How does this deal look?

Question

I am considering my first 4 unit and would appreciate the help of the BP community with analyzing the deal.
Some background: I am interested in buying this property to hold and start generating a rental portfolio. The building is out of state(PA), about 2 hours from my home. It has been fully rehabbed from top to bottom. All necessary CO's are in place. The property is situated in a neighborhood of SFR's which makes it kind of difficult when running the comps and finding a true value. I have to go further outside the area to find similar 4 units to compare but then the neighborhood changes so I guess those are not really comparable. The rental market appears strong from my due diligence and according to the REA that I am working with, very strong. 3 of the 4 units are already rented and the seller agrees to let me fill the fourth unit prior to closing. I am not sure if buying an occupied building is too risky as I did not have the benefit of screening the tenants? Leases are signed for a year each. The owner purchased the property for $45K and is now selling for $290K. I was going to offer $250K. I am not quite sure how he purchased for so low as all the other homes in the area are significantly higher. I also do not know how much rehab was required to get it to its present condition.
The numbers: I based everything off a purchase price of $270K to be conservative, although I am not sure how much higher than $250k I would be willing to go. I am trying to implement the 50% rule with 1/2 of the gross rent going to costs of holding the property, including 1. Rent loss (vacancy,concessions,non payment) 2. Capital Costs 3. Expenses (property tax, insurance, maintenance, property mgmt., turnover costs, cpa/attorney fees, utilities, landscaping) Thanks to J Scott for posting the video on the 50% rule which I am using here. The other half going to debt service.

$270,000 purchase price
RENTS:
unit 1 =$750
unit 2= $675
unit 3 = $625
unit 4= $900
Gross $2,950 month/$35,400 year

Expenses:
Taxes………………….. $379.16
Insurance ……………... $100.00
Property MgMT @ 12% $350.00
Vacancy @ 5%…………..$150.00
Water/Sewer…………….$100.00
TOTALS…………..monthly $1,079.16/$12,950 year

I plan on using conventional lending with 25% down ($67,500) mortgage of $202,500 and closing cost around 5K. I spoke to my mortgage broker who feels I could get 4.5% interest with a monthly payment of aprox $1040.00.

$2950(gross rent)-$1475(expenses)-$1,040(debt service)=$435 Cash flow.

How do these numbers seem? Am I over looking something or under estimating any of the expenses? Thanks in advance for reading and any opinions or suggestions.

Ray S. · Answer

At 45k, this property does not appear to be marginal at all. I think if you are a beginning investor, start in your own backyard. Buy the 45k unit, pay way too much to rehab it and learn a lot. Thats exactly how I started.

James G. · Answer

Thanks to Joel and Michael for your insight. I was a bit nervous about a few things on this deal, namely the occupied 3 units as well as the large difference between the sellers purchase price and his asking. Your comments drive this home even more. I thought the numbers seemed to work until you change the one variable that Joel mentioned and then the property becomes marginal as you said. I am not interested in a marginal property when I know there are deals out there to be had. Thanks again.

Michael Lauther · Answer

James you appear to have crunched the numbers fairly well however when you take into account the slight variation proposed by Joel your cash flow is significantly degraded. My point here is that while it appears your investment objective is not current income your margins are very thin. Even if you take your estimate of income you have less than an 8% return on your down payment. It would not take very much of a miscalculation to turn this number negative. I would be concerned about the limited track record of the property and would want to see a copy of the leases he has in place. Also given his low purchase price I would expect a detailed account of exactly what work was done to bring the property up to rent able condition. The numbers you present tell me you are buying to hold and are willing to accept a lower Cash return now for the prospect of future appreciation, current tax benefits and letting your tenants pay down your mortgage. This of course is a valid investment strategy. As you take the next steps in due diligence I would answer the following questions : Is this a neighborhood that will support growth once the economy turns around ? Is population increasing or decreasing? Are there major employers in the area? Is the property near public transportation ? What are the vacancy rates in the area? Have you spent time in the neighborhood talking to neighbors ? What are the prices of Single family homes and how does the rent on a comparable SFH compare to your apartment rental. If you pay $250,000 plus closing costs of 5K you are paying $63,750 per unit and getting an average of only 737 a month in rent. There are many more things I would want to know but these are the ones that come to mind as I read your post.

Joel Owens · Answer

So how do you know what the fourth unit will rent for in your calculations?? I would count the 4th unit on the lower side of the other 3 for expected rent equals 684 average for the 4th unit. So numbers would look like this. 2,734 a month/ 32,808 a year. 32,80 by half is 164,040 purchase price. I know the seller says everything is new. I don't like the fact that they just put renters in.How long have the 3 renters been there?? You have no history or track record of stable income with the property. You have to pay special attention to the leases and if anything is bad on them or need clarifying have the tenants sign an amendment to the leases before closing. You would do better to have say a 90 day option period and then if the property doesn't work out just hand it back or if it goes as planned then proceed to closing.You are putting a bunch of money down and the income doesn't have a stable history yet plus it is surrounded by SFR houses and it seems overpriced. Lot of negatives on the face of it.You can get a list of all the repairs and upgrades during due diligence.