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

[John Gentile]

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

[Anthony Thompson]

@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).