Decent deal??

Question

I found a 4 fam that needs some work, after all repairs I will have ~80k into it and it will have a 100-110k ARV. I would buy it cash and then refi the 80k I invest, so in the end I would have almost nothing out of pocket. It looks like I would make about 250 a month overall after getting a mortgage and applying the 50% rule. I know that most everyone shoots for $100 a door, but given the fact of close to 0 out of pocket would it be worthwhile?

J Scott · Answer

Capital costs are the large expenses that you'll incur every 10, 20 or 30 years (long-term).

For example, that boiler you just replaced will likely need to be replaced again in 20 years.  Is that the only one for the 4 units?  Or are there others that will need to be replaced at some point?  Regardless, that's another $7K you'll have every 20 years or so.

What about the roof?  At some point in the next 20 years, you'll likely pay $5-10K to replace the roof...and will keep paying that every 20 years for as long as you own the property.

How about water heaters?  I assume you have 4 of them.  Average lifespan is 8 years, so that's $700 or so every 8 years for 4 units, or about $7K every 20 years.

Just based on those three capital items, you'll pay about $20K every 20 years for capital costs.  That averages to about $1000/year.  You can choose to ignore the costs for 20 years, but from an accounting perspective, it (pretty much) all works out the same as figuring $1000/year.

And that doesn't even include things like siding repairs/replacement, major plumbing upgrades, major electrical upgrades, etc.  These are things you'll do every 20-40 years as well.

Btw, a lot of people think, "I'll be selling this unit in 10 years, so I don't really care about the new roof I'll need to replace in 20 years."  But, the buyer of the unit will see that the roof is only 10 years from replacement, and he'll discount his offer price based on that.  So, even if you don't incur the capital cost directly during your ownership, you'll likely lose a pro-rated amount of that cost when selling.

Joel Owens · Answer

That 80k is going to be trapped for awhile before you have a chance of getting it back.

The lender on the refi is going to want to see some seasoning on the occupancy level on the turn around before doing the loan.

19,200 rent is 400 a month per unit. This is a low income tenant dealing with a host of collection issues upon rehab. Really think upon the rehab of bulletproofing your units at that level for a lot of churning. Not sure but 400 a month sounds like 1 bed units. If so you will have a bunch of turnover due to size and lifestyle living of the tenants.

You are planning on 10k a door in rehab which is almost a gut job per unit. Here full guts on a 2 bed are about 12k a unit. 40,000 purchase is too rich. Gut jobs here the goal would be buying at 2,500 to 5,000 a door per based on the area. So 10k to 20k purchase price. If the rents were 600 to 800 per month after rehab purchase price could be closer to the 30k or so range.

If you go for this I would try to get the price lower and use hard money versus all cash at 80k for everything. When you tie up 80,000 in purchase and repairs you really have to buy low to guarantee you can recoup most of the money and be liquid again.

Rick Baggenstoss · Answer

Sounds too thin to me, but the devil is in the details.  50% rule can hurt you.

I'm starting to learn to look at the variables which are most likely to vary:

• What are your assumptions for vacancy and how nice of a neighborhood is it?
• How confident are you in your repair estimates?
• Why might your maintenance costs be higher/lower than estimated?
• Are rents correct? Who pays utilities?

Taxes, PM, and Insurance costs you probably have pretty well figured out +/- a bit.

Get the others nailed and you have your answer.

Rick

J Scott · Answer

I don't see any line items for CapEx, which would probably run you at least $1000/year over the long-term on a quad.  Also, don't see any turn-over/make-ready costs (and probably not included in the maintenance number).  Also, your vacancy number is pretty low -- hopefully you'll never have a tenant who you need to evict and who squats in a unit for months before you can get him out.

Account Closed · Answer

The TO cost is in the maintenance budget, I also have not added in deposits to the rental income. Can you explain the CapEx to me? I know what capital expenditures are, but I did not budget them on my other rental. Our goal is to find something that needs work so that once we have completed all renovations we have 25% equity, then refi to get our full amount back out. We have not budgeted it in on our flips or our rental we already own.

Account Closed · Answer

I ran the numbers on it and have posted them here. I overestimated on things I will be paying (insurance, utilities, etc) and underestimated on rent (I should be able to get 25-50 more a month than I expected. When we purchase the property we will be renovating all of the units 100% so new applicances, kitchen, windows, doors, cabinets, bathrooms and balconies. We are also putting in a new boiler for the steam heat. Thats all included in the 80k price. We know the roof is less than 10 years old too, so hopefully any large expenses will not arise for a few years, thus giving us a large amount of reserves after a few years.

Here is the data:

Cost of unit 40k

Renovations 40k

boiler:6800

windows&doors:5000

unit renovations: 16k (they are small and with them being low rent we do not want to go nice)

Per unit:

carpet &pad:1k

kitchen and bath floor: 300

appliances:1100

cabinets/counters/sink:800

Bath:500

Paint:100

Doors:200

balconies:4k

drywall work:3200

misc expenses: 5k

Annual rent 19,200

Annual Budget:

property tax: 1800

vacancy:800

insurance:1030

repairs & maint: 2400

utilities:3600

advertising:100

grounds keeping:600

misc:500

Annual Debt service:5756

Joel Owens · Answer

"Btw, a lot of people think, "I'll be selling this unit in 10 years, so I don't really care about the new roof I'll need to replace in 20 years." But, the buyer of the unit will see that the roof is only 10 years from replacement, and he'll discount his offer price based on that. So, even if you don't incur the capital cost directly during your ownership, you'll likely lose a pro-rated amount of that cost when selling."

This is so true and I see sellers do this all the time and they KNOW those CAPEX costs are coming after sucking out the cash flow for years and showing below market average costs. Inexperienced buyers will not catch this but seasoned investors will. You really have to buy with the goal in mind that when you sell it the most seasoned investors will give it the most conservative analysis and say " Yes this is still a deal at this price ". The less conservative you are when you go to exit the harder it will be to find a buyer and the longer to sell.

I had another commercial agent the other day tell me I make the bankers lending criteria look conservative in comparison to how stringent I am on the numbers! lol Well that maybe true but just because banks give the loans does not make the property a good deal. I have been down that road in the past with marginal deals and never ever again. I would rather buy a few quality properties at conservative  numbers over 5 years then load up on a bunch of marginal crap that will weigh me down and break even from some doing good and some doing bad and spinning my investing wheels.

Bill Jacobsen · Answer

As has been said above, you need to nail down the expenses as best you can. I don't know the going cap rate in your area but if a $110,000 property can achieve an 8 cap you have NOI of $8,800.  Also a loan of an $80,000 loan at 5% for 30 years has interest of $5,668 for cash flow of $3,132 or $261 per month.  If your cap rate is 3+ percentage points above your cost of money I believe it is a good deal.

If you said you were going to flip this property I would say the margin is too thin.

The low amount of cash flow could mean you are too leveraged.  Just know that your expenses will not evenly.  Only you know whether you can afford it.

Good Luck.

Bill

Gavin Welch · Answer

Hey Graham, I'm with Bill on this.. The margin sounds a bit thin.  I would really look at the neighborhood and see if there is a potential to rehab the units and raise the rent a bit.  Be careful of debt.. Nothing kills rental income cash flow faster than debt service..

Decent deal??

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