Would you do this deal with the known future CapEx?

Question

I have been analyzing an out of state property (640 sqft SFH 2 bed/1 bath) and am contemplating whether it would be a good deal. Here are the numbers:

Anticipated Sale Price: $44,000

Down Payment: $8800

Closing Costs: $2500

Total Investment: $11300

Immediate Repairs: Minor (2% seller concessions should cover the repairs)

Rent: $725/mo (existing tenant, market value is $750)

P&I: $160/mo

Taxes: $130/mo

Insurance: $55/mo

Mgmt Fees: $72.50/mo

Monthly Income: $307.50

I would put away $150 (20% of total rent) of the monthly income to account for maintenance, CapEx, and future vacancies. This would leave me with a cash flow of $157.50/mo. Although that's not a dazzling number, this deal is appealing to me because the property does not need immediate work. However, the reason I am hesitant is because of the known future CapEx:

-Garage roof (250 sqft) will need to be replaced in 2-3 years: $2000

-House roof (640 sqft) will need to be replaced in 5-9 years: $5000

-Water heater is 5 years old and will need to be replaced in 5-7 years: $600

-Stove and fridge are new but after the current tenant moves out I'd add a washer and dryer: $900

-Exterior paint looks good now but will likely need to be redone within 10 years: $1500

-A few of the windows are old and would likely need to be replaced within 10 years: $1500

So that's about $11,500 of known future CapEx. Now, let's say I plan to hold the property for 10 years. So if I put away $150 every month for maintenance, CapEx, and vacancies during these 10 years, this would give me a budget of $18,000. Since $11,500 of that is for CapEx, this means the other $6500 would be for maintenance and vacancies. That's $650/year.

Is $650/year enough for maintenance and vacancy? (average vacancy is every 2 years in the area).

If I were able to cash flow $157.50/mo, after 10 years, this would give me $18,900 of earnings. Which would be a 167% ROI. And this is before appreciation comes into play. Although I'm not counting on appreciation, if I was a betting man, I'd say the appreciation would cause my investment to at least double.

Would you do this deal or is the known future CapEx a red flag?

Joe Villeneuve · Answer

...or, you could replace the roof and the HWH now at a cost of 7600. Add that to your closing and bury it in the mortgage payment. That would only increase your monthly payment by 26/month. 26/month, with the funds coming from the tenant (rent) is a lot less than 11,500 in a lump sum where the source of those funds comes out of your pocket. Subtract that from your 20% retention (that does you no good anyway), you just increased your CF to over 300/mnth. Get a LOC to cover any future issues. This way you have those costs covered if they come up, but it won't cost you anything if it doesn't.

It's not how much something costs that matters (as long as it's covered) as much as how you are paying for it.

Joe Villeneuve · Answer

$10,300 out of pocket (cash)$3960 = Cash Flow per Year

2.6 = Years to recover Cost (cash)

Excellent Deal

Brendan Carlson · Answer

@Joe Villeneuve just wanted to let you know I took your advice -- the seller and I agreed on the terms, and I will be burying most of the repairs in the loan. Thanks so much for your help!

Brendan Carlson · Answer

@Joe Villeneuve The repair costs added just $14/mo to my mortgage payment (the seller paid for most and I ended up paying $1.5k out of pocket for the rest). I'm cash flowing $330/mo after mortgage + taxes + insurance + mgmt fees and paying myself $200/mo (for future investments) while putting away $130/mo for future maintenance + capex + vacancy (with a plan to adjust if too low). All in all, I only paid $11.5k out of pocket and if all goes well I'll have doubled my investment in 9-10 years (that's not including my increased equity and potential appreciation). I'm pretty happy and excited for my next investment!

Joe Villeneuve · Answer

Happy things worked out well for you.  How much did the repair costs add to your mortgage payment, and what was the resulting cash flow?

Joe Villeneuve · Answer

You can bury the stated repairs in the loan having the seller do the repairs and agreeing to a higher purchase price that covers the sellers cost.  Agree on that price ahead of time and make sure the seller includes receipts of the work done for your records since both should be under a transferable warranty...to you.  PM me if you want a better explanation.  It's pretty simple, but for clarity sake I think a one on one would be better.

Brendan Carlson · Answer

@Joe Villeneuve Thanks for the response, I like your thinking. I didn't even think about a LOC. As you can probably tell, I'm new to REI :)

I am not sure how I'd be able to add $7600 for repairs to the mortgage payment. The credit union I've been in contact with only allows for up to 3% seller concessions on investment properties. At a $44k purchase price, that's only $1320. Do you know of any other creative solutions I could explore?

Though, I'm thinking a HELOC could work. I could wait 5-7 years, build some equity, and then take out a HELOC to replace the roof, windows, water heater, and anything else that comes up. This would be a small loan so it wouldn't increase my monthly expenses by too much.

I would probably just pay to replace the garage roof and washer/dryer using rental income since those are more immediate needs (2-3 years) and it wouldn't make much sense to take out that small of a loan. That is something my 20% retention would ideally cover.

Does this sound like a good plan to you or would you handle it differently?

Eric James · Answer

I don't like those kind of deals, with margins that tight. Especially out of state. In reality you're probably going to have negative cash flow.

Would you do this deal with the known future CapEx?

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