Is the price unreasonable or am I unreasonable?

[Greg Callan]

Hello all,

I am very new to investment real estate. I am evaluating some of my first potential buys, but I could use some guidance to determine when a property is not a good deal because of the parameters of the property or when it is not a good deal because I am expecting to have my cake and eat it too. 

Here are some details. The property sale price is $450,000. I was originally told that each unit was renting at $750. While researching it, the rent for the units have increased to $850. I currently have an apartment that is much nicer in a better part of town for $1050, so I feel like $850 is probably stretching this property. Two of the four units are being completely renovated due to a water heater blow out. The concept pictures of the renovated apartments do look VERY nice. In fact, nicer inside than my $1050 a month apartment, but still quite a bit smaller and in a part of town that is not as nice. Thus, my assumption is that $850 a month might be pushing it and it is possible I may see the rental price roll back to $750 especially if there is a downturn in the housing economy. Regardless, I will go with the optimistic $850 for the initial discussion.

Thus, total incoming rent = $3400 ($850*4)

Net operating income per month =$ 3400 / 2 = $1700 (Using the 50% rule here. My own estimations of the expenses came out to 42%. Please let me know your opinion of the 50% rule. The management company indicated that 35% was a good rule of thumb for expenses but that seems way too low after reading many posts about the 50% rule.

Financing - a 10% downpayment on an FHA loan, with 4.75% interest, and $268 of PMI each month for 132 payments. The monthly principal and interest payment is $2149.00.

$1700 NOI/month - $2149mortgage = -$449 (negative cashflow after I pay my mortgage)

-$449 - 268PMI = -$717 (negative cashflow with PMI)

From this perspective, the real-estate doesn't look like a good investment, although property depreciation and tax losses would offset some of these losses in the first few years. So where do I go from here? Is the seller's price unreasonable or am I unreasonable to expect a property to cashflow with a 10% downpayment?

[Russell Brazil]

Well question 1 here is you said FHA loan. That indicates that you are looking at a 1-4 unit property that you plan to owner occupy.

So therefore things such as the expected rents and expected expenses will have zero to do with valuing the property. 1-4 unit properties are primarily values based on comparable sales.

Now id this is a 5+ unit, then you are looking at the wrong type of financing entirely.

Also, if you are using a low down payment, expecting cash flow isnt really something someone should expect.  When an investor buys a property, the assumption is its going to be at minimum 20% down, and typically more.