A 4% Deal For 1st Rental?

Question

Hey everyone! I would like to get some opinions on whether or not I should do this deal. It would be my first investment. Here are the details:

It is a triplex for $32,000 in a low-income area in the Midwest. Property was built in 1900. All units are currently occupied with tenants that have all been there at least 2 years. Rents are $465, $465, and $450 for a total of $1380 (over a 4% deal).

Owner pays utilities. He sent me an expense sheet with all the utility bills from 2016, which along with taxes and insurance add up to be $590 on average per month. I calculate that with $250 per month allocated towards repairs and CapEx, $100 per month for vacancy, the $590 per month in utilities insurance and taxes, and about $160 for a mortgage payment ($25,600 at 6%), I would still cash flow almost $300 per month. I would plan on slightly raising rents to make sure I'm cash-flowing at least $100 per door.

My concerns are the possibility of having CapEx hit me early on since it's an older property, and also the quality of tenants I'll have since it's in a low-income neighborhood.

Should I do this deal? Why or why not? And is there anything in particular I should watch out for?

Thanks in advance to anyone who decides to give me their advice!

Joe Cantanzriti · Answer

Absolutely.... I just did the math on what I still needed to replace. So for me, I replaced the roof immediately upon purchase so here's what mine simple analysis looked like.

**Divide # years down to a per month cost.

Roof - 25 years - ~$9,000 - monthly cost $30

HWT(2) - Replace both with 3 years most likely - $2,500 - monthly cost $70

Electrical - Replacing both panels in year 2- (now already completed) $2,000 - $165 / month in first year

Furnaces/AC - replacing all within 5 years - (one replaced now) - $5,500 ~$90 / month

So this is certainly not an exact science but this was how I originally looked at it (after purchase) ... not sure if I would have bought it had I thought all the way through it but it got me into the game and has worked out great for me. Just haven't made much money on this one yet.

So to sum it up, I budgeted $325 a month to replace the items that I needed to over the first 5 years.. I subtracted the roof out and added that $30 to my overall reserves since my plan is not to hold it more than 5 years for this property. So basically my $325 a month that I needed to just handle these specific items really cut into my "cashflow" that I originally thought I had. I had a cashflow of about $450 after all other expenses, vacancy, etc. So I actually only have a cashflow of something like $125 on my duplex since I know I'll need $325 a month out of that to do these major repairs. I did completely renovate the rest of the units, kitchen, baths, floors, etc so I don't expect to have major expenses aside from the ones I mentioned.

Joe Cantanzriti · Answer

Sounds like property management will be the make or break on this one, if managing yourself it would probably provide an excellent real estate education that's for sure. I own an older duplex that has great cash flow like this, something close to "3% rule" which on paper does equate to something like a 40% ROI..... however the CAPEX is what I overlooked on the older and cheaper property as many forums posts discuss here on BP. It's well worth taking a deep look at the roof, furnaces/ACs, Electrical, etc and put together a quick spreadsheet of when they realistically would need replaced along with a cost for that replacement. Even though you are hitting that 4% rule, when you need a roof, that cashflow for 3 years is gone to pay for the roof. I bought a very similar deal and have made out ok so far however I vastly underestimated the CAPEX.

Deanna Anderson · Answer

@Joe Cantanzriti  Since you noted that you vastly underestimated the CapEx for your older duplex, I'm curious how much you're now setting aside each month to cover future repair/replacement needs.  My husband and I are looking at similar properties and would appreciate your suggestions for CapEx allocations.

David Faulkner · Answer

4% deal is completely meaningless ... it literally has no bearing whatsoever on the long term profitability of the property. Let us go back to first principals ... if all the units are fully occupied at the rents listed, then why on Earth would the current owner sell to you at that price instead of holding and keeping the amazing return for themselves? For that matter, if it is listed property, then why haven't other local investors snatched it up? Now let's look at it from the tenants point of view ... they are renting for $465/mo and can drastically reduce their expenses by buying even a much nicer place ... then why don't they do that? Why do they instead rent a smaller, more expensive place in such a neighborhood?

Is it possible it is a great deal? Sure ... but I'd try to figure out sensible answers to the questions above before laying down your money. Wanting to believe something is true has no basis in it actually being true. If something seems to good to be true, it probably is. If it doesn't make sense intuitively, then it is either a lie or you are missing something. Is it true? What are you missing?

Grant Edwards · Answer

@Samantha Klein @Joe Cantanzriti @Maxwell Lee @Shawn Holsapple Thank you all so much for the advice. As tempting as it is, I think I'll take the advice you all have given me and hold off. Seems like a home run in the short term but long-term it just seems like it would be too much trouble. I don't want to take a large risk on my first investment.

Shawn Holsapple · Answer

@Grant Edwards - ahhh, these deals look so sexy on paper!  I've tried [and tried] to make them work always swearing I'd never do another old property again - and now I don't .

I've been old asset free for over 3 years now and don't plan on falling off the wagon.

The age, low rents, non tenant paid utilities, etc. will be a nightmare.  Plus, small multi unit properties are very hard to keep occupied in the MidWest as an added bonus...

All you need to make it worse is if the tenants pay weekly with cash!

Maxwell Lee · Answer

Yes it's a terrific ROI on paper but I agree with your concerns about capex and the tenant quality in general. You're paying utilities which means the actual rents are in the $350 range. That's just way too low for me to feel comfortable...even in an extremely cheap city. I hope you are nearby and plan to be hands on if you decide to buy. Good luck!!

Deanna Anderson · Answer

@Joe Cantanzriti Thanks for sharing all the details, Joe!

A 4% Deal For 1st Rental?

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