Deal analysis please?

Question

Hi everybody, and thanks for any ideas you might have about this. I looked at my first potential rental unit last week, and I'm pretty sure I'm going to pass. Here's the skizzy:

Two-family unit, B-grade, fair condition, 10 minute walk from my home. Water heaters seem to be in good to very good condition, propane boiler appears to be in very good shape, roof looks good. Plaster walls with some crumbling, electric seems all solid. Last year's rough numbers are below:

Asking price: $93,500.

Units rent for $650/$975 each, total yearly rent $19,500

Taxes: ($2,850)

Insurance ($485)

Propane ($2,326)

Yard ($605)

Water/Sewer ($597)

Other Expenses ($868)

Total Operating expenses ($7,790)

Last year's financing put the owner at a 12.5% cap rate, and a net yearly cash flow of just over $6K.

I can finance it on a HELOC from my home, 3.5% over 15 years with $2K in closing costs. A commercial loan is 5%+ on 20 years, with $3-4K closing costs, (boo-hiss.) If I finance $90K, payments are $650. If I finance $70K and pay the rest in cash, my monthly is just at $500.

if $650, projected annual return is $3910 assuming the above numbers hold and 100% occupancy (risky assumption)

if I drop $20K into the place in cash, my monthly payment is $500, and yearly return is $5710, again assuming a perfect world and full occupancy.

The best tweak I could see to the above numbers would be investing in separate on-demand heaters for each unit so that the propane cost was passed on, though I haven't looked into area rents enough to know if that would be competitive.

It feels potentially too risky for me as a first-timer - a large expenditure over the first several years wouldn't be unlikely, and that would destroy any small profit the rental would make. Plus, it feels like lots of potential hassle and risk for a few hundred a month, versus other potential options.

Am I missing something besides the obvious 2% rule? I'd be grateful to hear your perspective on this deal if you have a minute.

Thanks!

Randall Williams · Answer

lifesaver! Of course. Trying to rent spare rooms now in my house and finding the same. Thanks @Matt Motil - lifesaver.

Matt Motil · Answer

If they are up for renewal now, you might consider longer terms than 12 months. Being in a wintery climate that you are (like I am in Ohio), renting units in the winter can really suck. When you find yourself renting a unit in the winter, best to require an 18-month lease instead of a 12-month so the next time you go to lease up you are doing it in the summer and not the winter again. This won't eliminate the vacancy issues but it does help cut them down.

Brent Coombs · Answer

@Randall Williams, oooh, you got Bob roused. He is the resident "Cap Rate" police chief around here, so be careful when using "Cap Rate" in the same sentence as "Two family unit" when Bob's around.I agree with your thought about having separate on-demand heaters, but the "best tweak" I can think of is: Offering a lower price. Some Investors would routinely knock off say $20k from such an asking price - and just move on to the next one. A pure numbers game.So maybe, rather than just rejecting it because of some theoretical 2%/m it doesn't achieve, it may well be worth a closer look, and an Offer. There looks to be MANY pluses with this one. All the best...

Account Closed · Answer

please explain how the cap rate is affected by last years financing.

Randall Williams · Answer

My thought, too. Just soliciting wiser minds. Thanks!

Brent Coombs · Answer

@Randall Williams, for this one, at this time, my thought would be to borrow as much as you are ALLOWED to, keeping your reserve for another day, (another deal?). If finance was terribly expensive, I would have a different view. Cheers...

Randall Williams · Answer

@Matt Motil, and anybody else hanging in - this deal is moving, thank you. @Brent Coombs, I lowballed and they bit, thanks for the encouragement.Quick financing question? I have $27K in easy liquid now. If I put $20K into the deal up front, the monthly payments drop by $180. Does it make sense to lock away the $20K and cashflow better, or finance the whole thing and keep the extra pad?Thanks a million,

Randall Williams · Answer

@Matt Motil, that helps. I've calculated in 1 month vacancy yearly, which may be conservative. I'm tempted to ask both current renters to renew for a year, so I have some time to get my head around the management and expenses before having to fill vacancies.

Matt Motil · Answer

Sounds like you're in good hands here already, but I'd throw my $0.02 in on the vacancy rate. You're never going to have 100% occupancy. Ever. No matter what anyone tells you. Safe bet is to get an idea of the typical lease term that you see with properties like this (1-year, 2-year, 3- year, etc) and then assume you're going to need time between tenants to make repairs (there's always damage), repaint, rehab, clean, & re-rent. I usually assume a month to be safe in between tenants and use that figure in between the typical lease terms to determine how much reserve I should be carrying (Per unit) to cover vacancy. Hope that helps

Kay Kay Singh · Answer

It looks like you are already good at the numbers but there is always going to be some vacancy and also account for caped down the road which I did not see in your numbers.