First Deal: Rent or Flip?

Question

Would love to get some feedback on the following deal. I think I know which direction I would like to go, but I would be curious to hear what people would do in my shoes. The options would be to to rent the property out long-term (keeping it for 15+ years) or to flip it and use the capital to look for a Multi, which I know provides better numbers.

Area is an A-/A area with a solid school district. The neighborhood is one with many beginner families. The house is within walking distance of the nearby elementary school and it has a good-sized fenced yard.

Property: 4 bed / 2 ba. ~1,350 square feet

Purchase Price: $38,900 cash (originally listed at $70,000)

Rehab: $20,000 - In all likelihood, this is a high estimate, but I have remained ultra-conservative on these things since it's my first deal and I don't want to overlook anything.

All-in After Rehab: $58,900

I estimate that rehab will take around 2-3 months. It's pretty much all cosmetic.

ARV - Comps in area are around $80k-$90k

The numbers:

Rent: $1000 - This is probably a conservative figure. Area rentals for 3 bed properties are ~$900 and I've seen 4 bed properties as high as $1,300. None of those properties are as updated as mine will be.

Management: $100

Maintenance (15%): $150

Vacancy (10%): $100 (no idea if that's a good figure)

Tax: $140

Insurance (0.035% of purchase price): $21

Monthly net cashflow: ~$492

Annual CF: $5,900

~9.9% cash on cash return

Jean Christophe · Answer

Regarding 1031 comments,

"If the IRS considers a flip as held for resale, is it possible to turn it into investment property so that you can do a 1031 exchange? The answer is yes, but the IRS needs to see two things before they consider your property an investment.

First, you need to hold it at least a year so that it would qualify for long-term capital gains treatment (they don't want you turning short-term capital gains into long-term capital gains by doing an exchange).

Second, they want you to be in one tax year when you buy the property and another tax year when you sell it. Although not mentioned in the code section, it appears these attributes weigh heavily in their decision to decide whether your property was held for investment or held for resale. We tell our clients that if you hold your property for a year and a day from any point in time, you'll be in one tax year when you buy it, another when you sell it, and your property will qualify for 1031 exchange treatment.

In a market of fast-appreciating property values, flipping property for a quick profit has its rewards, but you'll be paying tax at ordinary tax rates. If you intend to buy another property with the proceeds, doing a 1031 could provide you with additional appreciation and the additional proceeds that would otherwise go for tax payments. To gain this benefit, just hold it for a year and a day. If you rent it out during this time, you might also gain additional cash flow."

Brian Garrett · Answer

Seems like a perfect deal to BRRRR and get the best of the both worlds!

Shiloh Lundahl · Answer

@Jean Christophe Awesome response. Thanks for adding your input.

Shiloh Lundahl · Answer

@Brian Garrett when you say you say you can not 1031 a flip, do you mean you can not do it if you have owned it less than a year?

Alex Huang · Answer

Oops. My bad.

Thanks for the clarification!

Brian Garrett · Answer

You cannot 1031 a flip.

Alex Huang · Answer

Thanks for the feedback.

I suppose that flip becomes more attractive, if I were confident that I could use that flip and find another adequate rental replacement via a 1031 exchange that cashflows better?

Shiloh Lundahl · Answer

@Alex Huang I would encourage you to do the lease option with it. It would maximize your profits.

Your all in is 58,900 plus the 2000 in closing costs to put into a long term loan that you get when it has been seasoned.  Some banks require a 6 month seasoning time, some require longer, and some require shorter.  You should be able to get 75% of the appraised value of the home.  At that point you should be able to get the loan for around 60k if the home appraises for 80K thus getting most of your money back from the loan.

You get $3900 for the price of the option from the person who wants to buy the home but may not be able to get a loan for it at this time due to either credit issues or some other issues, but they still look good enough credit wise to qualify in the next 5 years.

You rent at $1300 a month with a discount of $100 for taking care of everything with the property making the monthly rent only $1200.

You don't need to budget for cap ex, vacancy, or repairs if you have made all the repairs sufficient for the next 5 years before putting the tenant into the property.  The reason you don't need to budget for these things is because you explain that you are not looking for a renter, you are looking for an end buyer who will be treating the property as their own.  This means they will be taking care of the things as they break, etc. until they ultimately purchase the home within the 5 year option period.  When a tenant puts down an option fee of $3900 to $5000 they tend to want to stay and pay because of what they have put into the property.  You choose the option price of 95k (we usually do between 5% and 10% of the value of the property).

Also, because of the type of tenant you put into the property, you can manage it yourself because they will be taking care of most things with the property.

Here are your new numbers

-3000 All in ($58,900 - $60,000 for the bank loan + $2000 closing fees on the bank loan - $3900 for what you get back from the tenant for the option = -$3000 you will get back at the close of the loan).

1200 Rent

140 Taxes

21 Insurance

396 Mortgage (75% of value, at 5%, for 20 years)

643 in Cash Flow a month on have $0 into the property (actually after having been paid $3000)

$85,557 is the total profit over the next 5 years supposing they exercise the option on the last month.

This includes the difference between the loan pay down $43,977 (which is their purchase price of $95,000 and what you have left to pay on the loan $50,073 minus closing costs of 950 to transfer title) plus cash flow for 5 years $38,580 plus the $3000 from when you got the loan.

Brian Pulaski · Answer

What are your holding and closing costs? $58,900 to buy and renovate, if closing (both sides) and holding costs run up $7500-10k (not sure what your numbers are) selling at $90k is an ok deal, selling at $80k is not great. After taxes you will be left with short profit for 3-4 months (assuming the time to sell).

Morgan Klein · Answer

I would rehab it and see if that $1300 rent is attainable.  If you can get that and come in under your $20K rehab budget, you'd be looking at closer to 16% cash on cash and $759 monthly cash flow (based on your numbers and 10% PM fee).  That would be pretty hard to walk away from, in my opinion.

First Deal: Rent or Flip?

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