Cashflow investors require different information than owner-occupants; therefore, we have designed a property valuation report just for investors.

BTW, our new calculator is up and running. Check it out.

Asking Price: $360,000

Address: 3131 Michelson Dr #301 Irvine, CA 92612

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Snow, cement and ivory young towers
Someone called us Babylon
Those hungry hunters
Tracking down the hours
But where were all your shoulders when we cried
Were the darlings on the sideline
Dreaming up such cherished lies
To whisper in your ear before you die

Tower of Babel — Elton John

Are we the darlings on the sideline dreaming up such cherished lies? Am I crazy to think prices will still fall? Is it all a fantasy?

From Wikipedia’s entry on Tower of Babel — Genesis 11:1-9

And the whole earth was of one language, and of one speech. And it came to pass, as they journeyed from the east, that they found a plain in the land of Shinar; and they dwelt there…. Therefore is the name of it called Babel; because the Lord did there confound the language of all the earth: and from thence did the Lord scatter them abroad upon the face of all the earth.

During the bubble, everyone was of one language and one speech — kool aid; the collapse has counfounded the “real estate always goes up” crowd and scattered them upon the face of the pavement.

As I documented in Equity Inferno, these towers have a special significance to me; “(the) dark tower is
going to stand as the symbol for the height of hubris of the housing
bubble.” To me this property has always been the worst of the worst as far as valuations being detached from fundamentals. The readers of this blog should not be surprised to see properties like the ones I am featuring today are going for 60% off their peak purchase prices. As I will demonstrate, even at these prices, the properties are still greatly overvalued. I will go on record today making a bold prediction:

A condo at the Marquee at Park Place will sell for under $200,000.

That’s right, one of these condos will go for under $200,000, perhaps well under.

To demonstrate why I believe this will happen, we need to look at a different IHB report — one tailored to cashflow investors.

Cover Sheet

Similar to the report we prepare for owner-occupants, the report cover sheet contains summary information including
pictures, the address, and a few identifying characteristics. The first piece of summary data is the asking price, and
this is followed by the Comparable Value, and the Likely Transaction Price. There is no IHB Fundamental Value. Cashflow investors are not interested in how we may value the property, they want to know what rates of return are available, and they can decide their own price based on the cashflow. We provide the necessary data to make this determination.

Capitalization Rate and Cash-On-Cash Return

One key concept for Investment Value of Residential Real Estate is capitalization rate. The Capitalization (cap) Rate is the (yearly) Net Operating Income divided by Asking Price (assumed purchase price). It is the simplest measure of an investment’s financial performance, and it provides a convenient comparison to competing investment alternatives. A cap rate is like an interest rate on a checking account, a mutual fund return, or a bond yield. Cap rates change over time to reflect the perception of risk in real estate as compared to other investments.

The cap rate is inversely related to price; in other words, high cap rates are synonymous with low prices and visa versa. The cap rate an investor will accept varies from person to person. There is no single appropriate rate to apply to value. Instead, we show a range of values at different cap rates to show the current investment return someone can expect from this property.

The Cash-On-Cash Return is similar to a capitalization rate in that it shows a return on investment, but it is measured by comparing the Total Profit and Loss after Expenses, Debt and Taxes to the Total Cash Costs. This is the important rate of return for investors who are not purchasing with all cash. As long as debt is less expensive than the cap rate, the cash-on-cash returns can be magnified by increasing debt. This is an appropriate use of leverage to increase investment returns — to a point.

This property, even with a $360,000 asking price, only reflects a 3.67% cap rate. You would be better off in 10 year Treasuries. Since the cap rate is less than the interest rate (cost of debt), applying a mortgage to the property actually hurts the returns. This very unusual circumstance reflects how low cap rates became and how much the market was depending on appreciation.

Rental Income, Operating Expenses and Net Operating Income

An accurate estimate of income and expenses is required to value a property based on cashflow. The Gross Rent is the monthly rental rate pulled from comparable properties. Assuming this rent can be obtained, an allowance for Vacancy and Collection Loss is subtracted to arrive at a realistic Monthly Rental Income. The Operating Expenses are those fees and costs typical of rental properties. This does not include any financing or tax implications.

Many properties are purchased by wealthy individuals looking to diversify their holdings among asset classes. These investors want to deploy capital with safety and obtain a periodic, measurable return on their investment. Under those circumstances, the properties are purchased without debt. The preponderance of all-cash investments creates the need to view the investment on an all-cash basis.

Net Income is Rental Income minus Operating Expenses. The capitalization rate is based on Net Income. It is the rate of return on the investment when no debt is utilized. Once you introduce debt, returns get magnified, but so do the risks. This spreadsheet allows viewing different financing alternatives.

There are a few different line items to consider when the property is a rental investment. The Maintenance and Replacement Reserves are often double the cost of an owner occupied property. Unless you are managing the property yourself, there will be a Property Management Fee for someone to handle tenant issues. There will also be expenses related to your owning the property through tax filings and other Miscellaneous Expenses.

Financing and Taxes

The financing and taxes are considered separately because some owners do not finance the purchase. There are two items of note in this section as it differs from the owner occupant version. (1) The Tax Savings % will be your highest marginal tax rate. The assumption is that an owner of investment property has already given up the personal exemption, so any interest write off would be at the highest marginal rates — there is one caveat — the property must positive cashflow for the write-off to be allowed.

(2) The opportunity cost is ignored. The whole point of calculating the cap rate or the cash-on-cash return is to establish a value to compare to your opportunity cost. To try to adjust for it here would make the results inaccurate. It would be like comparing twice or double counting.

Cash Acquisition Demands

The Cash Acquisition Demands is similar to the owner occupant version except that the emergency cash reserves are removed. Emergency cash reserves is an important financial planning consideration for an owner-occupant, but an investor has other concerns.

Comparative Sales Value and Negotiating Range

This table is similar to the owner-occupant version as it shows the recent comps and projects negotiating ranges. When we estimate the Likely Transaction Price, we look at comparables and adjust it for the market trend. In order to see the reasoning behind our determination, I have added the Short Term Direction of Prices.

Capitalization Rates and Property Values

The Capitalization Rates and Property Values section replaces the Cashflow Value and IHB Fundamental Value section. As I said, each investor has their own required rate of return, so rather than present what we believe to be the right value, we show investors a range of values based on the cashflow. An investor who demands higher cap rates will bid more conservatively, and a more aggressive investor will bid higher.

Asking Price and Value Ranges

As with the owner-occupant version, the information is presented in a graphic form. The property values at different cap rates makes for an interesting view of pricing.

I base my prediction of a unit in this complex selling for under $200,000 from the chart above. The cap rate values are so low they fall off the bottom of my chart. Cap rates have to stay under 6.5% for this property not to fall below $200,000.

Comparable Sales, Comparable Rentals and Notes

This is the new and improved section based on the feedback from readers asking for the dates of the comparables. The notes are different including a section on the Capitalization Rate and Cash-On-Cash Return.

What were they thinking?

It is obvious that I do not believe these condos are a good investment. Any cashflow analysis at all would have revealed this fact to even the most kool aid intoxicated. The only reason people bought in these towers was to flip the property to an even bigger fool. There is no better example of Ponzi Scheme thinking and behavior than the buyers in the North Korea Towers.

Asking Price: $360,000

Income Requirement: $90,000

Downpayment Needed: $72,000

Purchase Price: $889,000

Purchase Date: 8/24/2006

Address: 3131 Michelson Dr #301 Irvine, CA 92612

200 degrees? Does this seem like an odd measurement to you?

bonuns? luxious? preimer?

OMG!!! 60% OFF!!!

Asking Price: $399,000

Income Requirement: $99,750

Downpayment Needed: $79,800

Purchase Price: $829,000

Purchase Date: 8/24/2006

Address: 3141 Michelson Dr #502 Irvine, CA 92612

How do you upgrade one of these? Gold fixtures?

The Marquee Park Place North Korea Towers are imploding. This was foreseeable. Cashflow analysis is not overly complicated, and it is a powerful to for avoiding catastrophes like today’s featured properties. There are no guarantees in investing, and we can only provide analysis and recommendations. Cashflow analysis has its limitations (you wouldn’t have bought anything after 2002), but these limitations are also its strength; unless you want to speculate in a housing bubble.