate for my place he would be at a 1% cap rate with those same numbers.)
cabinets are studio becker, prob better than your buddies in the big blue tower. Palms is a terrible location, but still better than One Rincon. No deeded parking. People bought here before the other mid-level condos came online and are bit behind.
re: no deeded parking
Palms residents got letters last month from the developer asking about their interest in purchasing their parking space.
“When a bank takes over a property, the lease is erased and the tenant generally evicted -with no notice or short notice.
Banks are not required to honor previous leases once the LL’s property is seized.”
What have you been smoking and where did you go to law school? A bank cannot void a lease.
M.R.
Someone wrote:
“When a bank takes over a property, the lease is erased and the tenant generally evicted -with no notice or short notice. Banks are not required to honor previous leases once the LL’s property is seized.”
Then M.R. wrote:
“What have you been smoking and where did you go to law school? A bank cannot void a lease.”
A lease is subordinate to a deed of trust and a forclosure will void all leases (but most banks will let a tenant stay until the end of a lease). If a forclosure would not wipe out a lease everyone would lease homes to friends for 99 years at $1 a year before the forclosure…