New to investing in Sacramento, am I analyzing my deal correctly?

[Alester Thomas]

Hello BP Community,

New investor here, under contract for a first investment property. Hoping my numbers are feasible as I acknowledge this isn't the most ideal deal. I posted this elsewhere but reposted this here as I felt it was more relevant to people who are already familiar to the Sacramento market.

Property is a duplex in a B/C neighborhood in Sacramento County, listed for 425k, under contract for 400k. Each side is 1200 sqft, 2bd/1.5bth, 2 car garage and driveway. Current tenant rents one side for 1500 and I will occupy the other side paying myself rent of 1500. My situation: I'm 27, have a decent job and have saved 60k in order to invest in something. I don't have the best credit, so I went FHA so I could go 3.5% down at a 3.3% rate with 0 pts. PITI is 2450. After inspections, the property will need 20k in rehab and renovations. Also I will need to replace the roof in a couple years (15k, but I'm attributing that expense to CapEx and will pay myself back with that). DP with closing costs is 20k. I am keeping 15% for CapEx, Vacancy and Maintenance (is this not conservative enough?) I will be managing the property while there and when I leave. Current tenant doesn't pay water, sewage, garbage which I will have to eat until I change the lease.

Projected Rent Revenue - 3000

PITI - 2450

15% Reserves - 450

Cash Flow = 100

Yearly CF - 1200

Total Investment - 40000

ROI - 3%

I acknowledge that 3% isn't great. Pro Forma makes it nicer with the possibility to raise rent to 1550 or maybe eventually 1600/side. Also, I'm not sure if investors take IRR into consideration with the principal paydown from the tenants, but that makes it nicer too. Though, I understand that money isn't realized until you sell or refinance. The other thing is refinancing from FHA to conventional (takes 8-9 yrs to reach 20% equity w/o app or depreciation) would take away the PMI and bring down the PITI to 2100 with 4.5% financing which would make the cash flow better, but would start over the 30 year term (not sure if that's good or bad to do). I'm considering that with my FHA financing, I'll be on the losing end of bidding wars with some of these cash/conv buyers. I got this into contract because I was the first offer and quickly got it under contract. The seller later got much better and higher offers and would really like to back out. Does this seem like an okay deal for me to do seeing how the market in Sac is? Thank you in advance!

[Carrie K.]

That's fairly tight, but I think it could work. 

Additional negative factors to consider:

• You didn't account for property management (10% or $300/mo) or yard service ($80-100/mo), if for some unexpected reason you had to move out of state.
• Have you double-checked that that rent is typical for the area? I took the liberty of looking at pending 2400 sf duplexes, and since there was only one, I ran the address through Rentometer. All I could see without a pro account was that the neighborhood's average rent for a 2 BR is lower than $1500. But those might be for apartments rather than a duplex home like this.
• Since your math doesn't include water, sewage, and garbage, that probably eats that additional $100 and a little bit more.

Additional positive factors to consider:

• Between $20k of renovations, mortgage paydown, and your credit starting to improve, you might be able to refinance to lower your PMI fairly quickly. (PMI varies based on credit and I believe also equity.) The renovations should be helping your value quite a bit. Perhaps by the time you'd need property management, you'd have a lower payment.
• I think you'll probably have adequate reserves. You would have about $20k in reserves to begin with, adding $5400/year minus whatever maintenance or vacancies come up every year (so let's say adding $3k/year). In a couple years, you'll have to replace the roof, so let's say that's in year 3, dropping you to $14k ($20k + $3k * 3 years minus $15k). That's still over 6 months in mortgage payments and larger than most surprise repairs. It would be nice to get that a bit higher over time, but it seems adequate, assuming you're right that the roof can wait for awhile.
• Since you've been able to save $60k, I assume you'll be able to save a little bit more just in case, even after covering the water, sewage, and garbage?

I did see that there are lower-cost duplexes in the market if you're feeling uneasy about this, but I'm not sure exactly what you're looking for, and you're right that getting under contract is not always easy. Good luck, whatever you decide!