First rental property.. Overpriced but good ROI??

Question

Hello all.. so I've been on BP for a few months now, kind of just reading/researching here and there and I can't seem to find anything too specific to my situation.  I live in the Daytona Beach area where the market is HOT right now, just as an example.. I purchased my home for about 135k five years ago and would list it for around 300 today, crazy! Even homes purchased 1 year ago for 145k are worth about 235k currently.. definitely upset looking at missed opportunity.

Well, I've been hunting for a rental for awhile now with no real success.. I happened to find one that is fairly cheap at 95k. Unfortunately, this is not  a home that I would expect to appreciate at all and its not in the best of areas (I've seen many people grading areas on this site, I'm not super familiar with the scoring system but I'd call this a D area).  That all being said.. with 20% down, I could be looking at full ROI in about 3.5 years  (the house was purchased for 8k -insane- about a year ago and completely redone).

My real question here is, what are your thoughts on a home that is too much money but has great ROI?? If I were to keep the home indefinitely, I feel like there is no real downside besides owing way too much on the home which obviously isn't a "good" situation but I think as long as you hold it as a rental, there is no real loss? In under 4 years it should have decent cash flow.. Please give me some opinions on this.. I'm a 27 yr old ho owns my primary residence with great equity and I'm really trying to get into the rental space.. Thanks in advance, I appreciate any and all advice!!

Joe Villeneuve · Answer

That's only a dilemma if you're focus is to buy a property.  If you focus (as it should be) is to make money, then I don't see any dilemma at all.

You're trying to rationalize a bad deal into a good one.  All I see is expensive repairs to mechanicals, structure, roof, etc...coming that will suck the life out of the CF.  That means you'll be working your a$$ off trying to stay above water cashwise, banking on a future event you have no control over to recover the cash you spent.  In order to make that future money, you are going to have to sell this property (100 plus year old property) when RE isn't as crazy, while there will be newer properties being sold at the same time.  That means it won't be a seller's market.  Which property do you think a buyer will choose?

What you are doing is speculating.  That's OK for the stock market.  There's no need to do it when you're investing in RE.

Don't focus on a property.  You're not a collector...you're an investor.  You want deals, not properties.

Marc Winter · Answer

Please keep in mind that "D" areas normally:  will take more repair expense; more hands-on management; will have vacancies/no-pays more often; tenants that will let their pitbull tear up the house and crap up the yard.  (I am a dog lover--can't blame the dog for the way they are trained/not-trained).

What I'm saying is that even if the numbers manage to work out on your spreadsheet, that is NOT money-in-the-bank.  If you had a 21 year old daughter, would you want her to live there?  After many years in property management, my experience is that holding a D property as a long-term rental will lose you money, IMHO.

Zach Jones · Answer

@Joe Villeneuve I bowed out and decided to step away from the opportunity... It was/is very tempting in this market but I'll agree with you on the massive risk.  Hopefully will find something else that will work.. appreciate your input Joe, thankyou.

JD Martin · Answer

Thoughts:

1. Class D is *a lot* of work. Don't fool yourself into thinking it will be easy money, even if you have lower rents than others in the area. It's a D class area for a reason.

2. A house that was purchased for $8k in that kind of area, I would look really hard at the fundamentals - electric system, plumbing, framing, insulation, foundation, roof, mechanical systems - and pay less attention to fancy kitchens or bathrooms.

3. A house that's 100 years old needs the aforementioned looked at closely as well.

4. Time forgives most (not all) overpayment on real estate because of the power of inflation to destroy debt and induce appreciation. If you hold a rental property long enough it's hard to make no return/negative return just because of the nature of markets and fiat currency.

Joe Villeneuve · Answer

I like the numbers, but I would never buy a property that was 100 years old.  Saying the interior of the home is "all knew" and assuming that to mean you won't have much in the way of repairs is laughable (sorry).  It's a 100 year old house.  The repairs you are going to need is what's behind the interior, and probably what that new interior is hiding....and, it will be very expensive.

Joe Villeneuve · Answer

I couldn't have said it better.

One more thing.  How do you get 100% ROI in 3.5 years, but it takes 4 years for you to reach acceptable CF?

Greg Scott · Answer

"In under 4 years it should have decent cash flow"   This statement suggests that it has minimal cash flow today.

"I could be looking at full ROI in 3.5 years"  When you add this statement, it appears your are estimating your profits based on future potential rents and appreciation.  You are thinking like a person buying a stock or mutual fund. In other words, you are speculating, hoping the price and rents go up.   This is not how successful investors get wealthy.

If you had great cash flow the day after you bought, I would say buy it.  Your return starts day 1.  That is not speculating.

If the cash flow was only marginal, but you were buying it for $10K or $20K less than the property was worth, I would say buy it.  Hold it for a little bit and sell or refi and you have a nice return. That is also not speculating.

Joe Villeneuve · Answer

Nobody can give you an answer without actual numbers.  Words don't make a property a deal...the numbers do.  Give us numbers without using percentages (unless you plan on buying things, and paying bills with them).

Cost of propertyDown Payment ($$$$$)RentTaxesInsuranceResulting Cash flowProperty appreciation of the last 3 years in the immediate area

Joe Villeneuve · Answer

Not in.  The home is "92" years old.  You can get an inspection that says the house has nothing broken now, but..., here is a short list of things that will get you trouble:

1 - No insulation.  Any insulation that was installed was loose, and by now has fallen down to the lower 2 feet of the walls.  This problem will severely impact you counting on long term tenants.  After a while of being cold all the time, or hot all the time, they will look for another place to live.

2 - Knob and Tube electrical.

3 - HVAC.  Could have a gravity furnace, poorly laid out and insufficient ductwork...particularly cold air returns improperly sized.

4 - Plumbing.  If the lines were replaced/updated at any time...great, but I bet the drains weren't, and the underground is crumbling, or will, or has been.

5 - Plaster walls.  Really sounds and looks cool, but very expensive to rip out and replace with drywall when dealing with #1 - 4 above.

6 - Windows.  The list of problems and costs for this one item would be too long to list here.

7 - ....need I go on?

An inspection can/will "pass" all of the above if they are working.

Zach Jones · Answer

@Joe Villeneuve "I'd do that deal in a second". I'm not trying to speculate the market in the future, I'm more or less trying to determine if the move is smart .. I'm only unsure of the roof really, and is this not what Inspections are for? And please understand; the only goal is to make money.  Rent = Constant Return, so after 3 years this a small income.. nothing major, but income.  When the market does drop and houses are selling at similar cash, then I'm buying the dip.

If it passes inspection, flying colors. You know the ROI. The home turns 100 in 8 years. Are you a in?

First rental property.. Overpriced but good ROI??

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