fully leased duplex in Dallas Metro

[Carolyn G.]

Thinking of purchasing duplex(es) in terrific Dallas area. Looking for appreciation, have long term outlook. These units are new with 1 year builder's warranty. $240K per duplex. Annual gross scheduled rent is $28,000. They are already rented. With 25% down, I can get a 30 yr loan at 5.375% with closing costs of $2,800 plus title fees =$1,007 /month PI. Annual taxes = $6800. Management fee is 6.5%. I know I have to take insurance, vacancies, etc. into consideration. Question is: Dallas area, great neighborhood with large homes, good schools, appreciation seems likely... I've done a bit of homework. Is there something I am missing? Should I be looking elsewhere? What factors should I look for in deciding the long term viability of renters at this price?

[Jon Holdman]

You could buy this property in Mansfield, TX:

http://www.realtor.com/realestateandhomes-detail/608-Kings-Way-Drive_Mansfield_TX_76063_1113073194

Since I'm sure that listing will not last forever, let me describe it. Its a four unit quad. Gross annual rents of $28,800 a year. Same as the one you're considering. Thing is, its listed on the MLS for $160K, only 67% of the price you're proposing to pay.

Don't like quads? How about a duplex:

http://www.realtor.com/realestateandhomes-detail/206-S-4Th-Avenue_Mansfield_TX_76063_1113428094

This one looks to be a fixer, so you would have to do some work. Thing is its priced at $88K.

OK, maybe not good comparisons, since the one you're proposing to buy is bright and new. There are, however, 44 listings on realtor.com at $120K or under. The ones at $120K look new or newly remodeled. Even the ones at $90-100K look fixed up. You have to get down below $80K before you're into the "investor special" houses. I even see one at $65K that says "ready to move in".

If you're buying at a retail price, you need a LOT of appreciation to make up for the costs. Even after 10 years at 3% annual appreciation, that $240K house is will only worth $323K. If you sell it and pay the costs, you net $297K. Your loan payoff at that time is about $148K out of your original $180K loan. So, you net $149K.

You put in your down payment of $60K, plus about $6K in closing costs.

Lets be optimistic and say that rents and expenses also both go up by inflation, even though expense increases have a funny of outpacing rent increases. So, your cash flow position should improve over time. You end up netting about $39K in cash flow over time.

In the end, your IRR is about 14%. That's not bad. Certainly better than CDs, and better than the claimed 10% annual return for stocks, not that I expect to see that any time soon.

But, how much of this is depending on appreciation? Well, almost all of it. Lets assume instead there is no appreciation in value, rents or expenses. Now your IRR drops to 4%, and its totally driven the cash flow. The only reason you get back more on the sale, about $73K, than you put in, about $66K is thanks to the principle paydown, which totaled $32K over the 10 years.

That's called a "sensitivity analysis". Since predicting appreciation is impossible, I would instead ask what happens in different situations. Well here are two, and only one is a good investment.

How likely is it that you'll see little or no appreciation? Well, as luck would have it, I bought a house south of Houston in 1987 and sold it in 1995. Right now, the economy looks a LOT like 1987. We were coming off some really bad times then, tons of foreclosures and "cram downs" (what we call short sales now) and a really bad lending environment. I bought that house for $55K and sold it, eight years later for $65K. That equates to 2% appreciation. 2% appreciation would give you an 11% IRR. In this case about one third of your return is from the cash flow and two thirds from the appreciation.

So, I'll go back to my original statement. This is a crummy deal. You're buying at retail. By definition, since when a developer sells a development, the price he gets is retail. You're putting 25% down. That's enough for you to buy any house anywhere in the US. You're hoping for appreciation, which may or may not come. If that's really your play, buy SFRs, not duplexes. SFRs are more strongly driven by demand for housing where duplexes are driven somewhat by investors. Do you own homework and find your own deal, rather than giving up a big cut to this developer.