Risky and complicated first deal in Newark, NJ – should I do it?

Question

Risky and complicated for a first deal – should I do it?

Hi BP community. I am writing with my first post, and I am writing at a time when I sense all of the hard work put in is about to lead to my first deal, on this one or another in the near future. Below I have detailed the deal, my financing strategy, and my three questions. Any and all insight, feedback, and advice is welcome.

Potential deal

I am looking at an off market turnkey property in Newark near West Side Park. The property was fully rehabbed by an investor and the details are as follows:

Tenants were recently placed in the three units on one-year leases with rent totally $3,950.
With a 30 year mortgage, 20% down, I would be looking at 70k down payment, 10k in closing costs, and payments of $2,100 with mortgage, taxes and insurance (I can't house hack it).
I budgeted for 8% for vacancy, 5% for repairs (lower end because just rehabbed), 10% for property management, $1500 per year for water, and $1,200 per year to set aside for CAP ex.
With those numbers, which I think are on the conservative side with new leases with tenants that were carefully screened and a rehabbed property, cash flow comes to approximately $700 a month.

Financing Strategy

I am from Newark/Hillside area, so I know this property is not located in the best area of Newark, but I think the numbers are good, and having a good property manager would help. If this is a solid deal, than the question is how do I get the money when I don’t have 70k plus closing costs. BP podcasts with @Joshua Dorkin and @Brandon Turnerand, especially, @Matt Faircloth’s great book, Raising Private Capital, have really helped me to think creatively. Here is my strategy:

Raise 70-80k from family members through their the use of a Self-Directed IRA and their retirement funds. (I know this process can take 30-45 days but I may be able to get the time with the investor)
I can offer a 10% return on their investment with a 5-7 year hold period (after annual custodian fee – would technically be 9% on 30k investment), which would allow me to build my equity to 40% and cash them out with their 20% initial investment. The family members with whom I am speaking are in their 40’s and don’t pay attention to their retirement funds, like most people, so they are willing to get a higher return and just have me do the work.
A 10% return on an 80k investment would come to $667 per month, which would be nearly my entire cash flow. That’s the risk. The upside is they get a higher return than they would in the market, and I would get my first property and benefit from depreciation, appreciation, and the equity build up, plus increasing rents over time.
I don’t have much cash, but if any emergencies arise, I can take a loan from my retirement fund. Also, I would put aside every dollar that is not used for vacancy or repairs, plus the capex money.

Questions:

1.Are my budgeted numbers solid and is this a good deal?
2.Is the strategy to finance the property fair on all sides and worth the risk for the upside?
3.Should I raise the funds as an unsecured line (loan) from family members with a promissory note or as a loan backed with a proportional percentage of the mortgage?

Moises Mari · Answer

Hi @Jason G.! We own and provide property management services to several 3 family homes in Newark, Essex County and this is my take on your deal. To begin, are these 3 bedroom, 1 bath apartments? How much is this property selling for? - Tenants: If this is a rehabbed property and it's renting at around $1,300, I'm going to assume they are 2 bedroom apartments, if they are 3's you may be able to increase rents a bit. - Rent control: In Newark 3 families and above that are not owner occupied are rent control apartments, if you move forward request an OPRA request and find out if rents are registered and if you are allow to charge the $1,300 they are charging, many newer investors never look into this. - Budget: Your budgets seem fair, I would consider a little higher for management fees as 10% is the standard rate, but management also has lease up fees yearly, and onboarding costs, along with some additional things that come up, I would safely say 10-12% to truly estimate the cost of management. Managing properties in Newark can be challenging specially in certain areas.- Vacancies: They are normally not a huge issue in Northern NJ, if the price of your rental is right.- Screening Tenants: Don't ever count on a flipper to carefully screen tenants, we have had to evict tenants from newly rehabbed properties many times (Not to scare you) but is good to go into these deals with a clear expectation. I don't want to down talk flippers in this field or areas, but unfortunately in some cases, they are looking to fill the apartments so they look attractive to an investor, also many times this is not their expertise, so they may not do a great job at it.- Water/Sewer: Regarding to your water/sewer expense, we own and provide property management services to many 3 families in Newark and our monthly water/sewer expense roams around $120-150 monthly, which brings the annual expense to $1,500 on the lower end. @Satha Palani (Any other Newark investor feel free to chime in)... Best of Luck!Moises

Kerryanne Henry · Answer

@Moises Mari Great advise, especially on the rent control bit. @Ibrahim Hughes thanks for sharing this tax insight! Though my taxes actually went down after purchasing a turnkey property.@Jason G. Congrats on finding what appears to be an ok deal. A word of caution about turnkey props in Newark... budget at least 10-15% for maintenance costs. My recent experience has been eye opening, many many shortcuts taken on the rehab and a majority of them could not have been picked up during the inspection....i.e. behind there wall electrical issues etc. Since you know the rehabber, you may trust them more but once you buy the property...all the issues are yours.I would suggest getting into the deal for as little as possible (3.5-5% down using FHA maybe) are you planning to owner occupy? If it's not owner occupied, then factor in property management. Even if you live close by, unless you enjoy being on call all the time... PM will be worth it, though this further eats into cash flow.JV-ing on a deal like this won't work well splitting cash-flow, so that 50/50 split is a better plan. Also banking on appreciation, especially in a rough area, considering a "market correction" is anticipated... is wishful thinking. Appreciation should be the icing on the cake. Absolutely budget at least $1500 annually for water/sewer. In Newark, you pay not only for water supply but also water treatment.. since Newark does not treat its own water.... My first few bills I was on the phone with the water Dept. because the bill was ridiculous.. and there were no leaks!Good luck!

Ibrahim Hughes · Answer

It looks decent. I believe that three families in that area are going for 350k. I don't think 350,000 will buy you a three family in North Newark. There you're looking in the 400s and 500's.Two points not mentioned here is whether or not the property has a green card from the state. I think you would want to hold about $5,000 in escrow from the seller to be used in case that silly did not get the green card yet. And the state is backed up so it's going to be a while before you get an actual inspection by the state and subsequent green card is the property passes. So you definitely want to hold enough money in escrow to make needed repairs and modifications if the state requires it.#2 - One last thing, have the taxes gone up yet on the new renovations? You might want to factor that into yourcash flow. I think Newark is working on a 64% tax ratio right now. So whatever they have the property assessed that currently , it represents 64% of what they think the market value is. So take a look at those numbers and see if you're anywhere near 350k. If not then you might want to adjust.

Allan Szlafrok · Answer

I think your budgeted numbers are pretty spot on. If its in a rough area maybe 10% for vacancy can be expected but thats being even more conservative. Then again you also might be able to negotiate with a local property manager for like an 8% or 9% fee. 10% is pretty standard but everything in real estate is a negotiation so try that. Your best bet is to take on some partners or family members for the equity. Even with a property manager you'll still be dealing with the property and you should make sure you're getting some cash flow to compensate for that. Either split the profits 50/50 or offer them a lower return. Dont forget the stock market was down last year its a pretty good time to be offering people an alternative asset class.

David Steinbok · Answer

Wow I'm surprised no one has responded yet. if you have checked your numbers and find that they work than go for it. As for financing the deal, if you don't have the down payment you need a jv partner. As you stated giving someone 10% on the 80k would eat up 8000$ of your cashflow. Instead offer them 50% of equity and 50% cashflow. At the end of every year what you have left in bank you split. And when you refinance in 4-5 years, I think that's what you said, then you split the refinanced money 50/50. They would essentially get most of their original deposit money back at that point. Hope that helps.

Eric A. · Answer

@Jason G. I have to say I’m stunned by the other responses on repairs. There is no way you will only be at 5% in repairs. Even if it is recently rehabbed what is the original built date? My multis range anywhere from 11% - 27% depending on the age and tenant makeup. It sounds like you won’t be in the best area so I would shoot hi and adjust lower if need be. It’s always the hidden repairs that you never think about. Good luck!

Jason G. · Answer

@Ray Harrell thanks, Ray. I agree. The thinking behind this one was I wouldn’t get the cash flow, at least not in the beginnning, but I would be doing the deal mainly to get the experience.

Jason G. · Answer

Thank you @David Steinbok @Ryan P. Kotschedoff @Allan Szlafrok. I like the 50/50 split that you all are talking about, but there are a few reasons I didn’t take this route - probably because of my lack of knowledge. First, I was concerned that if they owned it and invested with an SDIRA, half of the property would not be eligible for depreciation. Is there a way where the bank loan is in my name and we get the full benefit of depreciation and still have a 50/50 split? Also, I didn’t think an investor would be interested in a 50/50 split because the cash on cash return on the 70k amounts to 6%. With the depreciation, equity, and appreciation, the ROI would amount to more, but the property is not in an area that will appreciate quickly. Therefore, I didn’t think the split would be highly attractive, with lower returns and without much capital from me.Also, I was trying to avoid having my family members on the loan and have them go through all of the additional paper work. Is there a way to do that?I agree with your point, @Ryan P. Kotschedoff, about doing all of the work on a 50/50 split, and your point, @Allan Szlafrok, about negotiating. I know investors who are mainly looking to partner on bigger deals, but it doesn’t hurt to run this one by them.

Jhon Restrepo · Answer

hi, Mr jason, were you able to close deal of Newark property?

Farrukh Amini · Answer

Great point about turnkey properties @Kerryanne Henry I see that happening in Jersey City as well. Gotta be careful with newly renovated properties.