PLEASE Critique My Thought Process on a Potential Deal

[Johnathan Butler]

Hello BP Nation,

I’m looking at purchasing my first RE investment property in the west suburbs of Chicago within the next 90 days. In an effort to mitigate the amount of catastrophic mistakes that I’ll make as a newbie, I’m running numbers on potential deals to refine my understanding. Please take a look at the following deal and provide your expert insights!

Property: Two flat 3BR/2BA main house with a 3BR/1.5BA coach house. Total rentable space: 3653 SQ FT. I estimate 40K in repair costs. This is based on internet reconnaissance conducted with a GC by my side telling me what to look for. However, the house was built in 1912 and I’m sure that a home inspection will uncover some kind of issues with plumbing, windows, roof, electrical, subfloor, or something major.

Asking Price: $470K.

Gross Scheduled Income: $3250. I haven’t validated the leases. For the purpose of this exercise I will assume the seller is being truthful.

OE: $1861. I itemized the expenses (Taxes, Ins., Vacancy, Repairs, Cash Reserves, etc.) to the best of my ability.

NOI: $1389.

Mortgage/Insurance: $2224. This is based on a 0% down VA Loan at 3.75% with the 10K funding fee being financed as well.

CFBT: (-)865

At this point, this is a dead deal but please hear me out. I looked at the market comps and found that with 40K in repairs/updates I can quickly raise the GSI to $4600. Here are my projected numbers.

Asking Price: $470K

Gross Scheduled Income: $4600.

Expenses: $2300. I’m utilizing the 50% rule as it is higher than my original estimate and thereby more conservative.

NOI: $2300

At this point, I'm looking at different ways to make this deal work. I'm not married to it, just trying to work on my thought process. If I want to maintain a CFBT of $200 per door then I must keep my mortgage and insurance as $1700 which means I should pay no more than $370K for this property. Also, I've calculated the IRR and CAP with the current numbers and, as expected, they suck. I calculated the IRR and CAP with the projected numbers and came up with a respectable (I think) CAP of 6.57% which will increase to 7.85% in 10 years. My DCR would be 1.31. My COCR would be 10.99%. My cumulative CFBT would be $79,740 after 10 yrs in addition to a net profit of $100K at resale assuming 1% appreciation per year. My IRR would be (-) 55.69% and increase to 19.06% in 10 years.

I am bracing for impact and look forward to any and all feedback. Thank you for your time.

Respectfully,

John

[Joel Owens]

Hi John,

I would be worried about the age of 1912. That vintage year there are a ton of know problems to fix versus an 80's, 90's, 2000's vintage etc.

Now in your area 1912 might be as new as it gets. Here in GA where I live an old house might be 50 years old. Where some of my relatives live in Massachusetts a newer  house is 60 years old! So it's all relative to the area you invest in what is common.

You need to make sure all permits and additions were performed correctly and that the use you want for the property is not grandfathered in and then when you buy it goes away etc. Also some counties or cities have code that says for instance knob and tube wiring is grandfathered in but the minute one piece goes out you have to rip out and update the whole thing to todays code. That means there would be lurking time bombs waiting to go off with a large expense that could eat your cash flow for years before you recover.

Does landlord pay water on these properties? Is your area more pro-tenant on eviction laws and it takes longer to get bad tenants out?? If so I would use 60 to 65% annual costs on the property. Do not look at how pretty a building is with carpet and paint. Look at all the mechanicals and expensive stuff holding It up.

Even if you could raise to 4,600 rents you are still under 1% rent to sales price ratio at their 470,000 asking.

The area would have to be incredible to consider such a property where the rents have been rising 5 or 6% a year versus the national average of 2 to 3% and you expect and hope for appreciation to offset the minimal cash flow until rental increases hit.

National median household income is about 52,000. Investors buying at only 1% sales to rent ratio are generally buying in ultra premium area with high population levels, great jobs with growth, and median income 100,000 or more.

I just can't get excited about this property from what you have posted.