Solid Cash Flowing Property. Offer Above Asking Price?

Question

Long story short, I've been looking to pick up my first MFH this year and came across a property that is cash flowing very well. It's a 3 BR/1 Bath duplex that currently has tenants in both units. Both tenants are on Section 8 so I'm learning the in's and out's of that program, but it's cash flowing much higher than non-Section 8 comparables. According to the seller's agent, they've received multiple offers on this property, have asked all interested parties to submit their best and final offers this week and will be making a decision by Thursday. Both units are the same size, with similar amenities. Pending inspection, I don't believe either unit will need any renovations anytime soon. Newer A/C units, roof, water heater, etc.

Tenant A: Lived there since 2018. Lease expires in July but I believe wants to stay. Current rent = $1,250/month. FMR in this area for this particular size unit is $1,575 per huduser.gov. I can likely raise this to ~$1,500 when it's time to renew the lease at no additional cost to tenant.

Tenant B: Just signed a 1 year lease on April 31st. Current rent = $1,520/month. This rent will have to stay until it's time to renew next year and/or sign a new lease. It's close enough to the max FMR that I have no issues with this.

Average Rent = $1,385/unit.
10% Vacancy = $277/mo.
10% Property Management = $250/mo
Taxes = $120/mo.
Insurance = $200/mo (rough estimate).
Water = $150/mo (paid by LL)
Garbage/Lawn = $100/mo (rough estimate)
P+I = ~$885/mo (estimated 5% interest rate over 30 years, full asking price with 25% down).

I realize that some of the expense percentages are a little on the high side. Also I will be managing the property myself, but wanted to account for a PM down the road. Regardless, after all expenses are accounted for my numbers show a net cash flow of $479/mo. This is a conservative number and is very likely to be higher unless I'm missing something.

Asking price is $240K - my initial offer was $230K. As mentioned above, they decided to wait until Thursday to review all best offers before making any decisions. My question is, would you offer full asking price or make an even more attractive offer by going above what they're asking? This property is in what I would consider a low C class area so I don't expect much (if any) appreciation. That being said, the cash flow is still solid. If I were to offer higher than asking price to lock down the deal, the only thing that would change expense-wise would be my P+I, but that would be minimal.

Leave my offer 10k below asking, meet asking price, or go above - what would you guys do? Is there anything I'm overlooking? I greatly appreciate any advice you can provide, thanks in advance!

Marten M. · Answer

@Evan Polaski That's a good point. I've been searching for and analyzing properties daily so I'm sure something will work out soon. I already have pre-approval for funding but the inspection is something I wouldn't want to take out just yet as I'm not comfortable spotting issues that could be a major headache to deal with.I do have a handful of older listings that I'm looking closely at, but it seems more often than not that these properties have not sold for good reasons - won't pass 4 point inspection for some reason, sitting on an unmitigated sink hole, etc.

Evan Polaski · Answer

@Marten M., unfortunately you will likely see this a lot. There are a lot of cash buyers out there, and as a seller myself, cash offers, but mainly the lack of financing contingency, a faster close, and typically no inspections, means they win the deals.This is where going after stale listings can help. You can try lower offers, with less favorable terms to the seller (inspections, financing) and still get it, since no one else has wanted it yet.

Marten M. · Answer

@Evan Polaski Got it, thanks for the explanation there. It makes more sense now. This particular property was sold to somebody who was able to offer a larger up front cash offer anyway, but I do think it was a pretty solid deal. Oh well, back to the search. Thanks again for the responses guys!

Evan Polaski · Answer

@Marten M. I did not mean to necessarily imply you needed to keep an itemized list, but I do think it is prudent to understand useful life of each piece of the house and cost to replace each. I just see a lot of posts here along the lines of "this is a new house, so my capex is very low" which is true in the near term, but it also means you will have some massive expenses all lumped together down the road. A roof is going to cost what it costs, and will need replaced when it needs replaced, whether you have reserves or not. You can start saving for it now, in small increments, or find a way to pay for it when it needs it. I like the reserve a little over a long time method.I used to have a spreadsheet a long time ago with all sorts of items, their useful life and their cost to determine monthly reserves. And I would update it periodically, since you can't get a rough for $3k anymore like you could a decade ago (or I just am sick of headaches that came with that level of contractor). But you can do the same:Item Useful Life Cost Monthly reservesTHen just go item by item, appliance, HVAC, roof, exterior paint, decking, gutters, siding, windows, water heater, garbage disposal, flooring, faucets, cabinets, etc, etc, etc.As for leasing commissions: Let's use $1,000/mo lease on a 12 mo lease, and they move out after 2nd year.New lease Month 0: 1,000Renewal Month 12: 500Total Cost: 1,500Time period: 24 moCost per month $62.50 = 1500/24% reserves: 6.25% = 62.50/1000This obviously starts to go down as you get more term out of your tenants. Say 3 years: 5.56% monthly reserve = (1000+500+500)/36

Marten M. · Answer

@Evan Polaski I see, makes sense. I was under the impression that taking 10% of the monthly gross rent would account for those capex items, but it sounds like what you're suggesting is to itemize them individually in addition to a flat 10%? As far as the leasing commissions go, I did not think of that at all. When calculating that, you're saying take 1.5 months rent divided by 2 years? 0.75 month's rent divided by 12 months?

Evan Polaski · Answer

@Marten M., What @Tim Herman is getting at, and seems to be very frequently overlooked by most investors here, is that new things wear out. The Roof is new. But has a 25 yr life, so you need to understand what that will cost. If a tear off is $5,000, that is $200/yr you need to reserve or $16.67/mo. Water heater will likely cost $500 to replace, or $3.50/mo to have enough in reserves to cover that. HVAC $5,000 over 20 years $21/mo. When you start adding all those expenses up in buy and hold model, you are grossly under reserving. In terms of repairs, I have never spent LESS than $1500 on a turnover. There is always stuff that needs hit. You also don't account for any leasing commissions. In my area 1/2 to 1 month on new leases and 1/2 month on renewals is standard. If you are turning every 2 years with new tenant, that averages to 6.25% for that cost (1 month for a new lease and 1/2 for renewal = 1.5 months divided by 2 years = 0.75 month expense per year.

Marten M. · Answer

@Tim Herman Yes my mistake - I did calculate those costs into the numbers I ran, I just forgot to include them in my original post. I've updated it. I accounted for 10% repairs and maintenance. The cash flow I originally cited had this baked into the NOI, so it's still at $479/mo. The roof, A/C unit and 1 of the hot water heaters have been replace recently (I'm guessing when the last section 8 inspection was done which was 1 month ago).

Tim Herman · Answer

@Marten M. where are the repairs and capex. I use 15% combined. You would be the first landlord that didn't have either. My service calls average $150 per call. My capex budget includes but is not limited to: roof 25 life span, floors 10 year life span, appliances and hot water heater 12 year life span, hvac 20 tear life span, bath and kitchen remodel 20 year life span. Add another 15% costs or take $420 from your $479 you will end up with $60 true cash flow.