A few deals analyzed - needs constructive critique

[Jeff Tropeano]

Hello there!  Before I start on the deals, just want to say thank you in advance to those reading this, and the BP community overall for this incredible resource.

I've got a few opportunities available for our first buy & hold rental.  Some context - wife and I are looking to diversify a bit out of the market, get some passive income that we can reinvest in more properties over time.  We live in Colorado, which is a difficult buy + hold market, so we're looking at out-of-state turnkeys with property management.

Deal 1:

2 bedroom, 1 bath, 768 sq. feet. Memphis, 38128.

$45,000 listed - $650 rent

Taxes: $42, Insurance $40.

Assuming 3% Closing Costs, 20% Down, 30y loan, $171.49 Monthly Mortgage.

$10,058 Cash Required

14% Management Fee (including tenant finding), 5% Maintenance, 5% CAPEX, 8% Vacancy Allowance.

That's a 45% Expense to Rent Ratio.  Round up to 50% and it's $325 in monthly expenses.

Annual Numbers: $7,800 Gross Rent, $3,900 Net Income, $2,057.85 Mortgage = $1,841 Annual Cash Flow.  18% Cash on Cash Return, 8.7% Cap Rate.

Seems like a winner?

Deal 2:

4-plex, Cleveland.

$150,000 listed - $2,855 in rents.

Assuming 3% Closing Costs, 20% Down, 30y loan, $611 Monthly Mortgage.

$35,840 Cash Required

14% Management Fee (including tenant finding), 5% Maintenance, 5% CAPEX, 8% Vacancy Allowance.

That's a 53.4% Expense to Rent Ratio. That's $1,524 in monthly expenses.

Annual Numbers: $34,260 Gross Rent, $15,970 Net Income, $7,333 Mortgage = $8,637 Annual Cash Flow. 24% Cash on Cash Return, 10% Cap Rate.

Seems like another winner?

What am I missing?

Thanks again in advance!

[Chris Clothier]

@Jeff Tropeano - Welcome to the site!  For quick background, I started as a real estate investor while living in Denver back in 2003.  I owned a few long-term buy & holds in Denver, did a few fix-n-flips and eventually began  acquiring passive properties in Memphis.  Just as you stated, I wanted to maximize cash-flow from my passive investments, but I had a major advantage.  My family lived in Memphis, owned an investment company and I had lived there for years.

So, with that in mind, let me tell you that the investment you are thinking of making in Memphis in particular is not a good one.  There are a few reasons, but hopefully I can help you view this from a different perspective and help you make good decisions.

A $45,000 TURNKEY investment is never going to be a good investment regardless of market.  As an out-of-state, passive investor, you are looking for ease of transaction and a low-headache investment that protects your investment and allows you to make money on it.  First and foremost - PROTECT YOUR INVESTMENT!  At $45,000 sale price - whomever is marketing that to you as a turnkey investment is looking for a buyer who is attracted to the word Turnkey - not someone interested in quality nor protecting their investment.  

There simply is not enough money at that sales price for a company to buy a quality property, do a high-quality renovation where ALL deferred maintenance has been addressed and allow for the company to make a profit.  Something has to be cut and you can be assured that no one is doing anything for free.  What is cut is the renovation.  So my advice is to avoid these price points.  I do speak from experience.  I have passively owned properties at this price point in my history as an investor and they NEVER pay off as you expect.  Not when buying them as a Turnkey, passive investment.

Now - your property in particular.  These are all my opinions.

 - Never buy a 2-bedroom property in an area where most properties are larger.  2 bedroom properties work well in college and university areas.  I can't imagine an area in 38128 where you would want to purchase a 2-bedroom property.

 - At $700 a month rent, you can expect to lose great than 50% of your rental revenue due to uncollected rent, vacancy and maintenance.  This price point attracts a resident that is most likely insecure.  Job insecure, food, medicine, transportation insecure ~ and the first thing they need to give up is rent in times of crisis.  They are simply more transient. A resident looking to qualify at this price point is going to be making between $22,000 and maybe $30,000 per year.  

To be fair, there are great residents at this price point.  But that is not the norm.  As you get into higher rental price points, you attract more stable residents.  Fewer are able to be as stable at lower rents simply by fact that they are not earning as much income.  If they were earning more, they would be looking for better housing.   Keep that in mind.

 - Why you should expect to lose greater than 50% of your rent is that these properties tend to go vacant more often.  With each vacancy you will have costs to get the property ready.  Accounting for only 8% vacancy yearly means 30 days lost rent.  Unfortunately, with a higher rate of transience at this price point, leases will be broken with uncollected rent, and once the property is vacant, it needs to undergo a make-ready and then has to be marketed.  You can expect 60 days lost rent when you include lease-up.  That is 24% vacancy in a year and you will find that these price points perform that way on a regular basis.  At a minimum, expect 16% vacancy on average.

- Lastly, your maintenance and Capex costs will most likely be higher than 10%, but I do like that you have this number higher. You have to expect that your property will not be renovated to a high level at $45k. There will be a lot of deferred maintenance that will be a constant draw against your rent. I would be prepared for 15% or higher for maintenance and Capex at this price point.

 - You noted that you would like to put 20% down.  Unfortunately, you will find it very difficult if not impossible to find a lender willing to lend such a low amount on a property - especially an investment property with an out-of-state investor.  

I've been working with out of state investors buying in Memphis for going on 14 years.  My family has been managing here actively for the last 12.  I can tell you that this price point in this city is not a good investment for out-of-state investors.  Especially not when it is being marketed as Turnkey.  I have no idea, nor does it matter who you are working with.  These are not good investments no matter who the company is you are working with.  These properties are better left to local investors who will own this type of property for considerably less than you will own it for and they will self-manage.  Their costs will be lower and their returns will be much higher than you are looking at because these are very, very risky investments. 

Be patient with your investment decisions.  Don't rush.  The opportunity still exists for you to make a great passive investment and you can find quality Turnkey investments.  You just have to remember to protect your capital investment first which means making the highest quality investment you can when buying Turnkey.  Then, look to maximize your return.

Best to you