We’ve had a lot of students reach out to and ask us how our deal criteria has changed in this shifting market. Under normal market conditions we typically look for a 10% COC return in year 1.
However, with a high inflation and/or high interest rate markets our expectations change a little bit. Below we have a brief overview of the different market types and what returns we look for in varying market conditions.
Remember that all these numbers are general rules of thumb. Just in the past month and a half I found a deal in a growth market during the end of a high inflation period for housing and in the middle of a high and growing interest rate period. It was the worst of both worlds and probably what many would call one of the worst times to purchase a property. Well, we’ll have a 10-15% COC return in year 1.
What we’re trying to say is, yes the market conditions matter and do affect the availability of good deals, but they’re still there if you look hard enough. With that, we’ll go into what we think your baseline criteria should be in each different situation
Normal Market
Growth Markets
IRR: 20-25%
COC: 10-15%
Steady Markets
IRR: 20%+
COC: 15%+
Notes
Under ideal, or normal market conditions, deals are available, but will still require you to look for them. Rents and sale prices have more of an equilibrium, especially in steady markets where we typically see very little movement. In growth markets home prices will increase along with rents although rents typically lag behind a bit which is why our baseline for a return are lower in growth markets in year 1 than they are in steady markets.
High Inflation Market
Growth Markets
IRR: 10-15%+
COC: 3-5%+
Steady Markets
IRR: 15%+
COC: 5-10%
Notes
In high inflation markets rents will typically lag behind the property values. When doing your calculations keep in mind that rents should be increasing over the next 1-2 years to catch up to the inflated prices.
This means that a
lower COC return in year 1 is not indicative of your return in year 3-4. That is why we are okay to accept some lower returns upfront in high inflation markets knowing that rents lag and will catch up.
High Interest Rate Markets
Growth Markets
IRR: 10-15%+
COC: 3-5%+
Steady Markets
IRR: 15%+
COC: 5-10%
Notes
In high interest rate markets we are taking on a higher borrowing cost up front. We are assuming that over time interest rates will once again, as historical data has shown, fall. As these rates fall we can turn okay deals into great deals.
Just as in a high inflation market you can accept a lower COC return in year 1 because it is not indicative of your return in year 3-4. That is why it is okay to accept some lower returns upfront in high interest rate markets knowing that in a few years as rates lower we can refinance and get a lower rate.
Important Note
All of these numbers are general rules of thumb. There may be times in normal markets that you take a lower COC return in year 1 because you are getting a great deal in a market that has high growth and the investment will pay off 5 years down the road.
Giving out hard rules that must be followed is almost impossible. The one rule that we will always give out and stick to is that you should never invest in a deal that will not have a positive COC return in year 1. Maybe the deal does just better than break even and in some cases you’ll take that deal, but you should never take a deal with a negative return.
The reason we don’t ever recommend taking a deal with negative cash flow is that you are NOT purchasing an asset. It is NOT an investment. You are simply buying a liability.
Final Thoughts
We firmly believe that you can find deals in every type of market. We’ve continued to buy deals over the past two years during periods of high inflation and high interest. These deals are fewer and harder to find than they are during normal market conditions, but they are there.
Be patient, keep looking. On average we will look for a couple months before we find a deal that meets our criteria. If you don’t find a deal in a week or two of looking, don’t get discouraged. You might have to look at more deals, you might have to explore an out of state market, but the deals are there.
If you want some help finding and analyzing deals, reach out and we can help you!
