Would you do this buy and hold deal?

Question

Purchase price $185,000. Would offer $195K with no inspection. Using business line of credit @4.25%. Pay for a few years with line of credit then get a business loan for the remainder. $50K down from savings for down payment.

SFH, Brick, Cape Cod. 3 bedrooms/1.5 Bathrooms. Oil Heat. 1/2 acre level property. 2 car brick garage.

Property tax $3400. Rent $1600 plus oil and electricity. Cash flow $360 month.

Needs new carpet, paint and refrigerator.

Would you buy this?

Greg Scott · Answer

With $50K down and $360 per month you get an 8.6% cash on cash return. That is a bit on the skinny side, but not terrible. If this deal fits with your lifestyle, and there wasn't another, better opportunity presenting itself, I would do the deal.My only concern about what you wrote is the financing. I don't like holding long-term with short-term financing. A line of credit is short-term and a few years is long-term. You don't want to be in a situation where your line of credit is expiring and the credit markets are in turmoil.

Joe Villeneuve · Answer

Not in this lifetime or next. If you're putting $50k down (why that high anyway), and are only getting $4320/yr in CF, that means it will take you 12 years plus to recover your cost (DP) which is way too long. You'll encounter at least 2 large CAPEX out of pocket costs during that length of time, which means you'd be adding at least another 8 - 10k on top of the 50k cost, which would extend your recover time to at least 15 years...if all else goes perfect.It won't, so ad at least another $10k over that lifetime for misc. repairs and vacancy costs, so that 15 year recovery time starts looking more like 17-18 years. What that really means is you won't see a profit until then. Do you really want to wait that long? What if the market slacks off, or any other additional costs rears its ugly head?If I don't see my cash cos (DP) come back to me within 5 years, I don't want the property. I'm losing money hand of fist...exponentially.

Bruce Woodruff · Answer

Assuming your LOC is going to adjust upward as inflation rises? Still the numbers look ok to me..... it depends on the neighborhood and the expected appreciation as well IMO.

Paul Camuto · Answer

Hi Becky, not sure why you would start with an offer 10K over asking. You can always put in an offer with an escalation clause to cover you in this market. Everything is relative to your market. What have other homes cash flowed for? Compare what you can get local to you. Do you want to be in single family homes? 1/2 acre property seems a lot to maintain. Maybe condo or townhome? Minimize your down payment and don't get hung up on all the calculations. Run your sample analysis against all the other properties you would consider to have a cash flow baseline for you to judge specific to your area and what you can invest.

Erin Church · Answer

When you say cash flow - do you mean money over the PITI? Or do you mean after setting aside about 8-10% for the vacancy, capex, maintenance, and property management (so, 32-40% of the rent in total)? Cash flow is the money over PITI plus setting aside money for future needs of the property. I have a feeling that the numbers won't actually work. Also, don't forget about the cash to do the upgrades. Also, have you been doing this long enough that you can inspect plumbing, check out the electrical panel, look at the roof, hunt for foundation issues, drainage issues, etc? If so, then no problem on skipping the inspection, but if you haven't, don't make an offer blindly. It could potentially bite you pretty hard.I do love that you're deal hunting though! I'm sure you'll eventually run the numbers and find a winner! If you haven't attended one of the BP webinars on buying rental properties - I highly suggest it. :)

Joe Villeneuve · Answer

The reason why I only include PITI to calculate CF is that's the only actual expense you know will happen. All the rest may (probably) will happen, but until they do, the cash that comes out (flows) rom the deal comes out right after the PITI.Now, the rest of your list must be considered, but there are many ways to pay for them once they happen. When/if they do happen, they will reduce the CF for the period of time your are paying for them, but the base CF is when you take the rent and subtract the known expenses that happen every month from it...PITI.For me, all the rest of those expenses, are covered from a business LOC that isn't attached to any one property. That way I can use it for all of them, and if I sell a property, with an/the LOC attached to it, I lose the LOC,,,for all of my properties. When I have an one time expense (i.e. vacancy cost) for a property, the money comes from the LOC which is paid back in pieces...the property it was used on makes the LOC payments. Yes, this reduces the CF during the time I'm making these payments, but only during that time...the rest of the time, the CF is the base CF.This is why I don't include all of those added expenses in my CF calculation...they are NOT present every month, so if I include them every month they distort the actual CF and can cause a great.good deal to look bad...when it isn't. Subtracting those added potential expenses from the CF every month doesn't really work anyway. You'd have to subtract such a large amount to cover them there would be no good deals..ever...and that'd be wrong. You have to cover them, but effectively, not with an illusion.

Dan H. · Answer

My definition of cash flow is the cash after allocating for all expenses (PM, Maintenance/cap ex, PITI, vacancy/turnover, office (portion of phone, printer, office space, IT, internet, etc), misc (portion of LLC, umbrella coverage, mileage, unexpected utilities due to issue at property (example slab leak), etc.). Granted it is not until the property is sold that you know the true cash flow over the hold.You can use your definition of cash flow, but I question what you call the actual estimate of the profit cash after estimating all expenses.I also see some investors use NOI as cash flow because of the various financing options (no financing, high LTV financing, fixed long term, variable, etc.). Without knowing the financing terms, the cash flow estimate could be difficult to analyze (i.e. a good cash flow on 0% LTV is not necessarily a good investment and probably more likely a poor investment).What I have found is there seems to be many interpretations on the term "cash flow". Because there are so many interpretations, it is tough to know exactly what is included in the "cash flow" without clarification. When I use cash flow it is my best estimate of the expected cash flow after allocating for future items (i.e. maintenance/cap ex, vacancy). If I say something has small amount of positive cash flow this is what my hopefully conservative pro forma has projected accounting for everything that I could think of. It includes allocation for the roof eventually needing to be replaced, etc.

Joe Villeneuve · Answer

Don't get wrapped up with percentages as the numbers that you use to make decisions by. They mask the real numbers ($$$$) and they lie to you all the time. Have you ever spent a %%% in your life?

Scott E. · Answer

Assuming your cash flow number is correct, this is a deal I would do. I'm not familiar with business lines of credit so I don't know what that payment will look like but as long as you're accounting for repairs, maintenance, vacancy, and cap ex then you're good with your numbers.Consider the location as well though. The cash flow is just 1 element of a deal. Is this home in a decent neighborhood, sitting on a decent street, in an area where you forecast growth?

Greg M. · Answer

Cash Flow: What a person living paycheck-to-paycheck looks for.Total Return: What makes a person wealthy.