Analyze this deal - Memphis TN

[Abdul Azeez]

Hello Folks - I am being offered a turnkey property in the following neighborhood on Scottsdale Ave zip 38115 for $120,000. It is classified as a B+ neighborhood. The house in question is a 4/2 with projected rental income of $1295. I have run the calculations using the following forecasts - 10% management fee, 4.5% 30 year fixed with 25% down and vacancy allowance of 12.5% (assuming an average tenant would stay 2 years with 2 months to acquire the tenant and 1 month of rent as commission. So close to 1.5 months on an average in a 12 month period leading to 12.5%). I have also used 10% as a maintenance and CAPEX reserve. Using all this, it comes to $227 per month on a free cash flow basis. Is this a good deal? Do my numbers above look good including the confidence factor on rental estimate? Also, is this truly a B+ neighborhood or are there other factors to look at?

[Joseph S.]

@Abdul Azeez,

Here are my thoughts:

• Location - I’m out of state as well, but from what I’ve learned there is a B+ neighborhood in that area that is basically visualized as a box between Mt. Moriah Rd, Newberry Avenue, Mendenhall Road, and Hickory Hill Road. From what I understand the closer you get to the center of that box the better. Scottsdale Avenue runs between Mendenhall Road and Hickory Hill Road and is North of Newberry Avenue so it does fall within that zone (though towards the bottom end). Look at the address and see if it’s towards the middle or farther ends (East and West) to evaluate where it’s nestled within the zone.
• Rent – Even if it falls near the perfect area of that location I haven’t seen any houses in that area bring in $1,295. As a gut-check I would look at the expected rents on Zillow and Rentometer. Then I would jump onto Rent.com and see what is actively listed in the area. I usually like to take the lowest number from these sources when I’m first running my analysis. It’s by no means a perfect estimate, but it does get pretty close. If you get serious about the property I would ask your property management company (not the one connected to the turnkey company) to tell you what it will rent for (if you’ve picked a company with a good size portfolio they can look at their own rentals in the area and give you a very good estimate).
• Maintenance - I imagine when you say 10% as a maintenance and capex reserve you mean 10% of rent. I would caution you to use a percentage of the cost to rebuild (or to keep it simple the market value of the property) with the location and age of the building instead. I use 1-3%, 1% if it is in a good (B+ to A) area and built within the last 20 years, then I slide the scale up to 3% as it gets into a bad area and the property ages. The reason for this is that property values are tied much more closely to the cost to rebuild than rent values. I personally don’t let this number drop beneath $1200 per year since I’m a bit conservative, but if it's turnkey and everything is in perfect condition with all new systems I could be convinced to reduce this number a bit.
• Capex – Since you include your capex within your maintenance estimate of 10% I think it's probably too low. Here is a good article describing the breakdown of Capex and how much to estimate for it (https://www.biggerpockets.com/renewsblog/2015/10/1...).
• Property Taxes – I didn’t see you mention this in your breakdown. Memphis has both county and city taxes – this area of Memphis has both. A good rule of thumb is to estimate that taxes within Memphis will be 1.94% of the total value of the property. Bear in mind that certain areas of Shelby County are unincorporated so you aren’t stuck with city taxes (such as Cordova, Barretville, etc.). Just to keep things simple on your initial screening I’d use the 1.94% number and then anything you can save is gravy.
• Insurance - I also didn’t see you mention insurance. A good rule of thumb is $65 per year for every $10k of coverage for a catastrophic fire policy in the area.
• Initial Equity – As an out of state buyer I know that I have greater risk for something to go wrong (and a limited ability to successfully handle it) than somebody who is buying in their backyard. Even if you have a strong team in the area something could always go wrong so buying at a distance presents its own unique set of problems. Thus, you need an exit strategy you can employ without breaking the bank and wiping out whatever earnings you gained while you held the property. Because of this I always look to enter a property with at least 10-15% in equity so I can cover my sales and closing expenses and possibly a bit extra in case I have to provide the buyer an incentive because of the market cycle. I have not yet met a traditional turnkey company that fits this requirement (and based on what I know about this area, this property is marked up and won't provide that).

If you apply the above criteria to this deal you'll likely see your cash flow drop into the red. I'd walk away from this one.