Is it better to finance or pay cash?

[Brad Kaiser]

I'm looking at a low cost, multi-family property with a NOI of $11,312 (seller's figures). The asking price is just under $100k. If you had the option of paying cash or financing, which way would you go? I'm looking for an ROI of at least 12% for this unit.

[Will Johnston]

If you've got below market rents, no need to factor in vacancy at all, so your set there. (Low rents means you can either increase rents... good for your numbers... or if tenant does leave new, higher rents will cover any vacant time.)

I wouldn't have a problem with tenant taking care of the yard in exchange for lower rent, just make sure you don't end up paying $300/month for lawn service.

I'm guessing repair costs in Florence aren't as expensive in DC, but $2k/year on a 3-unit still seems really low to me. If that's his high estimate I'm guessing one or more of the following is happening:

1. Owner is doing repairs himself.
2. Tenants don't ask for repairs b/c rents are low.
3. Seller hasn't paid for many capital expenses (roof, furnace, etc.).
4. He's not keeping records, so he has no idea what he's actually spending.
5. He's full of it.

Hopefully it's not number 5.  I'm guessing it's a combination of 1, 2, 3, and 4 meaning you're in for some serious expenses. I paid $1800 to have a small part of a roof replaced on one of my houses last year. Washing machine went out in that same house. The two of those put me well over $2k right there, and that was just one unit. Not every year is that expensive, but I haven't had to replace the whole roof yet either.

When I'm analyzing a property (and again, this is my market), I estimate 10% for repairs and capex combined (I'm in a high-rent area but I'll go 15-20% if rents on the unit are low or it's in a part of town I expect to have tenants that might beat the place up), 5% for vacancy (10% in a less desirable area, but again, you don't need to worry about this), 6% for property management (10% is standard but I'm at 6%) and then I make an educated guess on water bill and lawn care.

I also make my best guess at what the deferred maintenance will cost to fix, and then I factor that into my acquisition cost. You've got to fix all of the stuff that's been ignored, but assuming you won't continue to ignore things when they break, that will be a one-time expense.

For this building I'd go with 20% expenses at current rents if you want to self-manage, 30% if you want someone else to manage.  That is, of course, assuming rents are below market.  If they're actually market-rate rents, then I'd factor in at least an additional 5% for vacancy, maybe 10% if rentals in your area aren't in high demand.

So, let's say you're going to self manage:

$3024 - Maintenance/Capex
$1398 - Taxes
$1080 - Water
$450 - Insurance

Your expenses total $5952, which leaves you with $9168/year.  Assuming $10k in deferred maintenance and 2% in closing costs, you're all in on your acquisition for $112,000, giving you an 8.2% return if you purchase cash.

If you put 75% down and get a 30 year loan at 5%, your monthly P&I payment will be $402.62 or $4831.44/year, which would leave you with $4336.56/year in cash flow.  But, of course, you only put in $37k ($10k maintenance, $2k closing, $25k down), so your cash on cash return is 11.7%, and your principle paydown would put you well over your 12% target.

If I were going to buy this building, I would purchase cash to get a better price, do the needed repairs, then get financing through Fannie Mae's delayed financing program (I think max 70% LTV). Ideally, after the repairs you'll be able to get it to appraise for at least your purchase price + initial repairs, maybe even more, which means you can get a slightly bigger loan which will give you an even better cash-on-cash return and invest your funds elsewhere.

Of course, I'm not a licensed real estate anything, a lawyer, or an accountant, and I certainly don't know your area, so you need to do your own due diligence.