REO Duplex deal

[Mariah Jeffery]

I'm in the Portland metro area. Getting cash flow in this area at all is difficult, and meeting the 1% rule is near impossible. However, I've been searching for two years and occasionally find something close.

Yesterday, I looked at a duplex in a good neighborhood a few miles from where I live. It's bank-owned, asking price of $160K. It's in pretty good condition with a few cosmetic repairs needed. It even had a new roof and new exterior paint recently. No more than $2K-$3K in fix-up costs should be needed.

The main problem is I don't know how to estimate the rent. Each unit is 810 sq ft, 2/1. I thought $750 and a friend with rentals in the area thought $750-$800, but the one comp on the same street shows 800 sq ft units renting for $650. Also, these same units were renting for only $525 in 2005, but the tenants were long-term and had not had their rents raised. Water/garbage is included in rent.

Comps indicate the value after fixed up is ~$200K. A similar, but larger, REO duplex in the area sold for $10K ABOVE the asking price 4 months earlier.

My question is how much to offer. I was thinking $150K cash when I thought the rents would be $1,500, but now it seems like the rents might be a bit high. Strictly going by the 1% rule, I'd have to subtract the $100/month utility bill from the rent to arrive at a price. But then I realistically would probably never buy something.

At $150K, if I take $120K back with a 20-year HEL, I'd basically break even the first year before taxes. My W2 income is high, so the tax benefits will be considerable.

I don't expect people on the internet who have never seen the place to tell me the magic # to offer. However, any guidance or insight would be appreciated.

Thanks,
MJ

[Jon Holdman]

The "1% rule" is guaranteed to lose you money on a monthly cash flow basis. You may have an opportunity to flip the place, or to gain through long term appreciation. But as a pure rental, rents equal to 1% of the purchase price will cost you out of pocket.

Not every month. When its filled and you have nothing by the PITI payment, you'll be OK. But as soon as you have a vacancy, an eviction, major tenant damage, or one of those big inevitable bills, you'll be out of pocket.

Based on the 50% rule (read in the Rental Property forum), rents of $1500 a month will be break even with a purchase plus rehab price of $112,730. That assumes a 7%, 30 year mortgage.

Rent: $1500
Expenses: $750
NOI: $750
Payment: $750 (7%, 30 years, $112,730)
Cash flow: -0-

Personally, I use 40% because I manage them myself. And break even is OK, because I'm speculating on long term gains. So, I'd go up to $135K if the rents were $1500.

A "good deal" would be to assume the 50% rule and go for $100 per door per month in real cash flow. That would put the max price at about $83K.

If your W2 income is high, tax benefits will be non-existent. Not sure what you mean by "high", but if your AGI is over $150K (including your spouse, if you're married) you cannot use the passive losses generated by a rental property to offset other income. So, there's no benefit at all. If your AGI is below $100K, you use up to $25K in passive losses to offset other income. Between those two figures, this "special allowance" phases out.

Keep in mind that much of the passive loss is generated by depreciation. Depreciation reduces the basis in the property. That increases your gain when you sell. When you sell, the portion of the gain up to the total depreciation taken (or, that could have been taken if you didn't) is subject to depreciation recapture tax. That's currently capped at 25%. So, the "tax benefits" of rental property are really only avoiding taxes on the difference between your marginal rate and 25%. Taxes on the 25% aren't avoided, just deferred. The only real tax benefit from rental property is the ability to shelter the rental income from income tax. But for that to work, you have to have rental income.