Memphis Duplex Analysis - Is this a good deal?

Question

Hi All,

I have a potential deal in Memphis, TN for a long-term buy and hold duplex (3 bed, 2 bath each side) that I'm a bit torn on (running into some paralysis analysis) and would love your thoughts! I tried to include all the pertinent information below:

Rental Income: $13,200

Rent: Currently has a tenant on one side at $550 per month without a lease – I’ve made it a condition of the sale that the tenant has either signed a new lease with my property management company or delivers that side vacant; other side is not rented out due to required rent ready repairs; rental comps in the area show between $550-600 (I’m being conservative and assuming $550).

Expenses:

Vacancy: 10% ($1,320)

Property Management: 10% of gross rents ($1,188)

Property Taxes: $2,065 ($905 for City of Memphis, $1,160 for Shelby County)

Property Insurance: $450 per year

Repairs and Maintenance Assumption: 2% of Property Value per year ($980 per year)

Utilities: separately metered; all paid by tenant except for lawn mowing at $25 once a month for $300

Advertising: 6% (roughly ½ of first month’s rent) $792 per year

Debt Service: Based on $49k purchase + repair price, 20% ($9.8k) down, 5% 30 year fixed is $2,525 per year

Location:

This is probably where most of my concern is coming from: Western edge of Hickory Hill, Memphis, 38115; major cross streets: just SW of Clarke Rd and Winchester Rd

Acquisition:

Purchase Price: $42k, seller to pay closing costs

Repairs: $7.5k

Total Acquisition Cost: $49.5k

ARV: Large range of comps in the area, best guess is $60k

Financial Metrics:

Net Operating Income: $6,105

Cap Rate: 12.33%

Cash Flow: $3,580 per year, $298.33 per month, $149.17 per unit per month

Cash-on-Cash Return: 36.5%

Do you think it's a good deal? What's a good price for this duplex?

Joseph S. · Answer

@Brent Coombs, I’ve seen a number of methods used for estimating maintenance costs. Most people that I’ve had the opportunity to do business with use the percent of property value because it ties directly to the cost to repair the physical asset, whereas rental income can vary significantly in relation to the cost of repairing the property. It also doesn’t hurt that Fannie Mae suggests using that method as well. Here’s a few sources referencing that method (http://www.jwbrealestatecapital.com/how-much-rental-income-to-holdback-for-maintenance-and-repairs/, http://www.zillow.com/blog/investing-101-estimating-rental-property-expenses-94824/, http://homeguides.sfgate.com/much-should-landlord-allocate-monthly-maintenance-repairs-80019.html, http://money.usnews.com/money/personal-finance/articles/2012/05/29/look-at-maintenance-costs-before-leaping-into-homeownership). However, as long as maintenance is properly forecasted and allocated, the method used to arrive at the number is neither here nor there.

Just out of curiosity, what percent of rent do you typically allocate for maintenance and what are the typical property value ranges?

Regarding insurance, I set the deductible at the highest the carrier allows – in my case $5k. Years ago I was a property and casualty underwriter for a major insurance company and learned that a number of people get the concept of insurance backwards. They over insure, pay out the nose each month for that coverage, and then use the policy for every minor issue that's covered. This results in 1) a higher monthly cost for initial coverage and 2) rate increases or policy terminations once they start making claims – and these follow you from insurer to insurer. This gets even worse when you start building a larger portfolio. You only want to use that coverage in the event of a liability issue or a near total loss. If you’ve purchased your property with enough margin and this occurs you just take the face value of the policy, close shop on that asset, buy another, and possibly pocket a few bucks in the process.

Curt Davis · Answer

you are going to have long term bad experience.  The numbers look great but it will never perform close to what you think.  you have to ask yourself, if it was such a great deal why is it being sold? Last duplex we sold was over 4yrs ago. Stay away.

Alex Craig · Answer

@Joseph S. Is this deal on Flowering Peach or near there? This street is essentially owned by out of state investors and several homes are listed for sale by out of state investors looking to get out. Area is really rough in my opinion. Someone else asked about a duplex on Flowering Peach here on BP about 2 or 3 weeks ago. I will try to find that thread.

Dean Letfus · Answer

Run Forrest run, area is bad dude, don't buy it.

Jason V. · Answer

@Joseph S. I think you're a touch low on maintenance and I would double or triple the landscaping budget (being off by $300 won't kill you there though.) On the other hand, I've never budgeted or paid for advertising as part of a single property, so maybe that's all a wash.

Biggest concern: I don't see where you're budgeting for Capital Expenses. Don't think roof or furnace exclusively, think appliances walking away in the night as well.

There are probably a couple thousand conversations about TurnKey properties on BiggerPockets at this point - lots of good info being rehashed here, but I'd think really hard about why you would rather buy a cheap house on the opposite side of the country than a slightly more expensive one within driving distance of your house.

Other than that, good job on the analysis. Good luck!

Brent Coombs · Answer

@Joseph S., I'm not currently in the rental game, but, do read a lot.

Here's a quote from that Zillow blog:- "So let’s say you collect $1,200 per month in rent, and your expenses are $450 per month. Your operating expense percentage would be 450/1,200 = 37.5 percent. For a bread-and-butter house, duplex or triplex building, 37.5 to 45 percent is probably a good estimate. Generally, the fancier the building, the higher the percentage operating expenses are of the GOI".

So, it's all about NET ROI, right? Once you know how much the gross income will be (represented as 100%), surely it does make sense to deduct every anticipated expense as a percentage of THAT figure? It makes sense to me that way - all expenses as a percentage of income! (You already know how much your gross return on investment is as a percentage of purchase price). Cheers...

Brent Coombs · Answer

@Joseph S., you wrote: "For clarification, I meant maintenance/repairs would be 2% of the property value ($980), not 2% of rent ($264)". Aah, but who works it out that way?

Gross rent per month is usually the only figure that's calculated as a percentage of purchase price (to firstly see if it meets your investing criteria eg. 1% or 2% "rules"), whereas all expenses are then (usually) worked out as a percentage of rent - not purchase price (eg. the "50% rule")!

Of course, you can choose your own method, but, I'd still guess that $980/y is too low!

How much is the deductible on that Insurance Policy? (How big an "ouch", every time you need it)?

Joseph S. · Answer

@Kyle Leinhart, @Brent Coombs, yup, if you get the right type of insurance (a high deductible, named perils fire policy) you can get insurance for that amount (quote in hand) in this area.

For clarification, I meant maintenance/repairs would be 2% of the property value ($980), not 2% of rent ($264). Estimating 5% of the property value for repairs and maintenance essentially has you fully rebuilding the property once every 20 years. That seems high for me – I typically target 2% (50 years). That said, based on the area, it might be necessary to go higher than my traditional target.

Regarding current rehab cost, the $7.5k will cover everything necessary to make it rent-ready and will resolve most (but not all) of the deferred maintenance.

Your note regarding boots on the ground is crucial. I do have fairly solid (at least so far) property management currently in place on another property I own in a different area of Memphis. However, I can’t get average maintenance cost, vacancy rates, risk information from them based on their portfolio (they hold this information close to the chest) which is what makes BP such a good sounding board for me.

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@Tyler Watts, thanks for critiquing the financials. I feel pretty good about those too; but like you said, the location is where I’m concerned.

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@Alex Craig, @Curt Davis, thanks for the advice. You hit the nail on the head - the area really is what concerns me regarding this deal. As you mentioned, there are currently 10 duplexes on sale in this area (though all of them are 2-2s priced in the $65k - $75k range not including repairs, where my deal would be a 3-2 for $49k inclusive of repairs). The property I’m looking at is just a couple streets east of where apple blossom ends (it’s on Firethorne – does that help in any way?). I found your other post and the average rehab cost to get a property back on the market was very helpful as well ($1400 every 18 months is pretty close to my estimate of 2% of property cost at $980 per year so I’m glad I’m in the ballpark).

Let me ask you both, at some point purchasing for buy and hold in this area would be worth it (at an extreme example, any of us would pull the trigger if it only cost $1), so what would it take to make this deal look positive in your books? What would you say would be a good price (rehab included) for the property)?

Tyler Watts · Answer

Location is everything. I don't know the area, but the numbers look great. Also depends what stage you are in the game. I have a duplex in NC with similar numbers to yours and it's a cash cow. The location is good and the neighbors are great. Go a mile down the street and it's rough. It did concern me, but after evaluating, I decided to move forward and it's been a great little place. I can't speak much on out of state investing, I'm the old school, OCD investor who has to drive by and look at my properties. As far as your evaluation of the property, the numbers look great and your doing a good job looking at it from that angle. So to answer your question, yes that is a good deal. If your concerned about the area, I'd research, research and research more! Not a bad investment to fly out and spend a day driving around and talking to the neighbors, you'll learn a ton from them about the history of the area!

Good Luck!

Memphis Duplex Analysis - Is this a good deal?

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