High sales price or too conservative of assumptions? (4 plexes)

[Corbin E.]

Per the title, I am evaluating small multi's on the MLX (duplex - quad size) and have found 90% of the deals I encounter don't pencil. The confusing part to me is that the MLS listings will provide the 1) Gross Annual Income 2) Insurance Expense 3) Gross Annual Expenses, however a quick division exercises reveals that #3 Gross Annual Expenses are 100% of the time less than 30% of #1 Gross Annual Income. Everything I have read on here mentions 40% expense ratio at the bare minimum should be assumed and often that should be closer to 45-50%. General assumptions I am making thus far include (assume duplex on deal below though per unit figures provided to generalize how I'm analyzing anything in the 2-4 unit range):

Financing:

-3.5% - 10% downpayment (depending on total capitalization), 4.65% interest rate o/ 30 year term

-1.75% upfront PMI required, with 0.8%/year amortized into loan payments for ongoing PMI

-3% plug for closing costs

-2% of loan amount for financing fees

-8% vacancy/collection loss

-$450/unit/year insurance

-7.5% Mgmt Fee on gross potential income

-$500/unit/year for R&M

-$300/unit/year for capital reserves

-All utilities pass through to tenant

-$30/month for landscaping

-$40/month for pest control

As mentioned, my cash flow after debt service on nearly all deals I look at (after adjusting the brokers' 20% expense ratio up to the 40-45% I am comfortable with) turns out negative or nearly $0/month, making me question whether the selling prices are absurdly high right now, whether my assumptions are far too conservative, or whether levering a deal to 90-96.5% (utilizing FHA 3.5% or anything up to 10% down) prevents anything from working due to the high monthly cost of financing which includes PMI. If the deals are truly this thin right now, then it would make sense that one has to pay 50% down or even all cash to get stuff to work. I'm in Dallas FYI, but would appreciate any insight from others on the above and whether your experiences have been similar as of late. Thank you!

[James C.]

Corbin, 

Looks like your numbers are ok. 90% of the deals don't pencil because 90% are listed higher than the cashflow will support. As Brandon says "99% of the properties on the MLS are priced too high, but for 99% there is a price that will make it work". You are looking at 4 and under which are appraised on a comparables basis, not on cashflow. Just for S&G, try looking at some 5 to 11 units, the should pencil more reasonably. DFW is a hot market at the moment, so finding deals will be tough. FWIW the MLS is a marketing tool. The objective of placing a property in the MLS is twofold. #1 to make the brokers phone ring so they can capture potential clients (buyers and sellers ) #2 to let other brokers know that a particular property is for sale, so the other brokers can show it to their buyers, so they can buy it. Remember no sale for a broker, no food on the table. They are leaving information out (like taxes) to attempt to get the phone to ring. In addition most SFR/2/3/4 unit sellers don't keep good track of their expenses, and the brokers either don't know or choose not to ask for risk of losing a listing Remember the broker listing the property has a fiduciary duty to the seller, not to the buyer. Their duty to the buyer (absent a buyers broker agreement ) is only honesty, if the seller says that those are the expenses, then that is what the broker puts out. You will find that more leverage makes positive cashflow more difficult, especially in smaller buildings. Make a spreadsheet with 3.5, 5, 10, 15, 20, 25 and 30% down on a 150k building and compute the payments. You can plot the curve and watch what happens, especially when PMI goes away. As a tip, try looking for assumable loans (FHA, CA, FHLMC and others) in addition to lease purchase, all good alternatives to large down payments.

Hope some of this helps. 

Good luck. 

Jim