The Cap Rate (Capitalization Rate) is a ratio commonly used to estimate the value of income producing properties and it is a common profitability index. Cap Rate is calculated by dividing the Net Operating Income (NOI) by the sales price or value of a property. The result is expressed as a percentage and the higher the percentage, the better. The search below is divided into three Orange County areas. The Cap rate may vary over time, as rental rates and the value of the property fluctuates. However, it is a popular, though static benchmark of profitability to most investors.Very high CAP rates in LA, Orange , and Riverside Counties
Note: Not all agents publish Cap Rates with their listings, as they may not aware of the required numbers. There may be many other listings available for sale with similar, but unpublished cap rates, so it is always advisable to search for income properties using multiple search methods.
Income properties - By region
Income property specialty searches
Commercial income properties
Duplexes, triplexes, and fourplexes are classified as "residential" property (4 units or less). "Commercial-level" income and investment properties are those with greater than 4 livable units. These can consist of apartment buildings, condo units, motels, hotels, or other large, multi-family income complexes. It can also include mixed-use buildings (sometimes known as "live-work"). This is a building with space for both commercial, business, or office use, plus space for residential use (my web page for residential live-work units is here.) The links below are for units in north OC, plus beach and coastal areas including Long Beach .If you are interested in one of these properties, please contact me.
There are several terms you will need to become familiar with when searching for income properties. Two of the most popular terms are Cap Rate and Gross Rent Multiplier (GRM). There are several other terms which you may see on MLS listings for income properties and it is important to know them also.
Cap Rate - Capitalization rate (or "cap rate") is the ratio between the net operating income produced by an asset and its capital cost (the original price paid to buy the asset) or alternatively its current market value. The rate is calculated in a simple fashion as follows: cap rate = annual net operating income / cost. For example, if a building is purchased for $1,000,000 sale price and it produces $100,000 in positive net operating income (the amount left over after fixed costs and variable costs are subtracted from gross lease income) during one year, then: $100,000 / $1,000,000 = 0.10 = 10% ( the asset's capitalization rate is ten percent). The lower the selling price the higher the cap rate. The higher the selling price, the lower the cap rate. In summary, from an investor's or buyer's perspective, the higher the Cap rate, the better.
Gross Rent Multiplier - Gross Rent Multiplier or "GRM" is the ratio of the price of a real estate investment to its annual rental income before expenses: Gross Rent Multiplier (GRM) = Sale Price / Potential Gross Income. Only two pieces of financial information are required to calculate the Gross Rent Multiplier for a property, the sales price and the total gross rents possible. The GRM is useful for comparing and selecting investment properties where operating costs can be expected to be uniform across properties. In this case, a property value may be estimated using the following related formula: Sale Price = Gross Rent Multiplier x Potential Gross Income. For GRM, the lower the number, the better.
Gross Scheduled Income - GSI is the maximum amount of annual rent you would collect if the property were 100% occupied all year and all tenants paid their rent. However, realistically owners experience vacancies and uncollected rents as well as generate other income outside of rents. Example: Ten Unit Property, 5 units rented at $1000 a month and 5 units rented at $1200 a month. GSI = Monthly Rents (5) X ($1000) + (5) X ($1200) = $11,000 monthly. $11,000 X 12 Months = $132,000 Annual Gross Scheduled Income.
Net Operating Income - NOI is equal to a property's yearly gross income less operating expenses. This number is a key number in evaluating multifamily investments, because it is used to determine value, profitability, and overall strength of the multifamily unit.
Operating Expenses - are costs associated with the operation and maintenance of an income producing property. These costs can include repairs, utilities, insurance, advertising, property taxes, realtor commissions, and other costs. it does not include 1) capital expenses such as improvements to the home, 2) income or capital gains taxes, or 3) mortgage interest.
Vacancy Allowance - This is an estimate of the amount of rent lost due to unoccupied units. This figure is rarely stated for income property listings, yet you should make an effort to estimate annual vacancy in order to calculate net profitability of your investment.
APOD - Annual Property Operating Data - This report lists all costs pertaining to running the property. All the utilities, taxes, mortgage payments, upkeep, etc
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What are the three most important factors to look for in a property?
As with any property, location is very important. Potential renters will pay more for areas that are safe and secure, have good school districts, a view, close to shopping and services, etc. How do you know? First, drive by the area yourself and use your own "gut feel". How does the neighborhood look? Is it a clean, pleasant looking neighborhood or do you see properties that lack maintenance, graffiti on the walls, cars parked all over the street, close to a freeway, etc. Second, check local crime statistics and school ratings. Good ratings clearly raise the desirability of a property. Is it close to shopping, entertainment, a local college, or the beach? These are also pluses.
2) CAP rate and the numbers!
The CAP rate is the standard investment gauge of the rate of return on a property. It is calculated as follows: Cap rate = annual net operating income / cost of property (see full description above). The highest CAP rates (up to 8% or more) are in desert areas like Palm Springs, where the cost of the properties is low, and rents are very good. You should expect far more modest CAP rates in areas like Orange County, where a 4 or 5% CAP is more realistic. Many high-end beach properties will have CAPs in the 3% range, but that is due to the value and cost of the location. Generally, you should pass on any inland area income property that has a CAP rate of less than 4.5%. Many agents do not put the actual CAP rate in the MLS, but it can be calculated once we know the actual rents and expenses. Note: Some properties are currently rented for below true market value, so many agents will list actual rents along with "pro-forma" rents, which is a projection of true market rent. It is OK to use pro-forma rents in lieu of actual rents, as long as you are fairly certain that the projected rents are realistic.
3) Condition of the property!
Many income properties are older (built in 1950s, 60s, or 70s). Because of this, one of the often over-looked issues is deferred maintenance. While a property may have a great location and perhaps a history of good income, you don't want to get stuck with a property that needs a new roof and myriad of other repairs. It is very important to have a full property inspection and also check to see if the property has been updated and maintained. Very often the photos of the property can give you the first clue. The agent may also state in the MLS that the property has been "recently updated" or "well maintained". While these statements can be subjective, it is at least a step in the right direction and will indicate a property that may be worth further investigation.
Other important factors
4) Number of bedrooms and bathrooms
The number of bedrooms and bathrooms of your property will have a large impact on how much rent you can charge. The minimum you should look for is 2 bedrooms and 1 bath in each unit. If the property has mixed units, having one unit with a 1 bedroom/1 bath configuration is OK, but avoid properties where all of the units are 1 bedroom. Single bedroom units usually rent for less than $1,000/mo, and appeal mostly to single persons or couples. Having all (or most) of the units with 2 or more bedrooms will increase the income of the property and have greater appeal to renters.
5) Separate utility metering
If the tenants pay their own electricity and gas, it will definitely help your bottom line. Properties that have individually metered units are a plus, because the tenant is responsible for utilities instead of you! By the way, water is not usually individually metered.
While not the most important thing to look for, having a property that has individual garages is very desirable. Tenants will appreciate the extra security and storage, plus you may be able to charge higher rents than for a similar property without garages.
Showing multi-unit / multi-family properties
If a property that you are interested in has a unit that is vacant, we will typically be allowed to visit and inspect that unit. You may be surprised to learn however, that many of the income producing properties for sale are not immediately show able and are frequently listed as "drive by only - subject to inspection". The reason for this is that many properties are fully rented and the listing agent (or property owner) does not wish to have all of the tenants disturbed for every showing. Instead, they will usually accommodate a showing of all units only after receiving an accepted offer. While this might seem problematic on the surface, the offer is always "subject to inspection" so your offer would not be binding if you did like what you saw, or if an inspection revealed issues that you were not comfortable with. If a property does have one or more a vacant units, I will be happy to arrange a showing for you. If however the property is listed as "drive by only", it is a good idea to go by the units yourself to check out the neighborhood and structure and see if you are interested in taking the next step. Here is a little more on this topic: Drive by only, subject to inspection
Investing in multi-unit properties
Before you invest in a Duplex, Triplex, Fourplex, or larger property, you will need to do your due diligence. Here is some of the criteria for purchasing multi-family units:
Step # 1 : I can help with both residential and commercial properties!
Properties with four units or less are considered residential property and you can use the services of a standard residential Realtor to assist you. Properties with greater than four units are considered to be commercial properties. I can help with both. Call me to discuss!
Step #2 : Check out market areas
Where do you want to invest? One of the beach areas? North OC? South OC? Close to business centers? Ask yourself the following:
Step #3 : Analyze your finances
Before you search for income property listings, take note of your financials
You will need to know your credit scores, debits, cash on hand and in reserve, because a lender will use these factors to determine your loan qualifications and purchasing power.
Step #4 : Consult with a lender and check out mortgage options
Call your lender or ask me for a referral. Income properties are classified as Multi-Family but still considered residential real estate, so financing is similar to a single family home. The major financing difference depends if you are going to be a owner/occupant or a pure landlord. The other variable to ask about is if a lender will take into the consideration the potential rental income on the property.
The down payment on the property is affected by your owner occupancy. For example a lender may allow 10% down if your are buying as a owner occupant and want 20% down if you are a buying as pure investment property. One thing you will want to ask any lender is what the occupancy period is before you can leave the property as an owner occupant and turn that unit into a rental. It may be a year, it may be more. Verify this outside of your lender per your state rules.
Step #5 : Create a plan for renting the unit(s)
Once you know your financing options, think about your income property marketing plan. With any investment property, numbers tell the story. Find vacancy and credit lose rates in the area you want to buy. If you experience a high rate of vacancy, will your cash reserve allow you to pay your mortgage? Estimating the vacancy rates are important but so are the local rental rates. This rental income rate should be based on recent history and should be the average rate. I can help you research this by running "comps" (comparables) for you!
Step #6 : Shop for homes and narrow your possibilities
I will help you look at home options that meet your criteria. My income property home searches (above) will help you search for units by, city, price, Cap Rate. or other criteria. Once you have a rough idea of "where" and "how much", we will look at comparable prices and potential rental amounts. I will also be happy to take you out for showings of your final selections.
If you interested in knowing the current mortgage loan rates for a duplex, triplex, or fourplex multi-family investor property, call me, or write to me at Ron@rondrealestate.com. I will be glad to provide you with several lender referrals. My contacts are residential and commercial multi-unit property mortgage specialists and they will be happy to help you find the right loan with the most competitive interest rate!
Questions and answers
For investment, is it better to buy four separate condominiums or a single fourplex?
This is a question I am asked quite frequently. Buying a single condo as a rental property is a great way to start if you are new to investing, but should you continue to accumulate single condos or purchase a multi-unit property? The key is really cash flow. A fourplex takes advantage of economies of scale. Having a single large building means you can purchase a single homeowners (landlord) insurance policy, maintain the entire building at once, and most likely pay less for a property manager. Four individual condos are generally more expensive to purchase than a single fourplex, plus the monthly cash flow can be severely impacted by multiple HOA dues, Mello Roos (for newer condos), and individual insurance policies. The advantage of separate condos is that they can be easily sold and have common area amenities like a pool and spa. Over all though, when you consider the added cost of multiple HOA dues, insurance policies, and property management, the fourplex is by far the winner for cash flow!
I will be happy to help you with an income or investment property in Orange County, CA. If you have specific requirements, just contact me. I will be glad to set up a custom search for you. I can also set up an automated e-mail for you that will alert you to any new listings or price reductions on the MLS. I can also help you with the sale of your multi-family property. Just call or e-mail me at Ron@rondrealestate.com