Is this really as bad of a deal as it looks, or did I mess up?

Question

This is one of my first formal analyses of real estate rental property, and I am taken aback at how bad of a deal this seems to be. Here are the relevant links:

MLS Listing

FHA Loan Calculator (with property tax, HI, and MIP estimations)

BP PDF report

Is it possible I plugged in an erroneous number somewhere to be coming up with -$452.24 monthly cash flow? It doesn't look like an even somewhat good deal until year 30 when the loan is paid off. Am I doing something wrong here?

James C. · Answer

Lucas,

I couldn't see the MLS or FHA calculator, so I am going off the BP report.

No you did nothing wrong.. it doesn't pass the 1% scan, nor the 50% scan. 280K *.01 = $2800 per month, and 50% of rents of $2000 leaves $1000 for expenses, so that won't cover mortgage of ~289K.

It's not a cash flow deal. Maybe an appreciation deal, but that IMHO is gambling.

And WHY are you spending $287K ARV to get $279K back?

Are the rents market @$500/mo/unit? if that is the case, then this needs to be about 125K to make it a deal, maybe 150K. If not, what are the ACTUAL MARKET RENTS?

See below signature for those numbers. Just a note: The numbers are a quick scan for me where I force 10% on and 10% of my money as a requirement of the deal, and look for positive cash flow to make a decision to look more closely, or let it go.

Good Luck!

Jim

Acquisitions

Assumptions

Item

Amount

Vacancy Reserves % (STD is 10%)

10%

Purchase Price

$125,000

Repairs Reserves % (STD is 10%)

10%

Acquisitions/Closing Costs

$2,500

Recoup % (Std 10% On and 10% of Money)

20%

Down Payment = 8 %

$10,000

Management (STD is 10%)

10%

Loan Amount

$117,500

Monthly Rental Income

$2,000.00

Interest (Yearly)

4%

Yearly Insurance

$1,000.00

Term (Years)

30

Monthly Condo Fee

$0.00

Payment

$560.96

Yearly Taxes

$2,000.00

Expenses (Aggregate, yearly)

Result

Monthly

Yearly

Cash Flow (Net)

$380.70

$4,568.44

NOI

$1,150.00

$11,300.00

ROI

36.55%

Cap Rate

3.65%

Ali Boone · Answer

It's all about where and what you are buying. Most places are unlikely to cash flow, and of course you want to be leery of ghettos that project cash flow but are high-risk. However, even despite where the current RE cycle is, there are good places that still cash flow. It's just about finding those. I live in Los Angeles where the idea of cash flow is laughable, so I buy out-of-state where I can get cash flow. You may not need to buy out-of-state since I would imagine there are places in MO that cash flow just fine, but it might be about you just buying the investment property by itself and not trying to live in it. That way the specific neighborhood isn't as critical and the numbers will actually pan out.

James C. · Answer

Lucas,

I find it RARE to find properties that actually cash flow at this stage in the cycle in certain markets. Find out what renters are renting, if it's SFR, then buy those, if it's MH, buy those. At the end of the day, the numbers are the numbers, you can't force the market, only flow with it. If you can't cash flow in your market, find another one.

If you are trying to house hack, then you might end up putting in more than $0 to make it work. Sometimes, you have to make your own deals (Farming, wholesalers, yellow letters, networking etc.) to get the numbers to work. It ain't easy, otherwise everyone would be doing it. To top it all off, with "easy money" all around, the number of "STUPID!" deals increases exponentially.

The definition of the "right deal" is situation dependent. I've seen lots of folks here talking about CA, DFW, Boston, MA and other "Hot" markets. IMHO, "Hot" markets are a great way to get burned. Those here who have been through more than one cycle have some experience there.

Housing is a necessity. If I wasn't able to move, I would calculate the cost of my housing choices. For example, the 4 unit, although it doesn't "cash flow" the way we would like it to, may be the best of all the options. Maybe you can find a 5 unit, and "decommission" one of the units, so you can get cheaper residential financing, and live in one of the 4, until you can occupy the 5th unit. If your SFR purchase option is <$952, then maybe that is the way to go. Is rent cost less than the after tax value of owning (probably not, unless it's in mom and dad's basement)? You won't know until you run the numbers.

Another option, invest in an area that has better returns, and use that to offset your housing costs, if you can't move. Remember, cash is fungible, that's what makes it great!

Talk to some lenders, friends etc. find out how you might need to put down for a >4 unit if you were going to occupy? They might not like it, but they might. Years ago, I was offered (and stupidly rejected) a 15 unit building by my HML, and THEY suggested I move into the top floor unit.

The point of all this: think creatively, think outside the box, examine your entire life from the "Lucas INC." point of view. You might be surprised what you come up with.

Hope this helps, or at least some food for thought.

Good Luck!

Jim

John Leavelle · Answer

Howdy @Lucas Mills

You are seeing the correct Cash Flow based on your numbers.  @James C. has already pointed out the main problems with this deal.  The purchase price is too high for the rental income. Also you are using the House Hack strategy (FHA loan - Owner occupy).  That means your rental income will really be $1,500 from 3 units.  And Cash Flow more like -$952.  Additionally, you are paying a low down payment that makes your mortgage payment a lot higher.

This is not a good deal unless you can purchase at a much lower price.

Ali Boone · Answer

Heya, yeah I have always gone the turnkey route for my own non-local properties, but honestly since you are located in MO, I'm not sure you necessarily need to go the turnkey route. You can probably buy cash-flowing properties in MO or close enough by where you could get a non-turnkey (saving some money). You can buy turnkeys, and I'm happy to chat anytime about ways to help increase the chance of getting a good turnkey property and the returns you could expect and all that.

I have a lot of potential resources I could send you-- comparing ways of buying-of-state, things to look for when buying any rental property, investing locally vs. afar, info on turnkeys, etc. I'm not sure really which to send right yet though because I think there's so many different ways you could still choose to go. I'm happy to chat offline more and as soon as I identify something I can help with, I can send resources. Or whatever you think would be most helpful to you now, let me know!

Happy to chat more anytime.

James C. · Answer

Lucas,

Sorry for the confusion OO in the context is Owner Occupied.

Jim

Lucas Mills · Answer

Hi John -

Yes, I was projecting to pay list price as a very conservative scenario. Arbitrarily speaking, I might try to get that property for 5-10k less than they're asking secondary to potential extensive repairs that may need to be done in order for it to make sense with the numbers. That said, I feel like I'd rather avoid this situation for my first foray into REI (an extensive rehab project) and instead get something a little nicer that doesn't require the knowledge and skills required to get something like this SFR to a rentable state (ceiling looks bad in places, walls look bad, etc.). Or maybe this doesn't look like an extensive rehab job - I really have no idea.

I just know that I've been warned to not spend too little on houses because what you make in cash flow you lose in vacancy, tenant issues, etc. I don't want to put myself in that situation.

Edit: Just saw your second reply. Yeah, that's what I was thinking. I think I need to be closer to the 100k mark in my area for the kind of property I want, but even then I'm somewhat concerned because I've seen nicer places with somewhat similar rent rates ($600 or so is fairly average here, for apartments much less dated than this), so I'm concerned about how the rent scales with the cost.

John Leavelle · Answer

@Lucas Mills

Just checked out the listing.  Yikes, inside is very dated.  Looks like a total cosmetic upgrade needed.  Looks like similar homes in that area may be Valued between $50K - $60K.  I would check what the Rental Market rates are for that type property.  Is there room to increase rents once property is renovated?

Alternatively, if you can purchase it at a lower price you may be able to flip it.  Of course that may be more work than you are wanting to do.

John Leavelle · Answer

@Lucas Mills

Your numbers/ratios are better.  However, you are still projecting to pay List price.  That being said, with the House Hacking strategy, make sure the property will Cash Flow without you living there.  Negative Cash Flow during the time you live there is a normal result of the strategy.  Once you move out and possibly Refinance it must be able to Cash Flow.

A problem you may have with the SFH is there may be a minimum FHA loan amount.  It is a complicated calculation.  Check with your lender.

Lucas Mills · Answer

Thanks Jim.

Yes, that does help. At least for my first investment, I'm 99% sure that I want to do it locally and learn some of those processes here in my area first.

When you say that I could "OO it for say 12-18 months while looking for a better deal", what does OO mean in this context?

If I'm going to look for an investment partner then it might make sense to consider higher income areas where I would, hopefully, have less headaches from tenant issues, vacancy, etc. That SFR is not in a warzone but it is in a somewhat lower income area. I wouldn't personally worry about walking up and down the street (at least in the daytime), but it does look like a bit of a rough area to me. I drove by today just to check it out in person.

I'm not married to the FHA, necessarily. I was considering homes like this SFA with which I could afford a 20% down payment thus avoiding the PMI. However, anything too far beyond that is out of my reach in the current time frame, unless I get an investor.

Additionally, it looks like it may be in need of some repairs/rehab. Here is the link to the listing, check out the interior photos if you have time:  http://www.realtor.com/realestateandhomes-detail/1624-N-Rogers-Ave_Springfield_MO_65803_M87605-55293

Is this really as bad of a deal as it looks, or did I mess up?

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