How to recognize a good deal vs a bad deal?

Question

Hi

I'm trying to learn, read, and grow my network in real-estate for about 1 month. I'm fairly new to the whole concept of investing into an MFH, but I think I'm ready to look into my next investment. I definitely don't want to precipitate myself into any first deal, but I need to start somewhere. I currently talking to a broker about his 4units MFH on the market and here are the specs for this deal:

Rent Roll:4x $550      monthly returns:$2,200.00        yearly returns:$26,400.00

Income & Expense

INCOME

Rental Income $26,400.00

Coin-op $1,200.00

Vacancy/ Credit

Allowance 5% $1,320.00

Total Income $26,280.00

EXPENSES (Best guess and ests totals 5% min $200)

- Management $2,400.00

- Utitlties: Water, Gas, Power $3,436.00

- Maintenance $1,320.00

- Insurance $2,000.00

- Includes Trash Property Tax $2,826.00

Total Expenses $11,982.00

NET OPERATING INCOME $14,298.00

RETURNS ANALYSIS

- Capitalization Rate 7.15%

- Project Cost $199,900.00

- Price Per SF $50.00

- Debt Amount $159,920.00

- Equity Required 20% $39,980.00

Net Operating Income $14,298.00

Debt Service $9,723.49

Net Cash Flow $4,574.51

Leveraged Return on Equity 11.44% $64,022 net worth accumulation

Principal Payment - 1st Year $2,579.85

Return on Equity after Principal Payment 17.89% $64,022.38

DSCR 1.4704591

Year 1 $7,154.36

Year 2 $9,852.51

Year 3 $12,674.51

Year 4 $15,626.51

Year 5 $18,714.51

Debt Service Assumptions

Interest Rate 4.50%

Amortization 30

LTV Ratio 80%

(Properties located in Wisconsin City Green Bay)

Take for a fact: I don't know the surrounding economy of the city at the moment and the area of this property. It seems to be a good deal, but I'm wondering what are some of the questions I should ask? and what should I pay the most attention to this deal or future deals?

He advises me to refinance the property after the 3 years and reinvest the money into another 4units to grow my real-estate? I have recently learned from the forum this part actually is a good advice by not trying to complete the mortgage because it would be considered as lost at a long run. (If I read correctly).

Last point: He advised me to take a small HELOC or an HEL of $50000 on my SFH which already paid off.

Any pieces of advice or suggestions are more than welcome!

Ryan Scott Isacksen · Answer

@Claude Sicard,

You will probably benefit from reaching out to some people in the area of the market.I would call up a broker or two and find out what cap rate things are typically selling at.

You can also reach out to some property management companies and get an idea of their rates and expected expenses for the area.

Claude Sicard · Answer

@Chad Nagel thanks for giving me an insight. I just read and learned the 1% rule now!

@Spencer Gray thanks for the creative approach and showing me another angle into this property. I'm asking him few more questions on this part now. I did look at the laundry projection this will help rent + value added. Rent seems to have variable based on the sqft and location. I don't know the property location, yet. I'll look at it for sure, it's a life learning lesson for now.

Spencer Gray · Answer

@Claude Sicard

I agree with @Chad Nagel that your maintenance seems pretty skinny, especially if you are having a 3rd party (or a management co) do the majority of the work. I would use 10% of your gross rent for maintenance instead of 5%. If you were well seasoned and knew exactly what it costs you it's one thing (5% is still low) but if not I would error on the side of being more conservative than even the probable. I'm sure there are plenty of pros on here that hit 5% for maintenance, but I bet they still underwrite 10%.

I also think you should include reserves for capital expenditures. You will need to (or should) be doing ongoing capital improvements in addition to ongoing maintenance if you want your property to appreciate. I would set aside or plan on spending at least 5-10% of your gross rent, because you will have years with $2-4k+ for cap ex.

On the upside can you charge back your tenants for utilities? or is that for common area/coin op? Could you add washer and dryer hookups, charge more rent and turn the laundry facility into another amenity like storage where you can then charge for additional rent?

Are rents at or below market? If you improve the units could you compete with higher end comps in the area and bump rents?

If you can push the value you may still have a deal even with more conservative underwriting assumptions.

Chad Nagel · Answer

Maintenance of $1320?

I understand you from cali, but you will spend close to $1300  just in snow removal for winter time, if we have a bad winter, not counting lawn care expenses in the summer. Don't forget cap x/ repairs in budget as well. This is a 1% deal its average nothing special.