Real Estate Blog

Over the past couple of months, we've been closing deals right and left with no end in sight. I'm certainly not complaining, and I suspect you aren't either. The real estate market in Austin isn't just bucking the national trend, it's operating in its own positive bubble. The time couldn't be better for smart investors, and we want to make sure we all stay smart. To that end, let's talk about cap rates.

I run into investors all the time who say, "I only want to see properties with a 10% cap or better." Their focus is so completely on "the cap rate" they've got laser beams coming out of their eyes. In the Austin market, you can certainly find cap rates upwards of 10%, -- Yet, at the end of the day, as I've said many times before, those investors who buy in with good appreciation do better than those who concentrate exclusively on cash flow.

Let's explore that.

In order to get a high cap rate, you have to either have exceptionally high rents on a reasonably price property or exceptionally low purchase price with normal rents. It's not always about cap rates. 

The old saw applies, "You get what you pay for." The Austin median home price is holding at $209,000. The first question you should ask yourself is, "Why is this property so cheap?" Properties with weaker demographics will most likely experience a high turn-over.

If you really dig into the rental history, you're going to find that every 12 to 18 months or so, you have a turn over. Take that into account and divide it into the cost of the "make ready." Now take that away from your cash flow calculation.

- Projected cash flow: $2,000.

- Make ready cost: $1,500

- Actual cash flow: $500

- Divide by 12-18 months: $30-$40

You've ended up with a break-even property.

Now, let's think in terms of lower cap rate, say 6% - 9% and add in appreciation. If the property has a track record of 5% appreciation (and there are areas in Austin that double that), and we compound that over the years you own the property, you're going to do very well with this investment.

Yes, you may have some months with maintenance and vacancies. You may have to put extra money in, but, bottom line? If the tenants stay in place, they're paying the note and the expenses.

Another and probably the biggest draw to properties in these neighborhoods for me is a solid exit strategy. When these properties sell, they will likely attract an owner occupant. Plus, during the time you are renting the property out, you can expect long-term tenants who will more readily accept rent increases.

My best advice: Instead of buying two cash flow properties with no appreciation track record, buy one quality property. I'd rather help you buy that one good investment than sell you multiple mediocre properties.  Keep in mind that it's not always about cap rates.  Higher cap rates in some cases, can mean less desirable areas, higher turn-over, and more management.

Remember, however, that regardless of where you buy, the way to keep your turnover low is to keep your tenants happy. Transitional tenants tend to be looking out for the bottom line in terms of their budget. Owners need to be conscientious and competitive. If you don't manage well and maintain the property, you're going to have high turnover no matter where you are.