Should I Buy or Walk?

Question

Hello BP Members,

I am considering purchasing a foreclosed Fanne Mae (HomePath) home with a lot of upsides and down sides.  I am in desperate need for some advice because I am not very experienced with the evaluating a deal.  Comps say it is worth $300k and I have a purchase price currently at $282k. (property tax is $3,950).

The GOOD:

The property has two separate dwellings with their own utilities.  The main home can be rented out for $1,650 (3bd, 2bath) a month and the second home for $1,250 a month (3bd, 1bath).  I am going to live in the main home but would like to consider them as both rentals in case I would like to move.

The BAD:

The main home needs some roof repairs ($3k) and the smaller home needs a new roof entirely ($7k).  I got a great roofer and he is giving me a deal.  The main home had multiple additions the home inspection recommend additional investigating.  Had a structural engineer design a mitigation for a structural flaw and a contractor bid for ($5k).  I estimate with these repairs and all the little things needed will cost $25k (very conservative).  Interest rate is high (5.1%, $1,850 note GFE) because it is HomePath home and conventional would not pass with current condition.  I estimate the cash on cash return to be about 14%.

Should I Buy or Walk?  With $55k I guess I could put 20% on two single families in stead but nothing worth buying around here.

Account Closed · Answer

Patrick,

Thank you for your input  So the 50% rule indicates that the property would have a negative cash flow by conservatily estimating expenses?  Finding a dwelling that would rent for twice the conventional note would be rare. I would have to either find someone to practically give the property away or get very creative with financing.

Can't I budget all the expenses and verify that there will be $100 or more net per door?  I understand that if the investment passes both rules it should pencil out but I have found it difficult to find these type of opportunities.

Account Closed · Answer

Thank you for the advice Sean, Bill, and Ellis.

I plan on watching it and make an offer before the new year. My thought is maybe the would be more motivated to sell lower to meet their numbers. Just speculating that would be a factor. Does anyone have any strategy for offers on foreclosures?

Patrick L. · Answer

@Joe Mercer The 50% rule is just a quick way of estimating your total expenses.  Some properties will be lower and some will be higher but if you see big negative cash flow with the estimation odds are you won't be making money on the investment.  It helps you include costs that many people leave off when running the numbers.  Everybody factors in taxes and insurance but to get your true expenses you also need to consider management costs, repair costs, capital expenses and vacancy.

Many people overlook the big ticket items that don't come up every year but will can be a major hit if not planned for accordingly.  What happens when the main building needs a new roof and that costs you $10k?  Roofs, water heaters, HVAC, appliances, flooring, cabinets, and everything else in the house all have a useful life and replacement needs to be accounted for.

You can try to budget it all out and while your mortgage (not included in the 50% rule), taxes, and insurance are easy to get exact numbers on   it's going to be impossible to get an exact figure for repairs and capital expenses. You also have to factor in a reasonable vacancy rate and I'd use 8% but it could be lower if you have something extremely desirable.  Whether or not you're going have a property manager there is a management cost, whether it's actual cash or your time.  I self manage my pile of rentals but there are still actual management costs and the value of my time so when I do any numbers on properties I'm buying I always include management costs. That way if you get burnt out on managing it yourself the numbers still work when you turn it over to a property manager.

I understand in some markets it's going to be very difficult to find properties that the numbers work on as a profitable rental and in those areas you're going to have to buy it as an appreciation play which is not something I'm comfortable doing.  Luckily in my market I can get to a 20% return after factoring in the 50% rule.

Patrick L. · Answer

I estimate that your return will be negative and you'll end up losing money with that property as a long term rental.  $2,900 in gross rent, minus a mortgage payment of $1,850 leaves you with $1,050 to cover all of your expenses for the month.  If you use the 50% rule you should expect to have cash flow of -$450/month.

Bill Gulley · Answer

About 4% under market with repairs, lipstick and holding costs, not even a question, walk away. Might go look at 260K max  :)

@Jon Holdman undefined

he can explain his % rules, but it depends on your market.

I don't care really what is asked, look at the property, estimate repairs, figure in holding and purchasing costs, look at the market, subtract costs and head damage profits and you'll  have a value to you, subtract 10% to negotiate and make an offer. Pay attention to the market value and the turn over, average days on the market at that price and area. Don't be afraid to walk away. :)

Bill Gulley · Answer

About 4% under market with repairs, lipstick and holding costs, not even a question, walk away. Might go look at 260K max to hold, 250 to flip, IMO  :)

Sean Kuhn · Answer

I agree, walk. Take that 55k and leverage it against two or three single family homes. Looking at your numbers quickly I would think you could gross more monthly with less borrowed.

Ellis San Jose · Answer

My vote is to walk. It's not even close to a good deal.