[Calc Review] Help me analyze this deal

[Account Closed]

Looking for some advice. This is a property in Indianapolis, IN. All the numbers are accurate. The purchase agreement was signed on 12/18.

After receiving the inspection report I was very hesitant to continue. The seller initially asked I sign an "As is" addendum. However, the seller has agreed to address all of the major issues found on the inspection report (also listed below).

It's also been very slow to get any income/expense ledger from either the seller or current property management. So far, I've only received two months of income and expenses. In the second month, the current tenant was 16 days late on rent payment.

Below is the link to my report and also the itemized major repairs listed by the inspector.

Questions

1. Would you go through with this (Please explain your reason)?

2.  Should I ask to see all evaluations from the contractors? I'm worried the work will either not get done or poorly done.

3. Is it possible the seller really didn't know the condition of the property? The seller disclosure document had about 95% stated as "Do Not Know".

At this point, I'm not sure if it's worth it to continue, hence this long post. I appreciate any and all advice.

View report

*This link comes directly from our calculators, based on information input by the member who posted.

ROOF

• The surface of the shingles have pitting present on the small rear roof and on ridges and peaks on the main roof. There are heavy stains on the North facing shingles and the granular material is loose on shingles, which are signs of wear and age and indicate that the roof may be nearing the end of it's useful life. Additionally we did see multiple scars/dents in the rear porch shingles, these could be due to tree debris, but could also be due to a past hail event. Due to the wear and issues mentioned above, we recommend the roof be fully evaluated by a qualified roofing contractor.
• The chimney is missing a rain cap on the top to prevent animal entry, the flue tiles inside are uneven and appear to have gaps present. The chimney has loose brick and mortar around the top and gaps and cracks in the brick and mortar around the sides. There are also gaps in the flashing at the bottom of the chimney. We recommend the chimney be fully evaluated by a qualified roofing or chimney contractor.

GROUNDS

• The front porch steps are different heights and present a tripping hazard, they are also missing a handrail for safety.
• The rear deck railings do not meet today's safety standards and are too far apart. The rim board/joists around the outside appear to be attached to support posts with screws/nails rather than bolts. We recommend it be evaluated by a qualified framing contractor for safety.
• The rear walk to the garage is heavily deteriorated and uneven and presents a tripping hazard.

GARAGE

• There is biological growth on the surfaces of the walls and roof decking in the garage.
• The top plate on the wall on the South rear side has rot/deterioration present.
• There are large gaps between the garage foundation block visible from the interior and mortar gaps visible on the exterior. We recommend the garage foundation be fully evaluated by a qualified foundation contractor.
• The ridge/peak shingles on the garage are cut dimensional shingles and are not designed for this type of installation, they are uneven and raised at the edges. The garage shingles have heavy wear on the surface of the shingles, with loose granular material. There are scars and dents on the shingles that could be from falling tree debris, but could also be due to a past hail event. We recommend the garage roof be fully evaluated by a qualified roofing contractor.

HEATING / COOLING

• Due to the cold outdoor air temperature at the time of the inspection, we only cycled the AC unit for a very short time to ensure it was operable. It's ability to operate and cool properly is unknown and could not be determined at this time. Recommend it be serviced and inspected by a qualified HVAC contractor when weather permits.
• The exhaust flue for the furnace enters the masonry chimney and has some gaps around this penetration. There is also an opening for a flue that is no longer installed directly above it. This opening is allowing for combustion gasses from the flue pipe below to leak out into the basement area. We recommend this be evaluated as soon as possible by a qualified HVAC or chimney contractor.
• The furnace filter was heavily covered with dirt/debris during today's inspection and could not be removed without damaging the filter. Due to the restriction in air flow it would create we did not reinstall it but left the furnace without a filter to prevent damage to the furnace.

PLUMBING

• There is a cast iron sewer or drain pipe on the floor of the South side of the basement, there is an open clean out missing a cap or covering on this pipe.
• The drain below the bath tub was leaking/dripping during today's inspection.
• The service wire to the water heater is not enclosed in conduit or a protective covering to guard against accidental damage to the wiring or its sheathing.
• The water heater TPR valve is missing the extension pipe to the floor for safety.

ELECTRICAL

• The house has some of the old knob and tube style wiring. This type of wiring was standard when the house was built, but now shows signs of improper connections. We recommend that you consult with a licensed electrician to evaluate the integrity of this wiring and make any needed repairs or replacement. Extra caution should be used when making any additions or changes to this wiring.
• The main electrical panel box appears to be new and recently installed, however it is very loose to the wall where it is attached to deteriorating boards and also has rust on the lugs on old breakers installed inside. We recommend it be evaluated by a qualified electrical contractor or engineer at this time.

KITCHEN / LAUNDRY

• There is a stain from biological or fungal growth on the inside bottom of the kitchen sink cabinet.
• The kitchen GFCI outlets did not trip when tested with our tester(button on the outlet did work), and also tested as being ungrounded.

• There is no anti-tip bracket installed on the back of the stove to prevent tipping when the oven door is open. The back door has gaps in the weather stripping at the top through which light can be seen.

BATHROOMS

• The bathroom GFCI outlets tested as being ungrounded and did not trip when testing with our tester (it did trip when the outlet's button was pushed).
• The bathroom is missing a window or exhaust fan to help control moisture.

INTERIOR ROOMS

• Kitchen and dining room windows have cracked panes of glass, many of the windows have damaged cords at the sides and no longer stay up when opened. Many of the windows also have loose sash chords at the bottom and damaged areas along the bottom sash chord as well. The right side dining room window has a damaged lock and the bedroom windows are very loose, one would not open and has gaps at the top and bottom. We recommend all the windows in the home be evaluated by a qualified window contractor.
• All of the outlets in the home are 3 prong outlets yet tested as being ungrounded. We recommend they be fully evaluated by a qualified electrical contractor or engineer.
• The front bedroom closet has foam insulation installed as the ceiling but has gaps around the sides that are not fully fire blocked/fire sealed to the level above.
• There are moisture stains and biological growth at the bottom of the rear bedroom closet wall opposite the bathroom.

ATTIC

• We could not find attic access in the interior of the home, there was a window on the front of the house over the front porch but it was caulked/sealed shut and we could not open it without causing damage. We did unscrew a board covering a gable vent opening on the front of the house and only had visual access from this vent opening, as it was too small and too high to safely enter the attic from this opening. We recommend proper attic access be provided for more thorough inspection and maintenance access to components within.
• The wood framing and rafters around the chimney have moisture stains and the brick and mortar of the chimney has heavy moisture stains and efflorescence. We recommend it be evaluated by a qualified chimney contractor (see Roof page for more chimney info).
• There appears to be an open, and possibly unsecured, junction box at the rear end of the attic.

FOUNDATION

• The basement stairs have loose/damaged steps, are sitting on loose boards at the bottom where the stringers have rotted/deteriorated. The support at the side also has heavy rot/deterioration at the bottom.
• There are open junction boxes in the basement ceiling.
• The block walls of the foundation have many areas with moisture staining and efflorescence, heaviest at the bottom, but present throughout the basement. The wall on the South side is bulging toward to the top/middle area as though it may have shifted or moved. There are gaps around the old furnace oil pipes on the South side near the crawl space wall. There are many areas where the block mortar is gapped, cracked and heavily worn. There is a large crack in the corner just beside the electrical panel box and gaps in the concrete with bare wood at the front South corner of the crawl space and a large crack in the front middle of the crawl space. We recommend the foundation be fully evaluated for both moisture intrusion and structural integrity(movement) by a qualified foundation contractor.
• We found a biological growth on the surface of wood framing, joists and sub floor in the basement/crawl space area. We found heavy growth below the bathroom and kitchen plumbing. We recommend it be fully evaluated by a qualified remediation contractor at this time.
• The boards below the bathroom plumbing are rotten and broken and heavily stained with bacterial and fungal growth, there is also a leak in this area .

[Ross Denman]

This entire scenario is pretty much the cookie cutter example of most deals that I see. The items in the inspection are all very common and you are looking at a minimum of $30k for renovations just for plumbing, electrical, HVAC, organic remediation, and fire/safety code compliance. None of it makes it a bad deal, but it may be a bigger deal than you want if it's your first or second property. I always recommend looking for a base hit to get started.

______________

A few other things that I will chime in on.

I recommend approaching a deal as if everyone is lying and hiding something. I'm really not that paranoid, but most people do not sell their cash cows... they sell their headaches. Being able to identify those headaches is going to help you in each deal. Some considerations are:

Location.

Location is the hardest thing to change about a home. Neighborhoods do change over time (usually for the worse) and even in the cases where lots of momentum is created by city initiatives, it still takes 5-10 years and there are tons of competition (look at Fountain Square and Bates-Hendricks right now.) Make sure that you are comfortable with the location.

How are the schools? How is the crime in the area? What is the median household income? What is the average education level? Areas that cater to families raising children are different than areas catering to young professionals and need to be considered differently. Areas in lower-income areas also need to be considered differently.

_____

Age of Home.

This is something else you have little control over. Even an full gut an rehab may not address every age-related problem with a home. I break homes up in to 3 categories and they all have different considerations.

• Pre-WWII homes - homes with plaster/lathe walls, probably old coal chutes, block or brick basements (sometimes cellar conversions,) originally knob and tub wiring and galvanized plumbing, original hardwood floors, old wood windows, etc. These are usually homes built before 1942.
• Post-WWII homes - homes with walls built with sheet rock/drywall, built with 100 amp service or better, wood or aluminum windows. usually built on crawl spaces or slabs, etc.
• Modern Homes - These are homes built after changes around 1978. Lead based paint was phased out and modern HVAC, plumbing, sewer lines, and electrical codes were used. Many of these homes are built in factories to bare minimum building codes though meaning that many of them will not last as long as the older homes.

Different ages of homes carry different service and maintenance costs as well. You also may have to consider energy efficiency as it's easier to keep tenants when they know that their other bills (heating, cooling, etc.) are less than they would be elsewhere.

_________

Understand the Target tenant demographic

Is this a home that will target college students, young professionals, young families, established families, empty nesters, or higher risk tenant pools? We have found the most predictable success in homes for established families, but you can have success with any of these types of homes. You just have to understand the differences. 

College Students - Roommate issues, excessive wear and tear, limited income, higher turnover. This means that you should renovate homes with higher quality materials to reduce the make-ready costs between tenants. This gets your home on the market faster for less money. Most tenants will stay 1-2 years in these types of rentals.

Young Professionals - This is an overall decent tenant demographic, but I am not as fond of large homes with Young Professional Roommate tenants. Especially men in their early twenties. It may be an opportunity for raging frat parties. The tenant retention is also going to be 1-3 years typically.

Young Families - This can be a trick demographic. The tenants now find themselves with new responsibilities, but they you usually have limited resources. These tenant usually outgrow these smaller family homes in 2-4 years.

Established Families - This is my favorite demographic to work with. You may have some excessive wear and tear to families with active children, but the tenant retention really makes up for it. These are larger homes with 3-4 bedrooms and at least 1.5 bathrooms. Preferably a home with an attached garage and fully equipped kitchen. These homes tend to carry the highest price range (managed rentals as high as $3,500/mo in Carmel) and relatively long tenancies (usually 3+ years.)

Empty Nesters/Retirees - This is a great demographic as well, but the same homes may also cater to your families and/or other demographics. This demographic may stay in a home indefinitely... usually dependent on medical and health situations more than anything else. We manage several 10+ year tenants in this demographic. Probably 20%-25% of the 2 bedrooms or small 3 bedroom homes.

__________

Residents

I tell my clients to not pay a premium for tenanted units unless you are certain that the tenants want to stay and that they are paying (or willing to pay) rents near the top of the market. Once again... most people are not selling their cash cows. Expect problems. When I have clients purchasing tenanted units, we always want:

• Copy of lease. When does it expire? How much are they supposed to be paying? How much is held in security? What obligations do the tenants and landlords have? Did you know that the lease for your tenant holds you responsible for lawn care??? if not, it certainly changes your numbers?
• Rent Rolls/Tenant Ledger. Get some kind of accounting to verify the that tenant is current and pays consistently. I've seen several people close on homes to find out that their tenants are 2 months behind in rent and plan on moving out. We have successful strategies that we incorporate in our office that work to keep many of these tenants and get them back in to reperformance, but even when that happens... almost half of those tenants end up not completing the lease and may need to be evicted. Once again, don't pay a premium for someone else's problem.
• Security Deposit. Is is accounted for? Who is holding it? Will it be turn-over at closing? You want some guarantee that if it is not available at closing, it will be transferring with the property. Get it in writing. Sometimes the PM may be holding it and can't cut a check for the SD until after the clients account is closed out, but be sure to account for it and get a written commitment. Otherwise, you will find yourself chasing it in the future with no leverage to obtain it.
• Tenant contact and copy of keys. Whether you manage the property yourself or hire a PM, someone will need to reach out to the tenant and alert them to the change in management as well as have access to the property for inspections, service, emergencies, lock-outs, etc.
• Trailing 12 - This one may be harder to get... but this is a list of expenses and income for a property over the last 12 months. This will give insights to maintenance, late rents, and other costs that may give insight in to the property.

It is very common to purchase homes with tenants who are paying below market, poorly performing tenants, homes with ongoing maintenance problems, etc. Knowing how to turn these around can be very profitable, but time consuming and need a bigger investment and not every home can afford the investment needed to turn things around. Another reason location and tenant demographic have such a big play in this.

____________

After understanding the information above, see if the numbers work. The numbers always work in the warzones on paper, but the reality is it's tough to match the paper without constant work and headaches. The numbers will be tighter the nicer the property becomes and the more desirable the location. Regardless of exit strategy, I wouldn't purchase a home that I wouldn't be comfortable holding on to. I won't hold on to a property that I wouldn't consider living in myself (maybe at a different time in my life than now) or allow my 21 year old daughter to live in.

I'm not a fan of the 2% rule anymore in Indianapolis as it usually puts you in C- or worse areas, but I do like nice homes that come in around 1.25%. Usually $80k rentals that rent for $950-$1,050/mo. Their not easy to come by, but they are out there. You get a mix of cash flow, equity, and appreciation that turns out to be very valuable as time goes on. Most of these deals have an IRR of 15%-25% averaged annually over a 5-10 year term, meaning that it is likely to double the investment every 4-6 years.

__________

If you're looking to build an Indianapolis portfolio, I'd be happy to have a phone call with you and see how we can help. I have a lot of resources in my network to help you build an effective and efficient team to identify opportunities, verify numbers, fund deal, inspect property, build rehab budget close, remodel, rent, manage, and more. Building your team is going to be the single most important decision that impacts your success. Not the deal, not the numbers, not the city... the team. A bad team can screw up a home with great numbers, regardless of inexpensive they are.