This deal has gotten complicated. Should I exit?

Question

Hello BP,

I'm new here. I've been reading the forums for a couple of months and now I need a sounding board. I'm new to real estate but not new to business.

My wife and I found 2 duplexes in the suburbs of Philadelphia.  They are near each-other separated by a driveway and fully rented.

Everything was going swimmingly with the negotiations, we brought the seller down to 600K from 700K, we went under contract yesterday and now the mortgage guy is changing his tune. He initially assured us and our Realtor that we could get the 2 properties for 10% down each (one as owner occupied and the other as investment). Now he is saying that he didn't say that.... long story short, the best he can do is 10% down on the owner occupied and 20% down on the investment. The problem is that we don't have enough cash for 10% and 20% deposits. We were comfortable with 10% and 10% down. A lot of lessons were learned through this process.... I'm gonna write a blog about this once it's all settled.

We are now presented with the following scenario:

Property 1 (Owner occupied): SP 350K on an FHA loan with 3.5% down @ 3.875
Property 2 (Investment): SP 250K on a 30yr fixed with 20% down @ 5.5

Cash needed for closing = 90K
Monthly mortgage payments = 4200/month (includes taxes, insurance, mi...)

SP for both properties = 600K
Rent generated = 4700/month 
Utilities = 1000/year (utilities paid by tenants except the water in property #2)
Insurance = 2000/year
Appliances insurance = 1200/year
Property tax = 10400/year (for both properties combined)

The question is: Is this still a good deal? When I ran the numbers it looked like I would be breaking even every month.

Since we were under the impression that we were getting 10% down on both properties the AOS was written that way. At this point we can get out of the agreement and cut our losses to the cost of the inspection.

What do you guys think?

Account Closed · Answer

This is not a good deal, and you should exit.  You will lose money on these properties.  You may break even most months, but when you have a vacancy or a big-ticket capital expenditure, you will lose a lot of money.

Jon Holdman · Answer

A better way to evaluate the property is to assume 100% financing at investor rates.  Assuming nothing down and 5.5% on both loans makes the total payment $3406.73.  That gives you a negative cash flow of $1056.73 a month.

Now, when you start putting in cash, you reduce the loss.  If you assume an all cash deal, your monthly cash flow is $2350 on an investment of $600K.  That's $28,200 a month for a cash on cash return of 4.7%.

Sorry, this is a bad deal (as far as cash flow) no matter how you slice it.

Now, there may be some other reason to buy these properties, such as future appreciation or splitting them up and selling them like condos.  And if you can sustain the loss, you may still be OK.  But for cash flow, these are losers.

Bechara Jaoudeh · Answer

Thank you all for your input! Now that I re-ran the numbers with the 50% rule and the added expenses I can see clearly why this is a bad deal. I'm so glad I posted this thread. I'm calling my realtor now to pull the plug.

Thanks a gain guys! I look forward to engaging more with the BP nation :)

Jon Holdman · Answer

Are you hoping for cash flow from these properties?  Paying $600K for $4700 in rent will not be cash flow positive or even break even.   Here's my evaluation:

Rent: $4,700
Expenses, vacancy, capital: $2,350 (50% rule, yeah, I know you won't believe this.)
NOI: $2,350
Payment: $2,723.80
Cash flow: -$373.80

It will be even worse while you're occupying one unit, though not as bad as just deducting one units rent.  I would assume you're not going to wreck the place or create any big expenses.

In your analysis you've neglected a bunch of expenses including maintenance, landscaping/snow removal, capital items, vacancy and property management.  If you're going to self manage, you can earn a nice chunk of that $2,350, but you will be doing a job to earn it.

Being able to get an investment with 20% down is actually very good.  Typically you would need 25-30%.  Be sure your mortgage broker isn't still making promises he can't keep.

Jon Holdman · Answer

$4700 a month total?  For three units or four?  Or, per unit?

Account Closed · Answer

It's funny to me to see an FHA loan with low down and low interest making a mortgage payment "too high".  Run your initial numbers at 100% debt service.  Don't play games by including your "rent".  You won't have $4700 each month because you factored in no repair or maintenance costs and your $1200 monthly contribution will be all used up most months.  No furnace serving on a 4 unit?  No plumbing issues?  Have you owned a house before? :)

That being said, why not take the same financing arrangement to a better deal?  Make it a goal to find something for $100K or less per unit with similar rents and stick to the goal. "Units" can be overpriced sometimes because of the perceived added ease of landlording units in one place, so it can be difficult to find a 4 plex deal.  You are on the right path, but there is no way you'll come out ahead on this one.

Michael Zuber · Answer

One last option you could have tried if the seller was open to it was to change the terms.  For exmple maybe the seller didn't want or need all the cash at closing.  Maybe the Seller could hold back 100K on each property.

Then maybe you could help educate the seller on the numbers that Jon and other ran you through and tell him how skinny the deal is on cash flow.  If the seller buys this you could structure the payments to fit the cash flow.  For example try 0% Interest for 2 years and then stup up to 3% and then 5%.  Or if you get real creative maybe you just accure interest and pay it off with a 5 year balloon but never actually pay interest until the year 5 balloon.

In the end this was a bad deal the way the contract was written up but sometimes you can just go in and change the terms and the deal looks better

Good Investing

Joel Owens · Answer

Some areas are just strictly more of an owner occupant play and hope for appreciation.

If you have limited  cash why not wholesale a few deals to build up your cash higher.

Then as liquid cash grows add a few rentals at a time.What you don't want to do is deplete all or most of your liquid cash on a marginal deal.

Bechara Jaoudeh · Answer

We started learning about RE investments and rental properties about 6 months ago. We learned a ton but still have a lot to learn.  I'm just so glad we found BP. It's great to have such a community of seasoned investors that share their knowledge.

Bill Gulley · Answer

As Jon mentioned, this is not a deal I would do either....but,

You're also buying a property in a location and seems you might be paying a premium. If that is a property you can hold for some time and suffer through it in the beginning it could be a better deal for you years in the future. Unlike most others here I have a bit of a speculative eye and an attitude that if don't eat any hay, it's an asset to hold. In other words, it doesn't always just boil down to numbers for cash flow in the first year or so, depends on your investment strategy.

What caught my eye on this thread was the title, should you bail out.
Without reading through long details of some deals, any investor that begins to feel uneasy in any deal probably won't be happy with it after they close. You can get cold feet, buyer's remorse and need to identify that, but when terms and conditions change and you feel like you're getting in over your head, you probably are. Walk away from such deals. You can't buy them all and there will always be another one. Good luck...

This deal has gotten complicated. Should I exit?

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