Bad neighborhood rental

[Mark Jones]

Hello Bigger Pockets Forum participants. My name is Mark and this is my first post. I've been perusing the forums for a few weeks now and have been listening to the podcast for a couple of months. My background is as an engineer (all about the numbers) and long time investor in the stock market. I have been learning about the benefits of real estate investing from a new perspective (i.e. cash flow quadrant, tax benefits, etc) that have made it clear to me I want to diversify my investing into real estate and not just the market. I want to start out small so that I can learn, and so I am looking for some advice on what I think is a reasonable first purchase.

As a preface, I am not entirely new to real estate, just real estate investing, as I have bought and sold many primary residences.

Asking price is $100k for both a 2/1/750sqft and a 1/1/750sqft. They are SFH's on a single lot. Both homes are occupied and generate a total of 1400/mo in rent. Tenants pay water and elec. Trash is part of tax bill. The larger home is concrete block with central ac, the smaller is stick built with window units. There is a septic system rather than city sewage.

Location is in a rough neighborhood that is adjacent to a growing popular area. Crime is higher but there are some houses that have been fixed up and sold for 140-150 at the 2/1/<1000sqft size. Habitat for Humanity built a nice new house next door a few years ago that still has excellent curb appeal.

Tenants in the larger unit were evicted for not paying. New tenants in place that are paying. Smaller unit has tenant since Jan, paying on time. Current owner has had 2 total evictions in his 4 years of ownership. He acquired the property via tax deed cert.

I need some help on my proforma assumptions. Here is what I have:

PM - 12% ($168)

R&M - 5% ($70)

Vacancy - 15% ($210)

Turnover expenses - 5% ($70)

Capex - 2% ($28)

I feel good about my other expenses (PITI, pest mgmt, landscaping), but having not been a landlord before, and so I am wondering if these are reasonable assumptions? Are there other things I should be accounting for since this is a low-income rental with 2 evictions by the previous owner in the last 4 years?

Thanks!

Mark

[Mark Jones]

@Neil Greene thanks for asking. The contract fell through, and for the reason I never would have expected: financing. I am an ideal borrower (credit, collateral, cash), but what I hadnt forseen on this property was that it would not conform to Fannie Mae underwriting standards. "Non-conforming" was something new that I learned.

The issue is that for 2 single family homes on one parcel, there needed to be a like property in the area for the appraiser to appraise. Though there are several of these, none had been sold in the last 12 months, which is what the appraiser needs to see. So, I was told by my lender (and verified by several others) that it would not appraise, therefore did not conform, and thus was ineligible for conventional financing. 

I updated the seller with this information and they said that they had a cash offer they were going to move on if I couldnt get the financing. The next day I started looking into commercial loans and portfolio loans. The 3 banks I went to for commercial turned me away for various reasons: not a large enough loan amount, not a substantial business history, etc. And, turns out that most banks stopped doing portfolio loans around the time Dodd/Frank passed. It was at the end of this day that the seller called and cancelled the contract.

I was a little relieved at the time because the inspection came back pretty bad. The back house had no heat, and though this is North Florida, on the day of the inspection it was in the 40's and the inspector found the oven on/open heating the house! The WDO inspector showed me that the back house was swiss cheese from termintes. And the septic tank, which had to be replaced was positioned in the yard that all of the drainage ran under the back house (which was set on concrete block piers) and was stagnant underneath, preventing any of the inspectors from inspecting underneath. On top of that, after the 4point inspection was complete, my insurer said the back houses needed a new roof on day 1.  The most I got out of the seller for this stuff was $1500 as he said the contract price of $85k was the as-is price, down from list of $99k. So, my contract at $83.5k and rent of $1500/mo absolved.

Then, I found out about 2 weeks ago that they house sold for $99k! I then realized why the seller was so quick to cancel my contract when, to the letter of the contract, I didnt secure financing in a timely manner.

I learned many things, here are a few:

- Just because I'm an ideal borrow for a SFH, primary residence, loan>$100k doesnt mean financing will be a cakewalk for another kind of property

- Had I been able to procure the cash in a timely manner to purchase the entire property, I could have retained the deal and figured out the money later. I was unwilling to liquidate equities and pay the cap gains tax just to do this. Consequently, I'm closing on a HELOC right now so that I have the cash immediately, when needed.

- I know how to find a good deal, closing it can be harder than finding it.

Mark