All Topics / Overseas Deals / Pro Forma VS. Reality affecting International Investors

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  • Profile photo of CheevesFinancialCheevesFinancial
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    @cheevesfinancial
    Join Date: 2010
    Post Count: 201

    I am writing this post because of a conversation I had with 2 of the forum members recently as well as a larger Canadian group I met with last week.  Grab a cup of coffee and I am looking forward to hearing everyone elses stories.

    With the surge of foreign dollars being invested in US housing markets, I have noticed a big discrepency in pro formas versus realities of ROI's.  Sadly, I see some on properties that I sell as well.  Being a commercial guy, I tend to put more "what if" expenses in my pro formas then most residential agents do to calculate an ROI.  First off, it is hard to derive that number on a 2 year history.  The market has gone 180 degrees in that time.  Everything is almost entirely done on a pro forma basis these days, which is your "expected" "estimated" ROI.

    I've explained to many investors who I speak to that to me, a higher ROI or Cap Rate mean higher risk.  Lower cap rates mean lower risk.  Well, at least that's my theory.. So, are you an investor who is looking for big cash flow or big ROI?  Chances are you are buying into a very risky area where renter performance history has been sub-par.  Even good property management can only mitigate this a certain amount.  But the properties as a result of being in inferior areas are cheap.. Rental rates are higher for whatever reason..  But can incomes sustain rental rate growth?  In some areas, only Section 8 assistance can come close to pro forma rental rates. 

    In my pro formas today, I calculate lower ROI's then my competitors on similar properties.  Do I lose business because of this?  Maybe.  That's fine by me.  I've built my business on referral and repeat business.  It's overwhelmingly stressful to continue to try to find new clients to sell to.  It's why I prefer loyal clients and their referrals :-)  So that business decision is easy for me. 

    It is laughable to think that you can get a 20% ROI in areas like Detroit.. Atlanta… Lehigh Acres…¬† Kansas City… etc…¬† Maybe on a pro forma but these areas are very high risk with non-violent crime happening every second of the day, ie.. home component / equipment theft.¬† Some say that investing in the bigger MSA areas (Metropolitan Statistical Areas) are better.¬† Well there are over 350 MSA areas in 51 states here.¬† Then there are over 400 MICROpolitan Statistical Areas in the U.S.¬† So where to invest where your pro forma is close to what a realistic return is?¬†

    FYI, Lehigh Acres duplexes are advertised at 16-18% ROI by many agents.  To me, my pro forma is a 12% and at best 12.5%.  As being one of the pioneers of the REO duplex program in Lehigh Acres over 2 years ago, pro formas have gone all over the map because of price increases.  But last years duplex buyers where my pro forma stated 13.5% based on those prices just showed an ACTUAL ROI of 9% on average.  Too many reasons to explain but this is what the reality was.  I still have to say, 9% is not a bad investment!  Double digit returns look sexy on paper for sure, but is it real?  Unfortunately, that is what people rely on these days.

    I'd like to see how homes in Atlanta and Detroit fared.  I had a Canadian investor group in last week.  They graciously let me look at their Detroit portfolio where they showed me their brokers pro forma of 24%.  They told me they would be happy with half of that.  They knew going in that they would never see 24% but believed 12% was possible.  Out of 17 homes they bought between them, the highest ACTUAL ROI was 3.7%.  Their homes were RIDDLED with non-payment, vandalism, theft, and tons and tons of maintenance calls.  I want to say it's the "unknown" factor when buying in warzones or those areas that have warzone traits.  But is it really "unknown", or is it greed of higher returns?  To me, investors simply want a return and they trust agents to get them good deals.  I believe most investors buying a 13% pro forma would be just as happy with a solid 8% Cap.  At least those I speak to are down with that.

    Most home had to be re-rented several times per year, resulting in repeat management tenant placement fees.¬† And no…No property managers will waive that.¬† It's kinda their problem but not really.¬†

    So, not to scare investors, but again, it's laughable to think you can buy 20+% ROI's on properties that can actually sustain that.¬† Give me a break.¬† The most accurate pro forma vs. reality comparisons I am seeing is in the bigger metro markets.¬† NY Metro….Los Angeles Metro…¬† But if you are looking for sub $100k properties, you are going to have a hard time getting close to pro forma.¬† THIS IS MY HUMBLE OPINION BASED ON WHAT I SEE PERSONALLY.¬† GOOD ROI's are still achievable.. But 15-20% would automatically raise a red flag to me.¬†

    There are plenty of foreign investors buying $500k properties, getting a 4% return.¬† Some buying multi-family for $500k getting 8% returns. They buy in the bigger metro markets because of upside and of what is going on in the economy right now.¬† Who buys upside?¬† Isn't speculation one of the issues that got the US in trouble?¬† Yes, but it's very different these days for many reasons.¬† These smaller properties with promises of unbelieveable returns are very very tough to actually achieve your goals on.¬† I am reluctant these days offering anything higher then 10%.¬† I try to find ways to bring that down a little.¬† Maybe higher reservers, more vacancy, etc.¬† Remember, over-promise and under-deliver!!¬† Oh wait…I said that wrong :-)

    My 2 cents. 

    CheevesFinancial | Cushman & Wakefield - Commercial Property SW FL
    http://www.CommercialRealEstateVoice.com
    Email Me | Phone Me

    Profile photo of Alex SCAlex SC
    Participant
    @alex-sc
    Join Date: 2011
    Post Count: 585
    CheevesFinancial wrote:
    I am writing this post because of a conversation I had with 2 of the forum members recently as well as a larger Canadian group I met with last week.  Grab a cup of coffee and I am looking forward to hearing everyone elses stories.

    With the surge of foreign dollars being invested in US housing markets, I have noticed a big discrepency in pro formas versus realities of ROI's.  Sadly, I see some on properties that I sell as well.  Being a commercial guy, I tend to put more "what if" expenses in my pro formas then most residential agents do to calculate an ROI.  First off, it is hard to derive that number on a 2 year history.  The market has gone 180 degrees in that time.  Everything is almost entirely done on a pro forma basis these days, which is your "expected" "estimated" ROI.

    I've explained to many investors who I speak to that to me, a higher ROI or Cap Rate mean higher risk.  Lower cap rates mean lower risk.  Well, at least that's my theory.. So, are you an investor who is looking for big cash flow or big ROI?  Chances are you are buying into a very risky area where renter performance history has been sub-par.  Even good property management can only mitigate this a certain amount.  But the properties as a result of being in inferior areas are cheap.. Rental rates are higher for whatever reason..  But can incomes sustain rental rate growth?  In some areas, only Section 8 assistance can come close to pro forma rental rates. 

    In my pro formas today, I calculate lower ROI's then my competitors on similar properties.  Do I lose business because of this?  Maybe.  That's fine by me.  I've built my business on referral and repeat business.  It's overwhelmingly stressful to continue to try to find new clients to sell to.  It's why I prefer loyal clients and their referrals :-)  So that business decision is easy for me. 

    It is laughable to think that you can get a 20% ROI in areas like Detroit.. Atlanta… Lehigh Acres…¬† Kansas City… etc…¬† Maybe on a pro forma but these areas are very high risk with non-violent crime happening every second of the day, ie.. home component / equipment theft.¬† Some say that investing in the bigger MSA areas (Metropolitan Statistical Areas) are better.¬† Well there are over 350 MSA areas in 51 states here.¬† Then there are over 400 MICROpolitan Statistical Areas in the U.S.¬† So where to invest where your pro forma is close to what a realistic return is?¬†

    FYI, Lehigh Acres duplexes are advertised at 16-18% ROI by many agents.  To me, my pro forma is a 12% and at best 12.5%.  As being one of the pioneers of the REO duplex program in Lehigh Acres over 2 years ago, pro formas have gone all over the map because of price increases.  But last years duplex buyers where my pro forma stated 13.5% based on those prices just showed an ACTUAL ROI of 9% on average.  Too many reasons to explain but this is what the reality was.  I still have to say, 9% is not a bad investment!  Double digit returns look sexy on paper for sure, but is it real?  Unfortunately, that is what people rely on these days.

    I'd like to see how homes in Atlanta and Detroit fared.  I had a Canadian investor group in last week.  They graciously let me look at their Detroit portfolio where they showed me their brokers pro forma of 24%.  They told me they would be happy with half of that.  They knew going in that they would never see 24% but believed 12% was possible.  Out of 17 homes they bought between them, the highest ACTUAL ROI was 3.7%.  Their homes were RIDDLED with non-payment, vandalism, theft, and tons and tons of maintenance calls.  I want to say it's the "unknown" factor when buying in warzones or those areas that have warzone traits.  But is it really "unknown", or is it greed of higher returns?  To me, investors simply want a return and they trust agents to get them good deals.  I believe most investors buying a 13% pro forma would be just as happy with a solid 8% Cap.  At least those I speak to are down with that.

    Most home had to be re-rented several times per year, resulting in repeat management tenant placement fees.¬† And no…No property managers will waive that.¬† It's kinda their problem but not really.¬†

    So, not to scare investors, but again, it's laughable to think you can buy 20+% ROI's on properties that can actually sustain that.¬† Give me a break.¬† The most accurate pro forma vs. reality comparisons I am seeing is in the bigger metro markets.¬† NY Metro….Los Angeles Metro…¬† But if you are looking for sub $100k properties, you are going to have a hard time getting close to pro forma.¬† THIS IS MY HUMBLE OPINION BASED ON WHAT I SEE PERSONALLY.¬† GOOD ROI's are still achievable.. But 15-20% would automatically raise a red flag to me.¬†

    There are plenty of foreign investors buying $500k properties, getting a 4% return.¬† Some buying multi-family for $500k getting 8% returns. They buy in the bigger metro markets because of upside and of what is going on in the economy right now.¬† Who buys upside?¬† Isn't speculation one of the issues that got the US in trouble?¬† Yes, but it's very different these days for many reasons.¬† These smaller properties with promises of unbelieveable returns are very very tough to actually achieve your goals on.¬† I am reluctant these days offering anything higher then 10%.¬† I try to find ways to bring that down a little.¬† Maybe higher reservers, more vacancy, etc.¬† Remember, over-promise and under-deliver!!¬† Oh wait…I said that wrong :-)

    My 2 cents. 

    Scott this is good really good . Get in touch with me , email or call is fine .

     I am in Memphis this coming week. Going to sit with Chris Clothier he has the marketing and customer service part of the business down for his clients. I am heading to NY the following week. Will you be in NY or  Florida. Lets discuss the higher end projects as the guys from Hong Kong and Malaysia are looking for bigger and better projects.

    Talk soon

    Profile photo of CheevesFinancialCheevesFinancial
    Participant
    @cheevesfinancial
    Join Date: 2010
    Post Count: 201

    Will do!  FYI, I'll be in my NJ office July 21-31. 

    A good point a forum member just e-mailed to me…¬† This forum was built around Steve McKnights philosophy of buying cheap for higher cash flow.¬† I am not saying you can't make a good yield on that..¬† The forum guests are likely in that demographic of buying cheap where "better"¬† MSA area pricepoints will be too high for most.¬†

    CheevesFinancial | Cushman & Wakefield - Commercial Property SW FL
    http://www.CommercialRealEstateVoice.com
    Email Me | Phone Me

    Profile photo of streamlineinvestingstreamlineinvesting
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    @streamlineinvesting
    Join Date: 2010
    Post Count: 171

    It is like any real investment, the higher the return, the higher the risk. Unfortunately figures can get a bit exaggerated when talking about some of these properties.

    I mean sure a property that sells for $30,000 can rent out for $600 per month. So now you can go and say it has a 24% gross yield. But then there is the issue of bad tenants that don't pay, changing over tenants, damage to the property, things breaking down, etc etc. All of a sudden your 24% is almost gone. It is important to note that 24% may sound high, but really it is only $7,200 in this example, which as you know sometimes does not get you going very far.

    It is important not to get carried away with the potential for a property in a perfect world, and try and look through the frosted glass and see the reality of the investment.

    The first property I purchased was in the Fort Myers area, $50,000 cost including renovations, rents for $650 a month, so almost a 16% gross yield. Had a couple issues, but we have good tenants and nothing major, typically gets a return of 7% net, so definitely cannot complain with that. The important thing is to realise that you are not going to collect the 20%+ returns into your pocket, and our expectations were for between 5% and 10% net return, so we are satisfied with how our properties are going. But I expect a lot of others out there are very disappointed.

    Profile photo of jayhinrichsjayhinrichs
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    @jayhinrichs
    Join Date: 2011
    Post Count: 1,177

    Cheeves,,

    I have posted these same comments now for a year,,, virtually verbatim

    One of the major issues with the OZ investor is many of them have leveraged there OZ property be it investment or personal residence to buy in the US… they pay about 7% interest on this.

    So they are buying in the states looking for those 15% net yeilds¬† and again who gives a good darn about Gross Gross just is not used here in the states…Its net net net…. Who cares if you gross 20 and only net 0¬† were does that get you.

    so any way… Thats the reality for a lot of these investors if they thought for one minute they would only get a 7 to 9% return they would just stay home and would not come to our sand box to play.

    I have seen that in my TWH model¬† other than the doctors from Perth I have not had one investor from OZ interested in 9% WITH EQUITY on top… Don't think they get that part… Its always the same thats great and I will invest with you if you give me 15%

    don't get me wrong I enjoy this banter… but there are going to be some sad faces when the historic numbers flush out.

    None of these people buying SFR's have any historical data to go on like a commerical property…. Your buying a empty house that needs work and is not rented.

    I do beleive the there are some that will get above 10% espcially some of the early Atlanta folks…

    However your spot on with Detroit and the really high intensity management areas… Never going to happen in a thousand years. period. Not at what these people are paying for them… My Detroit boys that I run with never pay more than 2k for a home put maybe 5 to 7k into it then rent it they can absorb the issues.. But the turn key buyer paying 25 to 50k they are sunk before they start.

    And its like some of the poster that bought through TRR in Atlanta who have a pretty good rep…. But still it takes them months to rehab which should only be 2 weeks outside and months to tennant most of their clients are hugely negative geared first year and then the real management issue happen… in years 2 and 3… Even though these are nicer homes that inner city there are still issues with PM , stealing , tenants etc etc..

    I like to say look at this nice foreclosure with the before pic's and most of these were owner occ… How can a 5 year old home need 15k in work because thats just how they live imagine them as tenants.. takes an iron fist.

    Good post.

    Alex call me

    Profile photo of CheevesFinancialCheevesFinancial
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    Join Date: 2010
    Post Count: 201

    Here is what everyone needs to read:

    According to a report by Morgan Stanley, wholesale real estate will offer real estate investors capital appreciation that they believe exists from the convergence of distressed to non-distressed prices as the backlog of inventory is cleared.  In certain markets, even buying at or slightly under retail prices will offer the same returns as assets make their way toward replacement cost.

    Think of the investment bank as you want.  Some of the smartest economic people in the world wrote this report.  This is from the Morgan Stanley 2.0 economic housing report a few months back.

    In this 47 page report, never once do they mention "Cap Rate" or "Net Yield" or "Cash Flow".  It's all about moderate cashflow and UPSIDE baby!  OZ investors need to pay close attention to this.  Buy cheap and get cheap results.

    CheevesFinancial | Cushman & Wakefield - Commercial Property SW FL
    http://www.CommercialRealEstateVoice.com
    Email Me | Phone Me

    Profile photo of Alex SCAlex SC
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    @alex-sc
    Join Date: 2011
    Post Count: 585
    jayhinrichs wrote:
    Cheeves,,

    I have posted these same comments now for a year,,, virtually verbatim

    One of the major issues with the OZ investor is many of them have leveraged there OZ property be it investment or personal residence to buy in the US… they pay about 7% interest on this. This leverage is why I call the Aussie investor our California and NY clients 6 to 8 years ago.¬† As they pulled money out of there homes leveraged and purchased properties in different markets.¬† Some did very well others not so well.

    So they are buying in the states looking for those 15% net yeilds¬† and again who gives a good darn about Gross Gross just is not used here in the states…Its net net net…. Who cares if you gross 20 and only net 0¬† were does that get you.

    so any way… Thats the reality for a lot of these investors if they thought for one minute they would only get a 7 to 9% return they would just stay home and would not come to our sand box to play.

    I have seen that in my TWH model¬† other than the doctors from Perth I have not had one investor from OZ interested in 9% WITH EQUITY on top… Don't think they get that part… Its always the same thats great and I will invest with you if you give me 15%¬† ( We have sold some houses in different markets I think your system is good but take some one like WI she has made the time to come here and put her funds to work. So why give up 50 % of the home this is got to be for the hands off investor only.

    don't get me wrong I enjoy this banter… but there are going to be some sad faces when the historic numbers flush out.

    None of these people buying SFR's have any historical data to go on like a commerical property…. Your buying a empty house that needs work and is not rented.

    I do beleive the there are some that will get above 10% espcially some of the early Atlanta folks… I think WI can most likely double her investment in less then 3 years or close to it with the way Atlanta numbers are moving up.

    However your spot on with Detroit and the really high intensity management areas… Never going to happen in a thousand years. period. Not at what these people are paying for them… My Detroit boys that I run with never pay more than 2k for a home put maybe 5 to 7k into it then rent it they can absorb the issues.. But the turn key buyer paying 25 to 50k they are sunk before they start.

    And its like some of the poster that bought through TRR in Atlanta who have a pretty good rep…. But still it takes them months to rehab which should only be 2 weeks outside and months to tennant most of their clients are hugely negative geared first year and then the real management issue happen… in years 2 and 3… Even though these are nicer homes that inner city there are still issues with PM , stealing , tenants etc etc.. TRR I followed them quite a bit Actaully thought about changing our email to a similiar system they use for new properties . They seems to have a good handle on things but with volume I know this 100% things will slow down. We went from trying to do and buy 50 homes in both Atlanta and Charlotte and basically every where in between. What a waste of time and effort , not a good thing. 90 days from start to finish is what I feel is good time to to fix _ rent and make sure all is good.¬† Now most are sooner but over all 90 days is good starting point.

    I like to say look at this nice foreclosure with the before pic's and most of these were owner occ… How can a 5 year old home need 15k in work because thats just how they live imagine them as tenants.. takes an iron fist. Yes $15k in rehab just picked up
    Here is an example and my budget before we get started so they can see a before budget.

    address is 2714  Chargrove LN Charlotte NC purchase price is $51,500 just picked it up. Bit older  home think it was  built in 92 rent estimate $950 ( we have several in area know I can get $1050)
    Rehab  Cost below

    Paint out side and inside $3k ( $2500 is price but I always build in extra)

    Ac unit replace $5k ( should cost $4500 ) or cheaper depends?

    Carpet _ tile $2500 . Should be less I like to over budget funds

    Update electrical and plumbing ( really mean inspect ) $2k

    Replace water heater with that.

    Miscellaneous stuff like blinds , door stoppers, Landscape ,   $1k ( very high)

    Inspections before and after about $800 and closing cost $1k

    So my cash lender has me in for $17k rough budget and purchase for $ $15,800 with purchase of $51,500 so we are now at $68k with rehab _inspection _ and purchase.


    Good post.

    Alex call me[/quote]Jay lets shoot for Friday working on trip to Memphis and NY be gone all next week.  Or skype would work.Friday is best day for calls or skype for me.

    Profile photo of Aj_RichoAj_Richo
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    @aj_richo
    Join Date: 2007
    Post Count: 18

    Hi Jay,

    "I have seen that in my TWH model other than the doctors from Perth I have not had one investor from OZ interested in 9% WITH EQUITY on top… "

    I have looked at your model and your website, I think that most Aussies do not understand the concept or are basically afraid of holding a piece of paper, over a property. They are brought up on the real tangible property concept. I.e. If you own the land and the bricks and mortar on it, then its worth investing in. You have something you can see inspect touch for your dollars, and resell if you have to. You can rent it out or keep it as a holiday home, ad nauseum :) The higher cost of borrowing at the 7% does make you question why you are doing it, knowing those rates could increase at any time.

    I think this is the stumbling block, to a degree myself included, my wife especially!

    Cheers
    Tony

    Profile photo of Texas Cash Cow Investments AustraliaTexas Cash Cow Investments Australia
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    @texas-cash-cow-investments-australia
    Join Date: 2011
    Post Count: 71

    Tony,

    It really all comes down to your own personal level of risk tolerance and understanding of what's on offer. Something that we don't appreciate in Australia is that the buying and selling of notes in the US is just as big as the buying and selling of real estate. As you say…we are brought up on bricks and mortar. Just as big a factor to consider is that owning and operating an investment property in Australia is nothing like owning an investment property in the US. By & large most Aussies pay their rent on time and don't treat their homes the way that US tenants do & will. When you take into account vacancy and maintenance and repairs it all eats into your cashflow and it wouldn't take much to go from a positive net cashflow to a negative net cashflow. If you had that situation so many months in the year… each year then all of a sudden what Jay say's and offers makes sense.

    To the hands off investor or someone that is only going to buy 1 property in the US or dip their toe in the water or perhaps that couldn't afford to cop vacancy and maintenance issues that eat in to the cashflow then Jay's model is perfect.

    To the investor that is willing to run this like a business and buy multiple properties and has a higher degree of risk tolerance then go it on your own after plenty of due diligence.

    The old RISK / REWARD ratio at play

    Profile photo of jayhinrichsjayhinrichs
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    @jayhinrichs
    Join Date: 2011
    Post Count: 1,177

    Tony,

    I realize our TWH model is a foriegn ( no pun intended concept)… As Texas Cash Cow states the note business is a lively one here in the US…¬† And many US investors would never own the bricks and mortor and only own notes.. they like being the bank and all the benefits that come with being the bank… Especially right now with the resetting of values.¬† Was not fun in 08… But its great fun now.

    JLH

    Profile photo of Ziv Nakajima-MagenZiv Nakajima-Magen
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    @zmagen
    Join Date: 2012
    Post Count: 523
    Aj_Richo wrote:
    …most Aussies do not understand the concept or are basically afraid of holding a piece of paper, over a property…

    While I understand the rationale, I find it to be a very limiting approach. Thinking about notes as a "real estate investment" proper is just plain wrong. It's alot more akin to investing in a RE fund or a term deposit, than investing in actual property – and requires a completely different set of DD skills.

    Ziv Nakajima-Magen | Nippon Tradings International (NTI)
    http://www.nippontradings.com
    Email Me | Phone Me

    Ziv Nakajima-Magen - Partner & Executive Manager, Asia-Pacific @ NTI - Japan Real-Estate Investment Property

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