First Rental - 4% Rule Quick Opinions Needed!!

[Zach Mitchell]

I am looking for some quick opinions on the deal below. Can I really go wrong with this?? I have submitted the contract and just waiting on the seller to sign but we have already agreed verbally. 

I have been looking to buy my first rental property for a long time and came across a listing for two duplexes for $35,000. You are reading that correctly, 4 units, $8,750 each. Rental rates are at $350/unit ($1,400 gross or 4%), with taxes around $1,100 annually and insurance around $1,000 (quoted by seller, not sure if accurate). There is one tenant who has been there for about 3 years who takes care of the yards for $50/mo, so taking out fixed expenses the net is about $1,175. After another 10% for management and a vacancy factor of 10%, even though the property has not had a vacant unit for over 5 years, and net rents are around $895. 

To me this looks like an NOI of around $10,740 indicating a cap rate of about 31%. I'm sure you're wanting to know how this is possible.... well, they are in the hood. Low income area, probably crime-ridden. Not stereotyping here either, I pulled the street on crimereports.com and there are literally break-ins on the same street within the last week. Should this stop me though? I'll never go to the properties unless a tenant moves out since they are about an hour away but I really don't see any need to. Most are long-term tenants and the seller said he has only had a few turnovers over the six years he has owned it.

In addition, both duplexes were re-plumbed (new supply lines), rewired, and had new windows put in, all in 2008. All separately metered and tenant pays own utilities. They both have metal roofs (not sure of age, seller guessed 20 years old) and there is no central a/c, just window units, and they are owned by the tenants, meaning no responsibility on my end for those. 

Lastly, I negotiated 70% seller financing on the deal so I am only going to be out of pocket $10,000! 5 year term, fixed at 8% so payments are about $500/mo. With net rents of $895 I would be cash flowing $400/mo. ($100/unit) with only $10,000 out of pocket.  

Can someone please snap me back into reality here. Where are the negatives to a deal like this?

[Blair Poelman]

Who has been managing the units? I bet the answer is THE SELLER.

Does the manager have an actual property management system that logs service calls, rents, delinquencies?  I bet the answer is NO.

Does the rent roll look perfect?  I bet the answer is YES  (pretty easy to BS this one)

Did the leases start as 1 year, but now they're all on month to month because the tenants are "solid", and there's no need for new 1 year leases?  I bet the answer is YES.

All pretty big red flags.

Good heavens, @Zach Mitchell you've really brought out the pessimist in me tonight!

If it were me (and I've been in this situation before), I would go walk through each unit - and just ask the tenants how things are, what they like and don't like about their apartment, who they pay, how much, how often, and then ask if they think the landlord takes care of the place.  They'll either give you a laundry list of problems, or they'll tell you everything you want to hear (because their landlord told them to keep their mouth shut during the inspection).

I think I may have looked at this exact same deal about 3 years ago in Memphis.  That deal sounded awesome until I spoke with one of the tenants who quietly told me "I can't tell you anything, I've been told to keep my mouth shut".

I've done these deals before.  hood houses come with their own special challenges, but do have great cashflow when it comes in.  Just don't have an expectation that you're going to be able to actually profit that 31%, since a bunch of that is going to go back into the properties when they turnover. 

I'm not saying it's a bad deal - just do some more research before you really get into it, and take some measures to protect yourself.  

I can see you and the seller a year from now:
You:  "This deal blows.  You freak'n lied to me, and I'm not paying you anymore."
Seller:  "Cool.  I'll keep your down payment and go record the Deed in Lieu because you're defaulting on the financing, so you can hit the bricks now"
You:  (Zach walks away irate but can't do anything to get his 10k downpayment back)

Also, don't fool yourself into thinking you'll manage them from home and only go there when there's a vacancy.  You'll probably be there fairly regularly.