Paying above appraisal for great cash flow?

[Jose Duque]

Hi all,First time posting on BP, could use some input on my first deal. I have a prospective contract on a student rental that generates about 2.4k in rent, it is one of the better cash flowing properties that I have found at a great price per room for my area (about 20k/room). Price is 120k (so its 6 rooms) and the owner who is an investor himself does not want to go below 120. Problem is that there is no chance that the house is going to appraise for 120, so the owner wants me to get a second mortgage for the difference since i won't have enough time to make up the difference myself by closing. This is one of the best cash flowing properties at about 540/mo that I have found in months and I would hate to loose it because I am too scared to pull the trigger. Thoughts?

[Michael Seeker]

@Jose Duque - if the seller is offering the second position financing, then it might make sense for you to negotiate terms with him that make sense to get the deal done.  I would suggest not using a term any shorter than 5 years on the 2nd position note.  If you are buying above what it will appraise for then you will not be able to refinance anytime soon to pay off the 2nd position (without putting cash in).

The obvious downside to paying above appraisal is that you immediately kill equity.  If you have $20K in cash and use it to buy a property that is worth $110K and has $100K of debt on it, you just turned $20K of liquid capital into <$10K net worth of fixed assets.

This can make sense if you have a long investment horizon and do not need to refinance soon.

Though you didn't ask/comment about it in your post, I would also caution against using rents provided by the seller as the basis for a purchase.  Are other houses in the area being rented this way?  Is there a high demand for students renting rooms for $400/mo in the area?  Have you accounted for added costs/headaches to deal with 6 people who may not know each other and/or may not get along well?

Paying above appraised value pretty much ensures you have no room for error, so make sure you know what you're getting into before pulling the trigger!