Louisville, KY - Rental Property - Bryant Grimes - Recently purchased first time investment property and looking for feedback

[Bryant Grimes]

I am a first time real estate investor and CPA in Louisville, KY and recently purchased a duplex (two unit each 1 bedroom one bath split level property) in the Highlands area which is a relatively high market value area in a prime location. I acquired the property for $175,000 and appraisal came in at $200,000. 

Total PITI is $1,066 / month after putting 15% down on the property. It is currently rented for $1,450 / month and the only other fixed expense pertaining to the property is water included in rental price which is ~$100 / month. Prior to purchasing property I was not aware of the additional expenses that should be considered based on various investment rules / gut checks and having completed the purchase I am looking for feedback on the deal and am looking for opinions in regards to if this was a "good" deal or not.

Additional factors to consider is the property appreciation value based on historic sale prices between points in time [i.e. sold in 2004 sold again in 2015] for similar properties in the similar area seems to be a consistent ~4%. Also, the rent for one unit has not been raised in approximately 5 years and the other in over 2 years, therefore I anticipate the rental market value upon tenant departure would be ~$1,600. Further, the area in which the duplex is located has an extremely low turnaround for tenants and by putting a sign in the yard and posting add on craigslist, most are rented within 5 days with landlord pick of multiple potential tenants. 

If there is any additional information I would need to include for readers to determine if this was a good deal or not please let me know and I can include. I am interested in continuing to invest in real estate and grow my real estate portfolio and any feedback provided would be greatly appreciated. 

[Clay Smith]

I would define a "good deal" as anything where Total Revenue - Total Cost = A Profit and the ROI is above market rate for the average stock market returns.

ASSUMPTIONS

• "15% down on the property" equates to $175,000 * 15% = $26,250 down payment
• "I acquired the property for $175,000 and appraisal came in at $200,000."  $200,000 - $175,000 = $25,000 equity position
• $1,600 a month income (fully rented) = $19,200 annual rental income
• You are spending $0 in repairs during this transaction.  This property is turn-key and rented.
• You will increase rents right away.

ROI:

• SIMPLE ROI: Your equity position is $26,250 down payment + $25,000 equity = $51,250. So $51,250/200,000 = 25.6% ROI.
• COMPLEX ROI: Before the ROI, cited above, may be realized in actual cash profits, the properties must be sold.
  • Normally it would cost you 4.5%-6% in realtor fees to sell it and 3% closing costs to buyer.  This calculates to $200,000 - ($200,000 * .075 fees) = $185,000. 
  • Your equity position would now be $26,250 down payment + $10,000 forecasted profit = $36,250. 
  • A complex ROI calculation would yield $36,250/185,000 = 19.6% ROI

INCOME APPROACH

Now, let's look at it from an income approach to see if your investment can stand on it's own:

• COSTS total $22,680
  • $19,200 * .07 vacancy rate = $1,344 lost rents per year due to vacancy
  • $19,200 * .25 for repairs = $4,800.  This includes turn over costs to fix the place up after a move out.  if you think this is high, think again.  This number is very real.
  • $100 a month in rent = $1,200 annual
  • $19,200 * .07 management rate = $1,344.  You count this regardless of if you self-manage
  • Principle + Interest + taxes is $1,066 = $12,792 annual
  • $100 * 12 = $1,200 for water
• $19,200 - $22,680 = ($3,480) annually, a loss of cash.

OTHER CONSIDERATIONS:

• Depreciation will be $200,000/27.5 years = $7,273.  You can reduce your Income from your regular job by this much.  This is an annual cost avoidance of $1,818 if you are in the 25% income bracket according to the IRS.
• Equity.  You are paying about $200 a month in principle.  This is $2,400 a year in equity gained.
• Appreciation.  Average appreciation rate for Louisville in the past 20yrs is about 4% annually. Inflation is at a 3% annual average across the US. You earn $200,000 * (4%-3%) = $2,000 annually in appreciation by locking in the price of your home today against the devaluation of the US dollar. 

SUMMARY

• Your asset will cost you $3,480 yearly or $290 monthly
• You will retain $1,818 will come back on your tax return.
• $2,400 in equity gained annually
• $2,000 annually in hidden earnings will add up by the time you sell it.

You will stand to lose $138.50 a month in cash.  You will net $2,738 annually by the time you sell.  Your principal payment will increase with time making this deal slightly better. 

RECOMENDATIONS:

I would lock tenants into 2yr lease minimums and screen rigorously. Consider allowing pets for a $200 fee and a $25 month charge to increase rents and offset your loss of cash.  Self-manage if on a tight budget, but be sure to do it right/well. 

Next time you purchase, consider B or C class neighborhoods with SFR's under $100,000 in ARV or multifamily under $50,000 per unit.  These generally cash flow better and can help keep you liquid.