Working on First Deal - Seeking Input

[Bryan Zayac]

Hey guys -- So I'm in the process of searching for my first deal. I've been looking at properties for a few months now. I found one that seems like a possible fit, and I'm going back to look at it this evening, as I was unable to get into one of the buildings on the previous trip. I'll give you the story on it:

Looks like the owner was making renovations to the 3 Bedroom SFH, which has been converted from a 2unit - 2BR & 1BR. Some tools are still on site. Tile hasn't been grouted. Still a good amount of work to be done, which is great, because I'm handy and have the capability to finish this space. One potential major concern is the floor. There are some serious high and low spots, the floor is not level. I plan on getting my contractor in there to take a look this weekend. With that said, the one 2 unit that I was able to see was it good shape. Just refinished. Nice space. Well maintained. Like I said, I'll be seeing the other 2 unit tonight.

The parcel is a 5 unit (used to be 6 unit), made up of 3 separate buildings, listed for $149K, has been on the market for 1.5 years, and has not been marketed well at all. Started at $205K:

Bldg 1 - 3 Bedroom/2 Bath SFH. This used to be a 2 unit.

Bldg 2 - 2 1 Bedroom/1 Bath Apt.

Bldg 3 - 2 1 Bedroom/1 Bath apt.

Bldg 1 needs work.

3 of the 4 1BR are rented, and are getting $600/month.

Here's how I figured the numbers:

Unit 1 - $1,100/month

Units 2-5 - $600/month

Mortgage	$750	12	$9,000
LOC Interest	$400	12	$4,800
Taxes	$3,000	1	$3,000
Insurance	$1,500	1	$1,500
Vacancy	$5,042	1	$5,042
Repairs	$125	12	$1,500
CapEx	$100	12	$1,200
Water/Sewer	$175	12	$2,100
Garbage	$50	12	$600
Management	12	$0

This shows a cash flow of $13,250.

I plan to manage the property myself. I have also included interest on LOC, which, assuming the property appraises out after, would not be included, so about $18,000 cash flow.

I understand this would be a commerical loan 5/1 ARM.

I am expecting to put about 30K into this, would buy for 130K with these calculations for an all in of 160K.

What am I missing?

I understand the likelihood of higher expenses due to multiple buildings. I would imagine my CapEx should be higher, maybe significantly?

Fire away. Thanks in advance.

[Chris K.]

@Bryan Zayac

1. CapEx wise you are reserving $240 each year per door. That's about as low as you can go with CapEx reserves. It's normally what I see set aside for newer, large apartment buildings. There's a famous @Ben Leybovich article floating around about how to estimate CapEx expenses. Try doing that and see what you get. I personally set aside anywhere from $800 to $1000 a year per door. It's conservative, but I like it. 

2. Your gross scheduled income is $42,000. Your vacancy is $5,042. So it looks like you budgeted 12 percent of vacancy. That's conservative so that's good. 

3. I calculate my maintenance reserve as a percentage based on my gross operating income (gross scheduled income minus vacancy plus other income). Your gross operating income is $37,958 a year. You are reserving about 3.95 percent. I understand that you are handy, but I would reserve at least 8% ($3036.64). Maybe 10% if you want to be conservative. 

4. It's fine to leave out property management for purposes of trying to calculate your actual cash flow. Just note that for purposes of determining your NOI (and ultimately your ARV), you want to include property management. I would put anywhere from 8% to 10% depending on your preference.

5. Can't really comment on the other items just based on the information you shared. Garbage and sewer seem a bit low but I don't know what Dunmore area charges off the top of my head. 

6. For purposes of calculating the NOI, let's do the standard assumption that many appraisers, lenders, and investors use in the area: 10% vacancy, 10% maintenance, and 10% PM. The other operating costs you have are sewer, garbage, tax, and flood. Assuming all the numbers are correct, your operating expense is around 39%.

If so, that's an excellent number. But again, I don't know if all your numbers are accurate and whether your rent expectations are reasonable. You can try to sort this out during due diligence (e.g. ask for Schedule E for this property for the past three years). 

7. Using the above method, the NOI I get is around $23k. Assuming a market cap rate of 10%, your property in mint condition is worth around $230k. The current price is $149k and you estimate that the rehab costs to be around $30k.

The fact that this property has been around on the market for 1.5 years suggests a few possibilities. Some of them include: 

• Your rent estimates are too high;
• There is something off about your operating expenses; 
• You are underestimating the rehab costs (perhaps you have major foundation issues); 
• You just found a great deal that everyone somehow missed for 1.5 years; and/or
• The owner decided to drop the price to $149k suddenly for whatever reason. 

8. Assuming you do have a great deal on your hand and all the numbers are reasonable, you probably have an ideal candidate for a BRRRR project. Do it at that way and your IRR should probably look really good.

Good luck! 

Disclaimer: While I’m an attorney licensed to practice in PA, I’m not your attorney. What I wrote above does not create an attorney/client relationship between us. I wrote the above for informational purposes. Do not rely on it as legal advice. Always consult with your attorney before you rely on the above information.