Formula to calculate for much rent needs to be to cover purchase price
Hi,
I was talking with a big underwriter and he said off the top of his head the only way a deal makes sense if you're paying $100,000 per door is that you're getting $1700 in rent? No explanation given. I can't figure it out. Can anyone makes sense of this or should I just ignore it?
[{"id": "iybbiks", "text": "Not enough info. What are expenses?", "replies": [], "depth": 1}, {"id": "iybe2gk", "text": "1700 x 12 = 20400. 100000 / 20400 = 4.9. 72/ 4.9 = 14.7 - 10% interest = 4.7 rate of return - 3.69 risk free rate on 10 year treasury. One percent! Yeah I see what he is saying.", "replies": [{"id": "iybklxp", "text": "Don\u2019t understand half these numbers. I see a rough GRM calculation. And then 72 out of nowhere. And then it subtracts a random 10% rate and then measures it to a 10-year t bond\u2026 I\u2019m confused.", "replies": [], "depth": 2}, {"id": "iybnzq8", "text": "Can you please explain?", "replies": [], "depth": 2}], "depth": 1}, {"id": "iybg2r8", "text": "There are lots of variables to consider to create such a formula, but here is what I would do (you will see why it's complicated). Every single item in the next sentence is a variable you need to either know or guesstimate. \n\n[(pro forma rent x units) - expenses ] = NOI / (purchase price + closing costs + additional capital put in) = yield on cost. That tells us what our untrended investment yield is.\n\nWe then compare yield on cost to our cost of financing and stabilized cap rates. If yield on cost is higher than those two, that tells us we are getting (or making) a good deal. So holding all other variables equal we could theoretically figure out what that rent number should be. You could do some algebra to figure out what that rent number should be given certain inputs, but good luck. Your broker buddy probably just has a rough idea from experience though.", "replies": [{"id": "iybobe3", "text": "Yeah but we weren't even discussing a specific deal or anything. He shot it out as a general rule. I think there are too many variables for that calculation.\nAnd how would I adapt that going forward? What about a property that's 84k/door? 130k/door etc?", "replies": [{"id": "iybro3r", "text": "Idk sounds like fuzzy math to me, probably just his experience", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "iybw8cl", "text": "He\u2019s doing back of the envelope math. \n\nIf I assume $10k/door OpEx (roughly what it is in my markets for institutionally-sized deals), you\u2019re looking at a 10 cap. \n\nWhether or not a 10 cap is sufficient depends on the risk profile and alternative investments, but a 10 is REALLY high. \n\nWhere is this and how many units?", "replies": [], "depth": 1}, {"id": "iycrqsk", "text": "There are too many variables and assumptions to BOE a large apartment building based on price and gross rent.\n\nHowever, the easiest way to break it down and check is (my assumptions below):\n1. $1700 Rent - 50% Expenses = $850 NOI\n2. $100,000 Price \u00d7 70% Loan = $70,000\n3. $70,000 Loan \u00d7 7% Interest = $5,586 Ann. Loan Pmt\n4. $5,586 Ann / 12 Months = $465.50 mo Loan Pmt\n5. $850 NOI - $465.50 mo. Loan Pmt = $384.50 Net mo. CF\n6. $384.50 Net mo. CF \u00d7 12 Mos = $4,614 Net Annual CF\n7. $4,614 Net Annual CF / $30,000 Down Payment = 15.4% Annual Cash on Cash yield\n\nThe BOE seems to check out, but a 15.4% annual yield is very healthy, so there is much room to adjust some of the assumptions. \n\nHowever, a $384.50 Net CF per month is also WAY beyond breakeven. So the $1,700 per $100,000 in price is a high enough SWAG but may price you out, since the real breakeven and reasonable levered cash yield is much lower.\n\nIf the point of the $1700 per $100,000 is to find breakeven, I call BS on this rule of thumb..since the actual break even is much lower and any sufficiently large monthly rent number will work here.\n\nI suspect the 1% rule is better..$1000 in rent for every $100,000, will get you close to breakeven very tightly on my assumptions.\n\nThe assumptions are:\n1) Expenses are generally 40-50% in most markets, depending on size, age, and quality.\n2) Loans are generally at 65-70% depending on size, units area credit quality, etc. I'm being generous here on the sizing.\n3) 7% rate is a middle-of-the-road figure allowing some buffer. Any higher is getting into bridge territory. Any lower is getting into bank or agency debt. There is no safe rule of thumb in this market...\n3) You need an amortization table if you don't want to work a mortgage calculator. 7% at 30 yrs amort equals approximately $6.65 per mo. for every $1000 of loan amount. For $70,000 a loan, you have $6.65 x 70 = $465.50 per month or $5,586 per yr\n4) 15.4% annual cash yield is very high as we typically expect a 5-9% net levered cash on cash yield, very roughly, considering age, quality and capital needs.", "replies": [{"id": "iyd0cba", "text": "Thanks", "replies": [{"id": "iydcozg", "text": "You're welcome.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "iycuncn", "text": "Comments like that are useful for chunking down large volumes of data into a simple point, in order to make a buying decision quicker.\n\nThat being said ..... your big underwriter friend is being EXTREMELY conservative with his assessment.  There is a ton of information you would still need for each individual property but spitballing his comment ..... I'll take 50K units if he has them at that price (site unseen) !!!", "replies": [], "depth": 1}, {"id": "iycv2li", "text": "Some people go by the \"1% rule\" which is that the monthly revenue is 1% of the purchase price at a minimum. Some people say 2% is a great return. He might be somewhere in the middle (1.7%). I don't see sophisticated investors doing this very often but it could be the way his smell test works before underwriting anything.", "replies": [], "depth": 1}, {"id": "iydiy56", "text": "Need to know NOI", "replies": [], "depth": 1}]