HELP! Tell me why this won't work...

[Michael Keller]

I originally posted this in the development and new construction forum, but didn't get the responses I was looking for. I thought this might be a better forum for the question. Thanks!

Recently, a friend and fellow real estate investor approached me with an opportunity. He wants to build 3 to 5 1,000 sqft homes in small towns that are within a 30 minute commute to a mid-size city in Texas. Through a local builder, who is a personal friend, we can purchase the land and construct the homes for approximately $65,000 each.

Based on my analysis, I believe that the new homes would appraise for at least $95,000 each. These towns predominantly consist of renters -- around 65%. Additionally, the availability of new, quality rentals in these towns is almost non-existent. Based on my analysis, I believe these homes would rent for at least $950/month.

Assuming a 75% LTV on a cash-out re-fi, we would be all in for $750 per property after closing costs. At a 5.25% APR on a 30 year note, we would cash flow $2,300-$2,900 per property in the first 5 years. The total ROI would be 472%-555% per property in the same period. Of course, we could also take 10 year or 15 year note and decrease cash flow in the short term for a higher return after 10 or 15 years.

The only limitations I see are the ability to scale and lack of appreciation. Each town could probably only sustain 3 to 5 homes. Additionally, the homes would likely never see any real appreciation. Nevertheless, if we built 50 homes in 5 years (5 homes in approximately 10 towns), we could have $145,000 in cash flow a year.

Does anyone see any glaring problems that I'm not considering? Why or how would this not work??

[Aaron K.]

Small towns are small for a reason.  People do not live there.  Depending on the size of the town you could have difficulty finding tenants especially tenants who are willing and able to pay more to live in new construction housing than what is currently available.  

Also with prices that low and the renter percentage being so high I would worry about tenants having stable employment you would want someone with $3,000 per month in income (3x the rent).  A $100,000 loan at 5% over 30 years is only $550 per month which many people with your desired income for the rental should be able to afford.

Just something to think about.