Issues and analysis of a rental property built before 1890?

Question

Hello everyone,

I am a starting out property investor in search of my first rental property.  I am contemplating making offers a possible duplex this week.  My only hesitation is that it was built in 1876.  The seller is asking for $90K, hoping to purchase for around $80K, the comps for the area are around $120K. Rents are about $700 per month per unit for the area.  Estimating initial repairs of around $3,000.  After running the numbers, I was getting a cash flow of around $250/month total.  I had the insurance quoted at around $1,450 per year, which is double compared to a property built after 1940ish.  I estimated that maintenance and repairs would be about 10% of the EGI, and the CapEx at 8% of EGI since it is an older property.  I was wondering if there are any other concerns I should factor in with a property that was built in 1876 compared to a property built in 1950ish, besides the doubled insurance rate and the higher CapEx?  Assuming that the foundation and structure are in decent condition.  Thank you all in advance for your help.

Sincerely, Lucas Duce

Joe Villeneuve · Answer

OK.  That clears up a few things, however....

1 - Using any number (%) to guess at the right amount to hold back for repairs is not only hoping, but foolish...and a waste of time.  Again, don't get lost in any percentage.  How much actual money does that mean in the end?  18% (we'll go with the max), of $1400 is a hair more than $3000/year...but that's the total you get at the end of the year.  What if you get an unexpected (and you can expect it with a house that is over a century old), rehab/CAPEX?  Will $1500 cover it?  You do realize that replacing anything in a house that old involves a much higher cost than one built 20 years ago?

2 - Analysis is a science.  When you say "All of the numbers are exact, and are rounded up to be generously conservative",...which is it?  Exact or rounded up?  Rounding up, thinking you are covering yourself, is rationalizing...and very dangerous.  Just because you are "rounding up", doesn't mean it's covered.

3 - You need to know exactly what repairs need to be done, and what the exact costs will be.  You need to know how old all of the following items in the house are:

a - Electrical (including the wiring, openings, and box)   b - Plumbing (pipes, drains, fixtures, bathroom, toilet and path from, etc...)   c - HVAC   d - Wall construction.  Can you say "plaster"....?  Plaster walls increase the replacement cost of everything else the connects to it, runs through it, and it supports.   e - Roof   f - Siding/brick   g - Foundation (this one can and will be the killer)   h - Windows and doors   I - Finish door/window hardware...inside and out   j - Exterior water drainage (there was none back then) and any damage done already (see "g" above)

You said you estimating $3000 for rehab now.  What does that include?

Lucas Duce · Answer

@Joe Villeneuve  All these numbers are exact, and are rounded up to be generously conservative.  The only estimates are the repairs and CapEx.  You originally "LMAO"ed at my CapEx percent of 8%.  I was informed that 5% for newer properties and 10% for older properties for CapEx reserves was a good estimate.  I dropped it down to 8% since my initially $3,000 was going to go towards CapEx repairs and new appliances.  Since 8% is too low, how much would you be dedicating to a CapEx reserve?

You've mentioned gross rent only being $700 twice now, I guess I should have made it more clear in my original post, but it's a duplex, so each unit is renting for $700, so a total of $1,400 a month. Unless you're running the numbers from a house hacking perspective with only one unit bringing in rental income, but I will only likely be living there for a year, so I ran the numbers as both units producing rental income. Which yields a positive cash flow.

Joe Villeneuve · Answer

1 - Stop using imaginary/wishes for numbers when you analyze.  You'll pay for it later.

2 - Stop using percentages for costs/income when you analyze (see #1).

3 - Use exact numbers.  If you don't have them, get them.

4 - Replace your calculator....you're at a negative cash flow, without calculating CAPEX/repairs into the analysis.

Calculations:   Rent = $700/monthProperty Manager             $70 (10%/month)T/I                                         242PMI                                         80Loan                                     363Total Expenses/Mo          $753

Cash Flow/Month          -   $53...as in, you're paying your tenants to live there.

Lucas Duce · Answer

@Joe Villeneuve

Lucas Duce · Answer

Hey Joe,

Thanks for your input.  These are my numbers: (house hacking but running the numbers as if renting out both units).

FHA loan of $77,200 at 3.875% interest rate.

EGI after vacancy: $14,310

Repairs, maintenance, CapEx: $2,576 (18% of EGI)

Management: $700 (but going to manage myself, included just in case which is why I slightly lowered it).

Insurance: $1,400

Prop. Taxes: $1,500

Water: $400

Garbage: $200

With PMI of $80/month the cash flow would actually be around $180, but expecting to refinance out after a couple of years.

Joe Villeneuve · Answer

There are so many rehab/construction issues with properties built before 1960 (let alone just after the Civil War) that I wouldn't come close to it...especially with the rent only $700/month.

This is where estimating rehab based on a percentage gets REI in big trouble.  Raising the CAPEX estimate to 8% (LMAO right now) isn't going to cover it.

I'm experienced, and an Architect, and I wouldn't come near this house as an investment...especially if it's your first one.

Where are you coming up with $250/month in cash flow?  Not possible.  You're negative....and you forgot taxes.