You say "Owner pays $650 a month for expenses" - what expenses would this include? I'm assuming trash, sewer, and water. There might be a owner's electrical panel? Since you mentioned taxes separately, are those on top of the $650 per month expenses? Or is that included? What about insurance?

You never mentioned what I call "percentage expenses", which include Maintenance (10%), Capital Expenses (CapEx) (10%), Vacancies (your choice for your market - anywhere from 2% to 10%), and Property Management (again, based on the market - say 8%).

Broken down:

Maintenance - expect an average of 10% of your income to be spent on general maintenance. This could include utility repairs (fridge, stove, etc), contractor work (electrical, small repairs, door repairs, new locks, etc), and other wear and tear maintenance.

CapEx - set aside 10% per month for when the "big ticket" items come due. Water heaters, stoves, furnaces, roof... the big repairs. When you need to replace these, you'll appreciate that 10% CapEx that you've been saving up.

Vacancies - set aside a certain percentage as an "Expense". When you do have a vacancy, you consume those savings rather than taking an immediate hit on your income. This is playing the numbers. Say you have a vacancy for two months, which means you are losing out on $900 per month for a total of $1800. Since you've been "saving up" or "expensing" vacancy each month, you consume that as an expense instead which means you are still "making" the same income. Another way of looking at this is that your Vacancy expense is a bucket that saves money for the day when you have a vacancy. A final way of looking at it is that if you can afford to set aside X% vacancy (based on your market's average vacancy rate), then you can afford to take the vacancies that will most likely hit you one day (at your market's average rate).

Property Management - Two ways of looking at this. First way: one day, you might not want to manage the property. Can you afford to pay a PM and still make a profit? Second way: you're managing the property, and your time should be worth something. Pay yourself.

Summing these up and adding to your already-listed expenses:

Maintenance - $270
CapEx - $270
Vacancies (5%) - $135
PM (8%) - $216
Expenses you listed: $650

Total percentage expenses per month - $891
Total Expenses per Month: $1,541

So your Income minus Expenses:
$2700 - $1541 = $1159 income per month

The last thing to be added in as expenses, and is dependent on your area: Inspections and Licensing. Usually there's an engineering firm or city firm that will provide this service. This usually comes out to $75 per unit for a license, and $75 per unit for inspection (once a year). This would come out to $450 annual. This might not seem like a lot, but when you scale it starts to add up. This is especially the case if the license or inspection aren't current, and you need to pay this year and also save up for next year.

Anyway, on to whether it's worth it or not.

If those numbers that you listed are real, and if the inspection (that I hope you have done) turns out looking good... yeah, that doesn't look bad. There are several ways of looking at this (go figure):

The 1% or 2% rule (depending on who you ask). Is the gross rent more than 1%/2% of the purchase price? That's the fastest (and least-accurate) method of seeing whether a property is a deal or not. It requires a really, really small amount of math and is super fast to do. So $2700 / $150,000 = 1.8%. You're in the ballpark of that number, so it's worth digging into. If you don't pass this quick test, it's usually not worth looking any further. Usually. Exceptions would be if you have a strong strategy planned for how to increase your income or decrease your expenses. If you pass this quick test, you would pull all of the expenses (utilities, taxes, insurance) plus the Percentage Expenses.

The ROI (Return on Investment) rule: this is really up to you. What returns are you looking for? Right now you could be making $1159 per month, or $13,908 per year with this deal. Let's assume you pay 20% down payment and 5% purchase fees = $30,000 + $7500 = $37,500 out of pocket. Your annual return is Annual Income divided by Purchase, or $13908 / $37500 = 37%. You set the goal that you want for this. Stock market average is anywhere from 10% to %16% depending on where you look up your data. Real estate is more work... how much is it worth for you? 20% ROI? 30% ROI? That's a goal for your to set up.

Ok... key take aways:

Never, ever skip the Percentage Expenses. Yeah, it makes your income look a heck of a lot better. But when you have repairs or CapEx or vacancies, you won't be liking it. These expenses will happen at some point, so count them as expenses from the beginning

Determine what your ROI goals are, and stick to that goal. Re-evaluate each year to see if your goals should change with the market / your situation.

Is this deal worth it? Yeah... I would go for it. The numbers are solid. That said, it really comes down to the inspection. Is the building in good repair? How much work will be needed for the vacant unit? If it's a weekend of work that you and some friends can do, I'd schedule an inspection now and start putting together how much money will be needed for the repairs of the vacant unit. Add those into your Purchase number and re-calculate your ROI. It shouldn't drop by more than 10% if it's only some ceiling work and counter tops, which will still put you at 27% ROI.

Some questions for your to ask: What's the ceiling damage? Water damage? What caused it? Is it fixed? How much will it cost to repair?

If you have questions, feel free to ask!

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Alexander GriffinPoster

Rental Property Investor
Houston, TX

Alexander GriffinPoster

Rental Property Investor
Houston, TX

Replied February 17, 2020 02:07

@Ben Wilkins Thanks so much much for the tremendous value!

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