I’ve been a member of the fastlane forum for only a short time, and thus do not necessarily have the stature in this community to stick my neck out and offer advice contrary to the attitudes on the forum.
This said, however, I’ve noticed some virtual “high-fiving” going on in the real estate segment here regarding cheap property, and this disturbing indeed because it is dangerous! In the spirit of this community, which I’ve gathered even in the short time that I’ve been here, to add value, I feel validated expressing the following perspective…if you just bought a house for $9,000 and are increasingly proud of yourself – hang on to your knickers, and you just might learn something…J
Some Assets are Worth Less than $0.
The first thing you must understand is that just because something is affordable, or in this case cheap, doesn’t make it good. There are some assets, believe it or not, that are worth less than $0 relative to the value they add to your life (much as some relationships are worth less than $0, but let’s leave that for another time..)
About ROI
What determines value of any investment is ROI – Return On Investment. Unfortunately, in real estate this return can be measured in a multitude of ways, and while some metrics are increasingly honest, other metrics are virtually meaningless. This is all matter of perspective.
For example, most people are familiar with Cash on Cash Return (CCR, or COC). CCR juxtaposes the total investment of capital to the total return of capital. Thus, is you spend $9,000 cash to buy a house at the court house steps, spend $15,000 more to put lipstick on that PIG (get it?), and spend another $1,000 for closing costs, then the total cash investment is $26,000.
Let us assume that you can rent that house for $600, which is a stretch, but for shits and giggles… $7,200 of Gross revenue per annum. Let’s just say that property taxes, insurance, R&M (repairs and maintenance), etc . total $250/month, or $3,000/annum. Seemingly, $4,200 of Annualized Cash Flow on an investment of $26,000 constitutes 16% return relative to CCR.
You have to understand that houses don’t sell for $9,000 for no good reason. The marketplace has decided that this house – what it is, and where it is – this house is only worth $9,000.
This means a lot of different things, and I could take this on a lot of tangents, however, let’s focus on vacancy for today – follow this logic:
· House is cheap; why?
· Because people don’t think it’s worth more; what does this mean?
· It means no owners want to live there; what does this mean?
· If the owners don’t want to live there, why should the tenants want to live there? They won’t want to live there…
In other words, the only tenants you’ll get into the house are people without better options. Everyone who can afford to, and qualify for will go somewhere else. What does this mean?
Physical Vacancy
Those cash flow numbers from above do not include vacancy, which is simply understood as the time a unit sits empty. In my town, vacancy may be 3%-5% in better assets classes, a $9,000 might sit vacant 20% of the time by the time it’s all said and done.
In dollar terms, you would account for this by subtracting $1,440 from the Gross Potential of $7,200 (which is 20%). This, in turn, will compress the cash flow number to $2,760, which now will constitute a 10.6% CCR… I hope you can do better, but we are not done L
Economic Vacancy
Economic vacancy accounts for all of the losses associated with vacancy that are not vacancy itself. Things like bad debt (this is people stiffing you), or concessions (these are discounts you give just to get people in), and many others. In a $9,000 house, because of what it is and where it is, you’d be lucky to run economic losses of 15% - they will be higher!
Subtract another 15% from gross potential and your CF now looks like $1,680 – 6.4% CCR.
Let’s Talk About CapEx
Let me ask you – people who stiff you for rent, are they going to be too concerns about taking good care of your property?
You got it – the rest of the cash flow that you think you have will be spent fixing holes in the walls…
Conclusion
This barely scratches the surface of that which is property. My intent was to undersore the point that not everything is as it seems in real estate – in fact, most things are not!
PIGs are dangerous indeed because people feel that since they are cheap, it’s impossible to lose. Wrong – it’s not only possible, it is the most likely outcome! In this case, your $9,000 house might be worth less than $0
Hope this helps.
This said, however, I’ve noticed some virtual “high-fiving” going on in the real estate segment here regarding cheap property, and this disturbing indeed because it is dangerous! In the spirit of this community, which I’ve gathered even in the short time that I’ve been here, to add value, I feel validated expressing the following perspective…if you just bought a house for $9,000 and are increasingly proud of yourself – hang on to your knickers, and you just might learn something…J
Some Assets are Worth Less than $0.
The first thing you must understand is that just because something is affordable, or in this case cheap, doesn’t make it good. There are some assets, believe it or not, that are worth less than $0 relative to the value they add to your life (much as some relationships are worth less than $0, but let’s leave that for another time..)
About ROI
What determines value of any investment is ROI – Return On Investment. Unfortunately, in real estate this return can be measured in a multitude of ways, and while some metrics are increasingly honest, other metrics are virtually meaningless. This is all matter of perspective.
For example, most people are familiar with Cash on Cash Return (CCR, or COC). CCR juxtaposes the total investment of capital to the total return of capital. Thus, is you spend $9,000 cash to buy a house at the court house steps, spend $15,000 more to put lipstick on that PIG (get it?), and spend another $1,000 for closing costs, then the total cash investment is $26,000.
Let us assume that you can rent that house for $600, which is a stretch, but for shits and giggles… $7,200 of Gross revenue per annum. Let’s just say that property taxes, insurance, R&M (repairs and maintenance), etc . total $250/month, or $3,000/annum. Seemingly, $4,200 of Annualized Cash Flow on an investment of $26,000 constitutes 16% return relative to CCR.
You have to understand that houses don’t sell for $9,000 for no good reason. The marketplace has decided that this house – what it is, and where it is – this house is only worth $9,000.
This means a lot of different things, and I could take this on a lot of tangents, however, let’s focus on vacancy for today – follow this logic:
· House is cheap; why?
· Because people don’t think it’s worth more; what does this mean?
· It means no owners want to live there; what does this mean?
· If the owners don’t want to live there, why should the tenants want to live there? They won’t want to live there…
In other words, the only tenants you’ll get into the house are people without better options. Everyone who can afford to, and qualify for will go somewhere else. What does this mean?
Physical Vacancy
Those cash flow numbers from above do not include vacancy, which is simply understood as the time a unit sits empty. In my town, vacancy may be 3%-5% in better assets classes, a $9,000 might sit vacant 20% of the time by the time it’s all said and done.
In dollar terms, you would account for this by subtracting $1,440 from the Gross Potential of $7,200 (which is 20%). This, in turn, will compress the cash flow number to $2,760, which now will constitute a 10.6% CCR… I hope you can do better, but we are not done L
Economic Vacancy
Economic vacancy accounts for all of the losses associated with vacancy that are not vacancy itself. Things like bad debt (this is people stiffing you), or concessions (these are discounts you give just to get people in), and many others. In a $9,000 house, because of what it is and where it is, you’d be lucky to run economic losses of 15% - they will be higher!
Subtract another 15% from gross potential and your CF now looks like $1,680 – 6.4% CCR.
Let’s Talk About CapEx
Let me ask you – people who stiff you for rent, are they going to be too concerns about taking good care of your property?
You got it – the rest of the cash flow that you think you have will be spent fixing holes in the walls…
Conclusion
This barely scratches the surface of that which is property. My intent was to undersore the point that not everything is as it seems in real estate – in fact, most things are not!
PIGs are dangerous indeed because people feel that since they are cheap, it’s impossible to lose. Wrong – it’s not only possible, it is the most likely outcome! In this case, your $9,000 house might be worth less than $0
Hope this helps.
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