Was I MISLED?!?! Or does it still make sense to keep going???

Question

Tell me what you guys think. I met a guy who runs a kind of one stop shop for investers to buy, rehab and rent/hold single family homes. They: 
-Find the houses
-Put together a report of what it costs me to buy and, what it will cost to rehab, what it will appraise at after rehabbed, what your new loan will be, what it will rent for and what your cash flow will be.
-They rehab and GC the projects
-They have tennant leasing to screen/rent it (first months rent is fee)
-They have banking connections if needed
-They will manage if needed for $75 a house per month (which I'm not doing at first)

Anyways seems like a good plan for a starter as they kind of handle everything. So here's my first deal.. Buy for $63,000 (cash) rehab for about $17,000 and they had the after rehab appraisal at $135,000, and said it will rent for $1250 a month. Then I would be able to get an 80% loan on the $135,000 and acually cash out on the deal. So I'm expecting to pull my 80k back out along with an additional 20K or so and still have equity in the property and still be able to cash flow a little while holding for future apreciation. Not a bad deal. And I had the banker ready to do the 80% to appraisal value loan as well. So basically here is where I'm at, rehab is done with the correct amount spent, renter is signing the lease for $1250 a month but here's where the problem is. It only appraised at $105,000. Which means the house is still appraising for more than I put in, say $82,500 in to $105,000 appraisal value, and I can still cash flow alright but it's not nearly as good as I was told it was going to be. I can't pull any additional money out of it, but I will be able to pull out 100% of what I put in at least. So basically for the time I have put in (which really wasn't much since they kind of did most of it) and no actual money left in the property since I will pull it back out. Basically with annual rental income of $15,000 and annual PITI of $10,800 less say one month of rent to be safe -1250 comes out to $3000 less another say $500 of misc. BS, I figure $2500 annual net cash flow to basically just be a landlord with none of my actual money in the property. As well as any principal pay down, and then of course taking advantage of a low market, and how much it will be worth in 10 years. Does this seem like a good investment to you guys to keep going? The only thing that really didn't go as planned was the $25,000 less appraised value I was banking on. This one is done so you can see it in black and white where it stands and they want me to jump on the next one which should be just about the same thing. I just like to hear your guys thoughts. I really like this guy but wonder if I need to start doing my own work to find the houses for closer to $50,000 myself in order for it to work better, but then lose all their support systems. What would you guys do if you were me???? THANK YOU IN ADVANCE!

Jon Holdman · Answer

First, this sort of deal is called a turnkey rental.  You must realize going in that this guy who's putting this all together is making a profit on this deal.  Since he's taking a cut, you're guaranteed that its not as good a deal as if you went out, found the house, fixed it up, and did it all yourself.  What you're getting in exchange is minimal effort on your part.

In this case, though, I think you put in too little effort.  $135K vs. $105K is a HUGE difference.  Did you pick the lender, mortgage broker and appraiser, or did the guy you're dealing with?  Is the appraiser independent of anyone else?  That is, were they hired under the HVCC rules?  If so, then the $105K figure is probably good.  If not, then that figure's likely high, too.  I suspect the seller gave you the $135K story and that you did nothing to verify that figure.  NEVER, EVER believe a value given to you buy a seller.  If you're going to be in this business, you MUST verify these figures yourself.  If you're unwilling or unable to do that, do not invest in real estate. You're a prime target for hucksters if you're willing to believe their values.

You're actually pretty lucky the appraisal came in high enough for you to get your money out.

The whole story about appraising for a high figure and doing a cash out 80% LTV refi to total crap.  Unless you've owned it at least a year, this is impossible.   If someone responsed that this is possible, I want to have the name of the bank or lender.  Otherwise I'll stand by the statement that it is impossible to do an 80% LTV NOO cash out refi based on a new appraisal in a few months.

What is possible is to do a 70% or 75% LTV NOO rate and term refi based on a new appraisal.  Even then its a challenge to do in under six months and a challenge if you don't have excellent credit and enough income to carry the new loan without the rental income.

So the simple fact you appear to be able to get this refi completed and get your money back out is a very significant accomplishment.  Congratulations.  Seriously, that's huge right now.

Now, lets consider the rental.  You have it rented for $1250.  First, are you sure that's market rent?  Are you sure the real rent isn't something lower and the seller is kicking back some difference to the tenant or adding something to get the rent to where you want it?  Even if you have a tenant now, odds are that you'll have a new one in a year or two, and you won't have any assistance from the seller.  Check the paper, craigslist, and make calls to for rent signs and be sure you KNOW what the real market rent is.  When a seller tells me its worth XX and will rent for YY the one thing I know for sure is those are the highest possible values for those two parameters.  I'm pretty confident the real values are somewhat lower.

Given the $1250 in rent, the 50% rule of thumb (read in the Rental Property forum about this) says expenses (including vacancies, insurance, taxes, maintenance, etc., etc., etc.) will be $625 a month.  That leaves you $625 a month in NOI.  Looks like you've got $80K into this place, and the refi's going to cost you $3000-4000 (some of that is the prepaids), so looks like your new loan is $84K.  At least you get back all or nearly all of your cash. Payment on $84K at 6% for 30 years is $504.  That leaves you true cash flow of $121 a month.  That's actually quite good.  As you say, the tenants are paying it down and you're above water.  That's not a bad deal, with a couple of caveats.

Those caveats are that you need to be sure there is real demand for rentals like this at the $1250 price and that the real value of this house is at least $105K.  If those are true, you have a pretty good deal.

Now, if you go out and find your own deals, you should be able to do better.  Especially if you have cash, which puts you in a very strong position.  Rest assured this guy is making money a bunch of ways:
1) on the house itself
2) on the rehab
3) on the property management (both the leasing and the ongoing management, if you do that)
4) maybe even on the loan
If you're willing to do the work, you can have at least some of that for yourself.  Maybe not all, because he has a system and is likely to be better at it than you will be at first, but you can pocket some of it.

Ali Samana · Answer

I agree with Jon and Chack above.  There are many companies that will offer turn key investments for you.  I would look really hard at their motivations, I might even ask directly if the deal is so good what is stopping that person from doing it themselves.  I have worked with companies that provide similar solutions and here is what I have found.

I always double check the numbers and try to guage the current market conditions to see where local market might be headed.  I also consider my exit strategy (in this case, renting) and see if it is realistic for the house/location.  lastly, I always get multiple quotes and get everything in writing.  I might not go with the rehab company they recommend if I can't find any other references, or if I can find another reputable company with a cheaper price.

To answer your question, I would continue with this deal and might even continue working with this company if I can tilt the table myway.

Hope it helps!

Joe Ward · Answer

Thank you Chack very good points and tips as well. Although this one is finished I am just debating on the next one.

Joe Ward · Answer

Thank you again Jon for the quick and very detailed response. I will take all this into consideration and do some more research. I mainly just wanted to get into the game so bad already I figured it makes sense lets do it and I will learn some stuff and then start doing it by myself. So even if the first one or two are not the best deals in the world but they are ok atleast, and I'm learning a lot, then it's worth it to me. Myself and so many people I know just talk and talk and talk and never actually do so atleast I finally took the plunge. I do know that $1250 is average rent right now for these 4 bedroom single families because I have done some research. The main thing I have to do is go out and check out about 10 myself in the area and see what I'm getting on my own for $40-$70K and then compare it to what they offer me. Thank you again soo much for your help Jon, you are truely one solid dude. I will chime into you if I have any more questions.

Chack Pesh · Answer

Good points made by Jon.
          
          The areas where you can lose money and therefore could go under are: -
          
          1/ Appraisal - if this done and the lender has accepted it (w/o reviews etc) then fine.  I would still check what the recent comps are in the area though.
          
          2/ Rental rates.  $1250 is a good rate.  Has the lease been signed?  What are the company's vetting processes?  Will they take just anyone or do they do background checks (credit, rental history etc.).  Call a local property management company, describe your property and let them tell you what rents to expect.
          
          3/ Is the rehab completed?  What if there is a cost overrun?   How long wil the rehab take and what are the associated holding costs.  Any overruns will likely come out your pocket!
          
          I see several red flags here.  I wouldn't necessarily stop moving forward with this deal but I would want some more information.  Can you talk with other clients of this company to see how it has been going for them?  Go look at some recent rehabs they've done.  Is the work of high quality?
          
          If you are satisifed and want to be a passive investor in such deals, then that is fine.  The company bringing you this deal aren't doing you any favors and are in this to make money.  Which is OK, as long as you are making money as well.  Since they're doing all the work, their profits will be much higher than yours.  And that is OK too.
          
          Having done a quite a few deals myself, I've found that the ones I got burnt on were the ones where I took a "back-seat" and did not do the proper due diligence.  I trusted somebody else and ended up paying dearly for it.
          
          Good luck!

Was I MISLED?!?! Or does it still make sense to keep going???

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