Am I crazy to do this deal? (First rental property)

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Am I crazy to do this deal? (First rental property)

John Gentile
Rental Property Investor · Foxboro, MA · Member since 2014 · 32 posts · 15 votes

Hi BP Community,

I'm in the Massachusetts market, south of Boston.  I have been looking at Rhode Island for more favorable prices.  My wife and I found a 3 family in Providence (east side a couple blocks from Brown University) we really like.  Asking price is 349k and we could get it for 335k (we are in the middle of negotiation).  It has a new roof put on a year ago with a lifetime warranty.  All capital expenditures are good for a long time.  Each unit was updated along with windows in 2013.  

The units are all rented but rent is below market - 950, 950, 900 (2BR, 2BR, 1BR).  I want to add access to the basement (it was closed off due to the stairs collapsing a number of years ago), to give tenants storage access and also to install washer and dryer units (these updates don't need to be done immediately, but I'm factoring them into the analysis).  Considering these additions along with some minor cosmetic updates and where the market is at, I feel like rents could be 1200, 1200, 1000 (sellers agent says 1200-1400 for the 2brs but I think that is high given the smaller sq footage).  Leases are up in March, April, May.  If the current tenants stay I may only go up by a smaller amount - 1100, 1100, 950.  I've been told they are excellent tenants.

The link below is the BP calculator analysis with current rents. As you can see, metrics like cash on cash ROI are not favorable. We really like the area, the property, and the fact that it attracts quality tenants and I know you can't put a price on that. Should I move forward with this under the assumption I should be getting better rents and knowing there aren't any big expenditures around the corner (pending an inspection)? I have analyzed a number of properties over the years and have been less excited about properties with better numbers that come along with other issues.

I know appreciation is lower and taxes are high in Providence. Also I'm funding a portion of this from a HELOC and that int payment will eat into some cashflow. However, if the rents can come up to where they should, cash flow would be an additional $600 cushioning that blow.

Thanks!

https://www.biggerpockets.com/calculators/shared/257326/9f4dfe3e-ad5d-4e9f-9607-37c274f7203e

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Anthony ThompsonPro Member
Buy and Hold Investor · Cranston, RI · Member since 2013 · 1k+ posts · 1k+ votes
8y

@John Gentile This deal only makes sense if you can really, truly increase the rents to 1200, 1200 and 1000 like you said. It does not make sense with the current rents. It is an "OK" deal if those are the new rents and you only have to spend ~$15,000 in repairs/improvements to the property to get the rents to those levels. Obviously, the more you spend, the lower your return will be.

I had to make a lot of assumptions in taking a quick look at this, for example I'm assuming all tenants pay their own utilities. If the owner is paying the utilities, it doesn't even make sense in the repair/raise-rent scenario and loses money in the current (as-is) scenario

I also assumed it would be a conventional loan with your putting 25% down.

I did not account for the fact that you'd be paying interest on your down payment since it's coming from a HELOC - I don't know your interest rate, but the numbers almost certainly don't make sense to do the deal if you have to borrow for the down payment, even in the raised-rents scenario.

And I'm always extremely hesitant to encourage any newer investor to buy a property where the current rents make it a thin or bad deal and it only makes sense with some proposed/assumed/pro-forma rent.

The phrase you'll see in MLS listings is "rents could be higher". My response is, "then why aren't they?" (already higher).

Maybe it's because the tenants were there for a while, the owners were bad at raising rents etc. But maybe there's some other reason you're not seeing. I would caution anyone against buying when a deal only makes sense on the assumption of being able to raise rents.

If owner pays utilities on this deal, I would say walk away. If tenants pay their own utilities and you're very certain about being able to get those 1200/1200/1000 rents, along with rehab #s no higher than 20K max to get them there, then after doing the work to the property you will have an "OK" deal (about a 5% cash on cash return). It's nothing to get excited about, but if you really like the area and there are other factors at play (e.g., you have to invest the money before your kids or spouse spend it ;) then you could do OK with it.

But it still seems a little thin to me and you'd be taking on some (admittedly small ish) risk to get a meh return. I guess I'd say, if you're going to hire a property manager (recommended, if you're in Boston), then run this deal by them to see their thoughts about the property and especially the expected/hoped-for new rents, since they'll be your "boots on the ground".

You absolutely need to take your HELOC interest into account though since that cost could tank even the rosiest scenario (that's still in the realm of the realistic).

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  • Joseph BirbigliaPro Member
    Investor · Providence, RI · Member since 2015 · 12 posts · 5 votes
    8y

    John, I don't think the numbers work. I have a 3-unit on the east side I picked up for that price two years ago, pretty similar, with 9 total bedrooms and substantially higher rents, and it's just starting to make sense. If you message me directly I can share more about that experience.   

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  • Anthony ThompsonPro Member
    Buy and Hold Investor · Cranston, RI · Member since 2013 · 1k+ posts · 1k+ votes
    8y

    @John Gentile This deal only makes sense if you can really, truly increase the rents to 1200, 1200 and 1000 like you said. It does not make sense with the current rents. It is an "OK" deal if those are the new rents and you only have to spend ~$15,000 in repairs/improvements to the property to get the rents to those levels. Obviously, the more you spend, the lower your return will be.

    I had to make a lot of assumptions in taking a quick look at this, for example I'm assuming all tenants pay their own utilities. If the owner is paying the utilities, it doesn't even make sense in the repair/raise-rent scenario and loses money in the current (as-is) scenario

    I also assumed it would be a conventional loan with your putting 25% down.

    I did not account for the fact that you'd be paying interest on your down payment since it's coming from a HELOC - I don't know your interest rate, but the numbers almost certainly don't make sense to do the deal if you have to borrow for the down payment, even in the raised-rents scenario.

    And I'm always extremely hesitant to encourage any newer investor to buy a property where the current rents make it a thin or bad deal and it only makes sense with some proposed/assumed/pro-forma rent.

    The phrase you'll see in MLS listings is "rents could be higher". My response is, "then why aren't they?" (already higher).

    Maybe it's because the tenants were there for a while, the owners were bad at raising rents etc. But maybe there's some other reason you're not seeing. I would caution anyone against buying when a deal only makes sense on the assumption of being able to raise rents.

    If owner pays utilities on this deal, I would say walk away. If tenants pay their own utilities and you're very certain about being able to get those 1200/1200/1000 rents, along with rehab #s no higher than 20K max to get them there, then after doing the work to the property you will have an "OK" deal (about a 5% cash on cash return). It's nothing to get excited about, but if you really like the area and there are other factors at play (e.g., you have to invest the money before your kids or spouse spend it ;) then you could do OK with it.

    But it still seems a little thin to me and you'd be taking on some (admittedly small ish) risk to get a meh return. I guess I'd say, if you're going to hire a property manager (recommended, if you're in Boston), then run this deal by them to see their thoughts about the property and especially the expected/hoped-for new rents, since they'll be your "boots on the ground".

    You absolutely need to take your HELOC interest into account though since that cost could tank even the rosiest scenario (that's still in the realm of the realistic).

    3Reply
  • John Gentile
    OP
    Rental Property Investor · Foxboro, MA · Member since 2014 · 32 posts · 15 votes
    8y

    @Anthony Thompson and @Joseph Birbiglia thank you for the reply.  

    Anthony - I would pay for water/sewer.  The tenants are paying for heat/electricity.    Yes it's a conventional loan at 25% down.  I feel pretty much the exact same way - with closer to market rents it's a better investment but not great.  Doesn't get me super excited to do the deal.  It's an assumption to assume I can get the rents.  From what I've heard, the current owner didn't want to raise them because he likes the tenants.  He hasn't had turnover in quite some time.  Very helpful.  Thanks!

    1Reply
  • Dan Curto
    Holliston, MA · Member since 2018 · 4 posts · 1 vote
    8y

    John - I'm new at this, but have been analyzing properties in Providence and Metro west (MA) for a few months now.  This deal would make me too nervous, but take that from someone who is fairly risk averse.  Maybe I'm missing it, but I don't see much allocated for repairs/maintenance/cap ex on your report.  That alone would make me pretty nervous as there seems to be little cushion.  I assume you are planning to manage the property on your own, which is reasonable since you are not that far away in Foxboro. 

    Not sure where you are in this process and if you have other properties.   For me Providence and most of Massachusetts feels priced pretty high, especially compared to rents and for Providence you have to add in an extremely high tax rate for non-owner occupied buildings.  I am being pretty cautious at the moment because it feels like there is little appreciation available and if the economy turns even a little it could make these close deals a huge albatross.  

    1Reply
  • Christian Allen
    Investor · Providence, RI · Member since 2016 · 77 posts · 65 votes
    8y

    @John Gentile welcome to the East Side market, returns can be pretty thin especially for a "turnkey" property.  I live not too far from that property on the east side of Hope Street.  My two cents would be this. 

    1. It is in a neighborhood called "Mount Hope" which is on the rise historically but compared to the rest of the East Side is usually the least desirable in my experience.  Doesn't mean it's not a good area but the students typically are aware of the best places for apartments so you would be less likely to get the higher dollar Brown student rent.  

    2. Since the units are only 900 sq ft, $1200/month may be a little bit of a stretch based on comparables in that neighborhood.  Not saying it's not possible but I would base your numbers on that being on the mid-higher end.   

    Luckily properties in that neighborhood have lower tax valuations so you save a little bit there.  

    2Reply
  • Nancy DeSocio
    Rental Property Investor · Cranston, RI · Member since 2017 · 171 posts · 158 votes
    8y

    @John Gentile, I'm a relatively new investor and looked at that property too (based on your description, I'm pretty sure it's the same one...unless collapsing stairwells are common in that area...ha ha!).  It was one of the nicer properties we saw for that price point in that location, but we passed on it for the same reason you and others have noted here...slim margins and making assumptions (though somewhat reasonable assumptions) on future rents.  It was hard for me to take the emotion out of this one, because I really liked that house!  Good luck with your decision...I hope it works in your favor!

    1Reply
  • John Gentile
    OP
    Rental Property Investor · Foxboro, MA · Member since 2014 · 32 posts · 15 votes
    8y

    @Dan Curto thanks very much.  Yes I would manage the property on my own.  The prices are very high right now. It's frustrating.  

    Taxes are very high in Providence.  They are astronomical as you get closer to Brown.  

    Makes you consider using one of those turkey companies in the midwest or down south and getting the 12-15% ROI. But where's the fun in that?

    1Reply
  • John Gentile
    OP
    Rental Property Investor · Foxboro, MA · Member since 2014 · 32 posts · 15 votes
    8y

    @Christian Allen Thank you!  I agree 1200 could be a stretch, which is why I'm not 100% confident about this deal.  Taxes are a bit lower but they still feel high ($6350) to me considering some of the towns I have been analyzing in Mass, which are in the 2000 - 5000 range.

    @Nancy DeSocio  haha that's pretty funny you saw the same place.  It's nice to see you had to think this through also.  I got a bit emotionally attached because my wife liked it also, and she is usually picky with real estate.  I'm usually strictly numbers.. if they don't work, I move on.  Thank you!

    0Reply
  • Rob L.
    Haverhill, MA · Member since 2009 · 293 posts · 157 votes
    8y

    @John Gentile I would pass.  Your expenses are too low and same with your cash flow. Yes, you could increase the rents over time but I've seen too many people get burned buying on what cash flow could be and not what it is currently. I'm not sure the age of the property but most 3 families are way are about 100 years old. We put aside 15% for expenses due to the older housing stock. 

    1Reply
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