Buying in a soft Rental market - does this deal make sense?

Question

I'm looking at my first deal and my broker is telling me the deal makes sense , even though it's cash flow negative... he says (and I agree, with some reservations) it makes sense from an appreciation standpoint.

It's a 1.5ba/2br condominium in South Florida. Nice area, nearby the Interstate, shopping, schools, 3 miles from the beach. There are 60 units in the building; the community has it's own pool and tennis courts. Probably $2000 in cosmetic repairs to be made. Current tenant's term ends in 30 days (has been there three years). Here are the numbers:

Asking Price: $130,000
Comps: Last 3 sales in the building have been $130,000 - $160,000
(My broker tells me the unit can be had for somewhere between $105k-$115k.)
Rent: $1000
HOA fees: $331
Down: 10%

The Monthly picture: $1000 - Rent ($331) - HOA fees ($75) - management ($205) - tax NET: $389

Now we add the mortgage in. Figuring 6.25% on 10% down (30yr fixed); the monthly payment is $637:

$1000 - Rent ($331) - HOA fees ($75) - management ($205) - tax ($637) - mtg NET: ($248)

At the height of the market, other units in the building were going for $200,000. Others on the market in the building are asking $160,000-ish. Figure the unit could be sold in 3 years for $160,000 (this seems realistic, given the current state of affairs)... so we look 36 months down the line and see:

Sale price: $160,000 Total investment (expenses x 36 months and down pmt): ($20,068) Loan balance: ($99,600) NET: $40,332

So, the question is, if one could reasonably expect the unit to sell for this price, does it STILL make sense if you're in the red on a monthly basis? I'm all ears...

Dan Menan · Answer

jewin,

Listen to the good advice you are getting here. In this market, do not buy on prospective appreciation. Fools game to be sure. Keep looking, the right deal WILL come to you. Hard work and education will make it happen. Buena suerte......

Michael Rossi · Answer

Darn, I'm still holding tulip bulbs!

Mike

Josh Ewin · Answer

So, I called the broker and told him my offer would simply be too low. Based on the numbers, not gut, the offer is just too low based on the comps and the seller's asking price.

Wheatie - thank you again for your wise insight. I feel very thick-headed right now about REI, but I'm sure that will pass in time. Thank you so much for your insight.

ramon6001 - very good post... it keeps me going to hear things like this: "there are a ton of deals out there just take your time and pick one. "

So, I'm back on the prowl. I'm speaking with my neighbor (and the selling broker for my own home, when I bought it some 5 years ago) to find some other opportunities. I'll keep you guys updated and will certainly have another deal to look at soon.

Jon Holdman · Answer

So, first I have to point out to any readers would don't like or believe in the "50% rule" to have a look at this puppy. Total estimated expenses on this one are 73%.

Honestly, I would not even pay $40K for this place.

With condos you never know where the HOA fees are going. If there are lots of foreclosures (which seems likely), the HOA fees could easily go up so the remaining owners can cover the total costs. At 10-15% increase in HOA fees would wipe out your cash flow.

Condos also have a warrantability issue. If too many of the units are rentals, buyers will have more difficulty getting loans. The HOA may also step in to stop rentals in order to avoid the property becoming non-warrantable.

If there are lots and lots of these available, rents are going to be depressed. Is there anything driving new jobs? Are there lots of rentals available or just a few? Any idea what the current average vacancy rate is for apartments? With a condo, you're competing with apartments for your tenant pool.

Here you've bumped into another of my thoughts:

Even if you really get the $53/month, it will take a bunch of them to get to your $5K/month goal.

Ramon Owens · Answer

He is right your missining something and thats"Your ROI!" you are buying a property dollar for dollar on a hope that it stays rented.I say go out and find a better deal.But if they sell it to you for .60 to .80 cents on the dollar then you buy a deal like that otherwise calm down and dont be so ancious, there are a ton of deals out there just take your time and pick one.

GET THAT MONEY MAN!

Josh Ewin · Answer

Wheatie, CumminsHomesLLC,Ryan_Webber...

Thank you all for your insight. Wheatie, you're right here. I can see it in my own neighborhood. We had our home appraised last year and the comps in the neighborhood were all over the place... many of the homes were bought by investors looking to flip the properties... the bottom fell out of the market and these investors got stuck; particularly when their teaser rates went up.

The broker is telling me to make an offer. Well, let's make an offer... but one that makes sense. Units like this in other neighborhoods were selling for $40-$50k 4 years ago. So, lets see what makes sense here. The HOA fees cover insurance, water/sewage/waste and cable. Electricity would be the occupant's responsibilty. So, expenses are as follows (Wheatie, I'm adding $900 in annual expenses for repairs and advertising here, am I in the ballpark?):

$1000 - Rent ($331) - HOA fees ($75) - management ($75) - expenses ($205) - tax ------------------ NET: $314

Working backwards, with 6.75% interest and 10% down... that gives us:

$40,000 - Offer Amount $4,000 - Down payment $800 - Closing costs $36,000 mortgage

Total Down + Closting = $4800 Monthly Payment: $234

$1000 - Rent ($331) - HOA fees ($75) - management ($75) - expenses ($205) - tax ($27) - vacancies ($234) - mortgage ------------------ NET: $53

Am I right here in saying that no one in their right mind would pay any more than $40,000 for the property? I'm not accounting for vacancies in here either. Given the state of the market, (and the high likihood that the current owner is loosing on the property every month), I think it makes sense here to put in a realistic offer. Do the numbers I have here work? Am I missing anything?

That being said, my goal when I started reading and learning about REI, was to build up $5000 in monthly revenue. I'm a VP and make a decent living; credit score is almost perfect... it seems that the market is the problem. Is this goal of $60k in annual rental income realistic by any stretch of the imagination?

Ryan Webber · Answer

You're buying on appreciation in a market that is going through a bust? We aren't done with this real estate correction. We still have another year or so before it even stops FALLING in the areas that boomed over the last decade, which Florida is one of the major ones.

I would agree with Jon that you are more likely to pay a higher price today than what you will be able to sell it for in the next three years.

I also agree with Jason that you should never trust your broker's advice. Don't ever rely on an agent's advice for investment decisions or you will end broker than your broker.

Overall, I also think the crap's table at the Bellagio would be a better investment.

Jason Cummins · Answer

Let me just add this. Of coarse your broker is telling you it's a good deal. He is the only one that would make any money on this deal. You probably will not.

Do you really want to eat $300/month for the possibility of appreciation? That is a huge risk for you that (if wheatie is correct, and I am sure he is) has a high probability of failing (depreciating instead of appreciating any time soon)

In my personal opinion, do not do the deal.

Jon Holdman · Answer

You have still missed some of the expenses. Advertising for tenants, utilities, at least when its vacant, vacancy, any damage from the tenants, etc. So, your monthly negative cash flow is even worse than you think. Every month of vacancy in the next three years is $1000 in additional negative cash flow, for example, or $27/month. So, lets be optimistic and say your real outlay is $300/month.

You buy at $115K (ranges always make me assume the worst.) You pay closing costs and loan orig fees of 3%, $3.3K. You hold for three years, paying $300/month, $10.8K. You sell for $160K. You pay 8% in total closing costs on the sale, of $12.8K. You have to pay off the $115K loan that's barely dented after three years. $160K-115K-3.3K-10.8K-12.8. Your net profit: $18K.

That assumes the property that's now worth $115K will be worth $160K in three years. That implies 11.5% appreciation for the next three years. Now, its hard to make predictions, especially about the future, but I'm pretty confident we're NOT going to see this appreciation. Especially in a boom area like FL.

I would go so far as to say I think it more likely that this unit will actually be worth $80K in three years than worth $160K. They built thousands and thousands of units just like this in FL, catering to a booming market for speculators. Many, maybe most, of those units are now upside down. Many are owned by speculators who are hurting now, and will be really hurting when their option ARM caps out over the next two years. I think the price you pay today will be higher than any price you'll be able to sell it for in the next three years. With all the transaction costs and the monthly outlay, you're nearly guaranteed to have a money loser. Better to take that $10K to the Bellagio and put it on the craps table. At least there you have a chance of winning.

Buying in a soft Rental market - does this deal make sense?

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