What would you do?

Question

Hi All!

My husband and I just looked at two duplexes. We can buy them individually or as a package. Here are my calculations using the BP analysis tool if we buy them as a package:

Monthly Income: $2,795.00

Monthly Expenses: $2,222.31

Monthly Cash Flow:  $572.69

Pro Forma Cap Rate: 10.36%

NOI: $13,983.00

Total Cash Needed: $41,250.00

Cash on Cash ROI: 16.66%

Purchase Cap Rate: 11.19%

Gross Rent Mult: 3.73

2% rule: 2.07

Debt coverage ratio: 1.97

Total monthly cashflow using the 50% rule: $804.94

Here's one of my many questions: I entered 10% of gross monthly rents as expenses for both CapEx and repairs. Of course, that affects the analysis pretty significantly. Am I using the wrong percentage? What do you normally use for these figures?  A percentage of the gross monthly rents or a straight dollar amount?

Also, for the $41,250 to get in, would you take on an equity partner (what percent of the deal would you offer), or a debt partner (what interest rate would you offer to pay), or do it by yourself (even if it meant borrowing against your IRA)?

Thanks in advance for the advice!

Cheers~

Tara Piantanida-Kelly

Brandon Hicks · Answer

$10,000 for closing and DD on a $125k deal !?!?

That makes me want to puke. I closed 6 deals last year with less than that total of out of pocket!!  (3 duplexes, 2 houses, a 5 unit complex)

The key to investing in buy and hold real estate IMO is to get whatever money you put in back out! The less you put in, the easier it is to get it back out.

Will the seller hold paper either through a land contract or a second for 10-15% of the sales price?

Can you use a local bank with lower closing costs?

Pretend you have NO money and put the deal together without it.

I would shoot for a land contract with as little down as possible. I can close a land contract for around $700 in Indiana ($350 attorney's, $300 for lien search and closing by title company, $30-40 for doc prep by TC, $30 in courthouse recording fees.)

I bought 2 duplexes on adjoining parcels from different owners last year with the same terms. No cash down, 20 year amortization, 5 year balloons and 5% interest. I also bought a triplex and a duplex on the same parcel for no cash down, 20 yr amortization, 5 year balloon, and 6% interest.

Here is the wording on the down payment from my letter of intent. Most of my deals are unlisted properties by the way. Its easier to buy direct when going no cash down since there is no commission to deal with.

"The down payment is to be made up entirely from credits for prorated property taxes, prorated rent for the month closing takes place and security deposits that you have collected from the current tenant(s). The land contract note amount will be the balance owed after the above credits have been subtracted."

Let me know if you need further explanation on that.

Ive done over $900k in land contracts in the last 3 years for a total of around $20-22k out of pocket. Most of that cash came from cash flow from my properties. I haven't calculated COC but im guessing my retirement will be better than it would've been had I trusted Wall Street with it :)

Tara Piantanida-Kelly · Answer

@Brandon Hicks , this is fabulous information!  Thanks for sharing it!  I figured I was estimating on the high side.  Since this is my first attempt, I tried to be very conservative, in case I missed something.  You give a really interesting and creative alternative to my more traditional approach.  I'm scheduled to attend a real estate symposium on creative real estate financing later this month, but maybe I should just learn it from you!  :)

Roy N. · Answer

@Tara Piantanida-Kelly

Have you analysed both properties separately, is one definitely stronger than the other (i.e. is one closer to 3% rate, but both combined are 2%)?  Is either or both property tenanted at the moment?  @Susan  Gillespie make a good point, if one is head and shoulders above the other (and it is still 2%+ rent), the cherry pick.  There will always be another property.

If the two properties are basically the same (i.e. 2% rent) and they are presently generating revenue, you could purchase both now and pay out half (or more) of your IRA loan when you sell the other property in the spring.  Yes your free cash-flow may suffer a little in the short term.

You would be looking at 6-8% (or more) with a private lender, which would change your projections significantly, so if you can borrow penalty free from your IRA, it may/should be a lower opportunity cost of capital.

BTW: Your closing estimate may be a little high, but that's better than the alternative.   If the rest of your numbers are conservative and nothing is left out you should have a solid deal.   If there is opportunity for forced appreciation, then you may be able to refinance in 1-2 years and pay out any remaining balance on your IRA loan.

Tara Piantanida-Kelly · Answer

@Susan  Gillespie

- Thanks for the reply!

Hi Tara, what is the condition of the duplexes? Pretty good.  New furnaces and water heaters.  Newer roofs.

Are they currently rented, or vacant and need repair? All 4 are currently rented.  Month-to-month after the initial 1-year lease expired.  3 of the 4 units are  rented at under market rates.

What is the housing quality and price trend in the neighborhood?  It's quite mixed.  It's a rural area, but with a desirable school district and few rentals in the area.

Have you included all expenses? I think so.  My initial analysis used 10% of gross monthly rental income for CapEx and another 10% for repairs and maintenance.  That brought the COC and cash flow estimates way down, but I'd rather be safe than sorry.

Do you have time, experience and/or a property manager for taking on four units?  The existing property manager (along with the realtor) brought us through the properties.  He's local, and has been managing them for quite a few years.  We would look to keep him on.

My thoughts:

-Is one duplex better? Cherry pick the best one if you're more comfortable with costs. Partners can be a lot of work and it takes time to find the right partner and type of agreement.  That's exactly what my husband and I were just discussing during dinner.  We're now thinking that perhaps we should just make an offer on the larger duplex - it's a bit more money, but it also has a higher annual income.  And we would have to come up with less for the down, closing costs and due diligence.

-I wouldn't borrow IRA money for real estate due to penalty potential. Or would you live in the duplex to take a penalty free withdrawal?  We're not looking to withdraw from the IRA (which would cause penalties and a tax liability).  We're looking to do a short-term loan against a portion of the IRA.

-I don't have detail on expenses in your analysis, or know age, condition or deferred maintenance issues, but I look for net cash flow of at least $300/month. You're just under, but maybe you see something else compelling in the deal?  The property was built in the early 70's.  For our area, that's young!  (My house is over 100 years old!).  The roofs are newer, and all four units have new furnaces and new (or newer) water heaters.

I rely on cash flow projections and internal rate of return for my buy and hold decisions. Good luck with yours. Let us know how it goes.

Thank you, thank you, thank you, Susan!  Your input is incredibly helpful!

Tara Piantanida-Kelly · Answer

@Roy N.

Or ... maybe you have the ability to improve your current deal. You've stated the cash needed as 41.25K, but you have not indicated the ask & offer prices, nor the LTV you are aiming to achieve.

We're looking at offering $125,000 for the package.  25% down ($31,250) and $10,000 for closing and due diligence.  We can borrow the $41,250 against an IRA with no penalties (other than interest on the loan), but that, of course, will affect our cash flow estimates.

Perhaps what we should do is just look at the larger duplex.  We would probably only need $24,000 to get in (25% down = $19000 plus $5000 for closing and due diligence).  The amount we borrow against the IRA would be less, and we could pay it in full when we sell a different property this spring.

Susan Gillespie · Answer

Hi Tara, what is the condition of the duplexes? Are they currently rented, or vacant and need repair? What is the housing quality and price trend in the neighborhood? Have you included all expenses? Do you have time, experience and/or a property manager for taking on four units?

My thoughts:

-Is one duplex better? Cherry pick the best one if you're more comfortable with costs. Partners can be a lot of work and it takes time to find the right partner and type of agreement.

-I wouldn't borrow IRA money for real estate due to penalty potential. Or would you live in the duplex to take a penalty free withdrawal?

-I don't have detail on expenses in your analysis, or know age, condition or deferred maintenance issues, but I look for net cash flow of at least $300/month. You're just under, but maybe you see something else compelling in the deal?

I rely on cash flow projections and internal rate of return for my buy and hold decisions. Good luck with yours. Let us know how it goes.

Roy N. · Answer

@Tara Piantanida-Kelly

You may be hard pressed to make 35% CoC deal in western New York ... though you are next door to the rust belt, so perhaps they do exist in your area.

If you wander a little further west towards Cleveland, you could may find deals like that (there are some that produce 3.0+% rent).

Or ... maybe you have the ability to improve your current deal.  You've stated the cash needed as 41.25K, but you have not indicated the ask & offer prices, nor the LTV you are aiming to achieve.

Tara Piantanida-Kelly · Answer

Thanks, @Kevin Brown !  That's good info!

Kevin Brown · Answer

@Tara Piantanida-Kelly

The leveraged properties I have run around 35% COC.

Tara Piantanida-Kelly · Answer

Yes, @Roy N.    This is a duplicate of the info I entered on the Deal Analysis Forum yesterday.  You gave great info, but yours was the only reply.  I was hoping for additional input (which you gave here - thanks again!).  @Kevin Brown , what kind of COC and/or cash flow would you want with $45k in?  Just curious to see what others use as benchmarks...  Thanks to both of you for your responses!

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