Deal Analysis: Low End Buy, R & H SFR v. Solid Multi v. Flip

[Jason V.]

I'm thinking myself around in circles, and hoping for the input of the BP community to settle me down. Feel free to skip down to the bottom if you just want to look at the numbers, but the numbers aren't what are really tripping me up right now.

Background: I'm 30, work full-time as an Engineer, and have no debt besides my two mortgages - our current residence, and our former residence, which is now our one rental. 

The rental was a HUD foreclosure, and for all the work I wound up doing to it (completely re-wired and re-plumbed, full tear-off roof, all new windows and doors, new siding, new deck, every ceiling, wall and floor replaced. Oh, and I had to cut out a section of exterior wall and rebuild it because of severe water damage caused by a DIY tub surround) - I should have just build a new house.

My wife works full time as an RN, and we have 12, 6 and 3 year olds, all with special needs - a story all to itself - and I love to talk about it! :-) In our current financial situation, our local Community Bank has Pre-Qualified us for $300,000 worth of additional mortgages, and we currently have $20,000 in cash set aside for REI. Because we live simply, we are able to save an additional $900-$1000 every week.

Our current SFR cashflows about $4,000 per year, and we are looking to expand our portfolio (which I feel silly saying, considering we're small part-timers) with small multi-family properties. The cashflow numbers on multis are much better in this area, because we have some of the highest taxes in the country. We are still open to more SFRs, but we have to be able to buy them cheaper than cheap for the numbers to work.

When we started shopping for multis, we were looking at the low end of the price range. $40-60k duplexes, and we had an offer accepted on a 5 unit for 70k, which fell through. And that may have been a good thing. Since then, I've been becoming more interested in moving up the price range a little bit, mostly because I keep hearing on BP and especially the podcast that cheap properties aren't really a great deal when it comes down to it. 

*Numbers Start*

This week we're going to look at 2 quads that are about 3 minutes away from each other in a slightly nicer area with slightly lower taxes than our hometown. Both have the same unit breakdown - one two unit and three singles. I estimate they will both have a gross monthly rate of $2,300. One is a beautiful property, very well maintained and has been on the market for several years - it is currently listed at $139,900 (annual taxes 3504). The other is a very solid property and has been on the market for 8 months, currently listed at $114,900 (annual taxes 4739.) Zillow (and yes, I know not to trust it, but I don't have a better source) claims 2% appreciation for this area. 

We're also going to look at a quad that is three doubles and a single, which is about 15 minutes from the other properties, probably in a 'better' direction. This property has been for sale on and off for 8 years, and is currently listed at 124,900 (2198 annual taxes.) It is listed as having gross monthly rent of 2900, but the owner of this building pays heat. I would estimate that expense to be $100-$200 per unit in the winter, but will ask for utility bills if we keep moving forward. 

So all of this is well and good - I'm comfortable running the numbers on these three, and there almost doesn't seem to be a bad choice, although the third property may be a slight winner on cashflow, but slightly tougher to manage. 

And here's where I get thrown for a loop: there's a brand-new listing for a foreclosure in my area for cheap. It's assessed at 110,000, and every other house on the road of a similar size (although much newer/nicer construction) is in the $150,000-$200,000 range. The foreclosure is a cash only deal because there's something keeping it from being financed (from the pictures and the huge price drop, I would have to guess something in the way of major structural/foundational.) Even if I had to drop a ton of money to get it up to shape, I think I could be all into it and have it back on the market for under $75,000, and would estimate it selling in the $120,000 range. The problem with this scenario is that I'm tapped out on cash just buying it, then will be borrowing for renovations, and if that goes badly, then I don't get what I expect out of it, I've got all my time and money tied up with a house that isn't doing me any good. 

OR, I could buy a super cheap foreclosure (like our first home) put the minimum into it (paint, floors, appliances, etc.) to get it rentable, and have it rented for ~$850 a month, less than $13k, all in. (This last option might happen at some point anyway, because that house has been empty forever.) 

*Numbers Stop*

I think my fear with the multis is that I've heard again and again and again to buy things below their intrinsic value - but if I'm just buying things off the MLS, aren't I paying intrinsic value, or more?

And my fear in every situation is that I'm underestimating costs and overestimating rents and/or sell prices, despite my research and best estimates. 

Or maybe I just committed the rookie mistake of not having my strategy in place before looking for properties, or allowing myself to get distracted from what my focus should have been. My goal is to generate enough passive income that it becomes an option for my wife to work. 

Or maybe I just want someone to tell me what to do because being a grown up is hard. And if this isn't the most rambling, disjointed post in the history of BP, than I'm not sure what is. If you made it this far, thanks for bearing with me!

[Miguel "Mike" Perez]

I don't have an easy answer for you.

Those numbers you listed are just the tip of the iceberg and if you know icebergs there is a lot more of it you cannot see versus what you can see.

My advice is to analyze each property using the rental calculator or something similar. I use my own spreadsheet inspired by that calculator. That will show you the whole iceberg, and the answer will come easier. It's just like using the right tool for the job. If you need to drive a nail, but you don't have a hammer, you spin your wheels trying to find something else to use as a hammer.

Sure you can drive a nail with the butt of a screwdriver, but it will take you 20 times as long and you will hurt yourself 90% of the time.

Identify the right tool and apply it to this job.

I recommend a thorough analysis.

Be equally conservative on estimating income and expenses across all of them.

Save your future self from having your personal life come tumbling down at the expense of your REI life and budget for property management because as a dad of 3 kids (regardless of special needs), husband of a career woman, and engineer at some firm that always wants more of your time for equal or less pay, you might want to have the option of calling in for assistance in the property management department.

No shame in that. In fact I think it's silly to have the brains of the operations taking house calls from tenants or other similar activity.

If you can do any of those options you listed, but need to pick one, then choose the one with highest cash on cash return or ROI as it is often referred to. If you don't have the money to do one of those options, you can always get it, but is it worth the price you'll pay?

I'm not afraid of debt but it should be used wisely.

What is your exist strategy? You should have a couple in place. Can you sell for a profit if you were to list it after PLANNED IMPROVEMENTS? Can you rent it and start getting ROI? Could you refinance for lower cost of borrowing?

Hope that helps.