What could have been done better?

Question

This was my first investment property. At 25 years old, I did my first investment with 2 years of real estate experience. Knock on wood, I am doing well with it but wanted to share my numbers and see if I could get some constructive criticism for my next investment purchase.

This is a 2 bed, 2 bath condo in New Jersey.

Purchase price: $189,000 all cashTaxes: $334/month ($4000/yr) Insurance: $19/month ($219/yr)Association: $351/monthRent: $1600/month

I've seen many formulas to calculate whether a deal is good or not. But since the property is already purchased, looking to know after the fact if this is a good deal, and if not, what could have been done better?

Rod Desinord · Answer

Got over the first hurdle of getting a deal done. According to many polls out there a high percentage of people are just talkers

Steven Lewis · Answer

This is my first unit. My goal was buy and hold - rental investment. Collect rent every month. From an amateur standpoint, I've succeeded in that aspect, but the reason for my post was to see where I could have done better. In NJ, it's merely impossible to find a unit 70% below market value. Plus I wasn't looking to do any rehab. So at the time, most units were selling around $200k. I bought at $10k below market value (I figured that was a good price already). Short sales were selling at the same price, and I didn't want to deal with that hassle, so I figured at $189k, it was a fair deal. It rented out quickly and I've obtain my goal of a rental property. But again, I have all that cash tied up in the property. So looking for advice on what could have done better, and how to use that cash from this property to finance my next deal - thank you for all your help and insight.

Mike H. · Answer

Check around some of the local banks and ask them if they do commercial loans on SFH's. The condo thing may become a barrier though. Local banks tend to shy away some from condos versus SFHs.

But local banks would have no problem doing a loan under an LLC.  It would be a commercial loan - typically 5 yr balloon, amortized over 20 or 25 years. Rates around 5% or so.

Still, its far better than leaving all that money in the deal.

So you paid 189k for a unit worth 200k to maybe 230k? I guess the key is what is actually worth? Is it 200k or 230k? If 230k, then you're close to 80% so you got some equity there.If its 200k, then that was not a good deal at all. You basically paid retail.

As a rule of thumb, you typically want to be all in (purchase plus rehab) at 70% of the ARV of the property. So if the house is worth 200k, then you would want to have a purchase price plus rehab costs of 140k.  And it may be ok to go to 75% of the ARV so you could be all in at 150k.  But to pay 190k for a property worth 200k just doesn't seem to be a good investment.

Again, it could very well be your area is really tough to get discounts though. The coastal areas can be a whole other model.

Just curious but what was your goal with the investment? What do you see the return being overall?  And how much would you guess appreciation would go up year over year in those units - if you had to guess?

Keep in mind, most investors suggest that investing for appreciation is not investing, its more in line with speculating. But the coastal investors over the years have made out like bandits because of appreciation so it may be more a calculated risk than a risk there. But one well worth the potential reward.

Steven Lewis · Answer

Mike, thanks for your insight. I've seen multiple units go under contract anywhere between $200-$230k. I bought the unit very modern, so crossing my fingers I don't have too many repair costs. So if for whatever reason I needed to sell RIGHT NOW, I could probably get $200k for it and break even on the sale or net a little money (after closing costs). My goal here is long term hold though.

Regarding tying up all the money, I've thought about pulling it out and using that money as down payment on other homes. But I already carry a mortgage for a 2nd home. Furthermore, the unit is in my LLC and have found it difficult for lenders to loan to LLC. Any input on what I should do with the money? The property is free and clear and I am netting money. Versus now carrying a mortgage.

Mike H. · Answer

RE: Vacancy and repair percentages

Vacancy is very market specific. But its also something that is difficult when you only have one unit. You have may get a tenant that stays for 5 years or you may end up with 5 tenants in a row that only stay a year. Move out is typically 1 month of vacancy.

Note: Turnover is absolutely the biggest enemy of a landlord.

I would factor 5% for vacancy.  I'm seeing much better - 2 to 3%. But 5% is about the typical number I see people use and thats the number I use as an estimate even though my numbers are much better.  In terms of repairs, the fact that you have a condo limits some of the repairs you're going to have to do so thats actually a good thing. That HOA fee better cover all of the common repairs. :-)

Based on what little I know of the unit, I would suggest between $75 to $100/mo for repairs and cap ex. But that really depends on how big the unit actually is and what age it is and how much was updated. That would likely be reasonable as an estimate though.

RE: The deal analysis

Now, in terms of the deal. The first question I have is what is the unit worth?You said you paid 189k but what is it actually worth?If the thing is worth 500k, then its a great deal even with the lack of cash flow. :-)If its worth 189k and it has no cash flow then I'm just not seeing it.

Here is typically how I calculate what my deal looks like.I factor in the mortgage payment for financing the entire purchase and rehab amount. Then taxes and insurance. Then I subtract that from my estimated rent. I want to hit 350 to 400 minimum on my gross monthly profit to consider it a deal.

So, if my purchase price is 70k and rehab is 30k, then I figure the loan payments on 100k loan (600/mo). Then taxes another 300/mo. And insurance another 75/mo. My PITI would be 975/mo.  If my estimated rent is 1400/mo then its a deal.  If its 1200/mo then its not.

I'm a big believer that vacancy, repairs and cap ex are all pretty subjective. I think a lot depends on the house, some luck, etc. So my take on that is that if I can make 400 or so a month on gross profit (i.e. before vacancy, repairs, cap ex), I should be able to have a net profit on the house with no money down.  Then I know I'm getting a good deal.

Now if I were to put down 30% of the purchase plus rehab (30k), then my gross profit would go up roughly 180/mo. So my net would be even more.   But I really like to use that gross profit based on financing the total purchase and rehab costs so that I always get a relative indicator to help me see whether its a good deal or not.

In your case, I'm not seeing the numbers working at all.If you were to get a loan of 190k, your payments would be roughly 1150/mo.Taxes, insurance and HOA = 700/mo.

You're at 1850/mo and your rent is only 1,600.You don't even have a gross profit with those numbers so you definitely wouldn't have a net profit. In my mind, thats not a good investment at all and there's no I would ever do something like that.

Now, that being said, there are some other factors to consider.1) Area. That may be a good cash flow scenario for your area. I know some of the coastal areas (california, new york) seem to be very difficult to find property that will cash flow. Its an appreciation play. And in your case maybe that makes it a great deal.

Again, I would look at the relative numbers.  if you were to have bought a SFH, what would your gross cash flow look like? Would it be break even? Negative 1,000/mo? etc.

That would give you a better idea as to where this deal falls in terms of your area.

2) Lack of leverage. I guess the other thing that concerns me here is by not using any leverage, you're missing out one of several legs that real estate makes you money - specifically principal paydown.

3) Actual return. As one poster stated above, while it doesn't appear to be a good investment relatively speaking, its real estate. And believe it or not, you can actually buy stuff wrong in real estate and still do pretty good.

You just parked 190k into that unit. Your taxes insurance and HOA are running 700/mo. Figure vacancy and repairs another 180/mo or so (5% x 1600 and 100/mo for repairs). That means you should be netting roughly 600/mo or 7,200 a year.

Plus you're getting appreciation. I'm assuming that NJ is a bit higher than here in the midwest so lets say you're getting 4% appreciation. Thats 8k a year. Total return is 15k a year on 190k or just around 8% returns.

Not great but not terrible either. And your depreciation should be around 5k or 6k a year so that should make most of your rental income tax free. So of that 8% you're not paying taxes on much of any of it (def not the appreciation and only 1k or 2k of the rental income).

But thats where the leverage would come in. If you had a loan on the property, you'd get principal paydown and have a mortgage interest expense to write off too. Your returns would look better.

4) Lastly, the value of time will eventually kick in. Rents are going to go up over time. So your cash flow will continue to increase.

So, for me, I think I'd still like to know what the unit is worth - i.e. did you get any equity in the place when you bought it?

And two, I don't like the cash flow on that thing at all and I also don't like tying up all that cash either. It significantly reduces your rate of return on your money.....

Jeff B. · Answer

Vacancy Factor is commonly 8-12% of the  GSI.

Repairs & Cap expenses: ~10% of GSI.

Remember, the above are estimates, and your real  experience may be better or worse. Manage well and your cash flow will remain as is.

GOOD JOB.

Steven Lewis · Answer

Makes perfect sense - thanks for clarify.

Mike Wood · Answer

@Steven Lewis that 8.33% would be your vacancy rate per year.  This would be used for budget on a yearly basis.  So you can think about it as a reduction in income due to the projected loss of rent.

Based on your only repair being $600, than your repair costs would be 3.125% (=600/(1600*12). But given that you have only had it one year, and only one repair, that low of a expense budget could be too low.

So while it is really budgeting, it could be thought of as reserves. Since if you send all of your income from the property every month and need it, then when these things happen, you will be unable to pay for them.

Steven Lewis · Answer

Some more background - I've had the unit for little over a year now. Had to repair the AC unit for ~$600. Other than that, no other major issues thus far. Regarding the 8.33%, are you saying that you would keep at least one month rent in reserve?  I'm sorry, but I am not following you - what is this number meant for?

Jeff Rabinowitz · Answer

A very general rule of thumb is to allow 10% of the rent for vacancy. No tenant stays forever and when they leave there will almost always be some prep that has to be done for the next tenant and some period of vacancy. I don't have experience with condos. For my single families I allow, at least, another 10% for maintenance. I would expect you could allow for a much smaller maintenance budget for condos than sf homes if the association dues cover exterior maintenance, roofs, etc. but you should allow for something. Are you responsible for a water heater, a/c, furnace, etc.? Add up what the items you are responsible for would cost to repair/replace and divide them by their reasonable (figured conservatively) useful life. That is a reasonable guess for a maintenance allowance. The more units you own and the longer you own them, the easier it will be to estimate what is right for you.

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