Pro Forma VS. Reality affecting International Investors

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.