Real Estate Agent · Jersey City, NJ · Member since 2015 · 110 posts · 53 votes
Hi Everyone,
I have a lead that I've been doing working on and I have a beyond nice guy who I really bonded with who is a motivated seller potentially digging himself in a hole.
I've calculated ARV and it's been really difficult because a lot of the potential comps were foreclosed or short sales, etc. - I took a property that was similar and totally renovated that sold at 152K so I'm going off that.
(He told me there was a house across the street that sold for 175K that was similar to his however, I couldn't find that anywhere so not sure if it's true.)
He owes 140K on his mortgage and has put about 25K into renovations over the years, but I would say it still needs about 20K-30K repairs to be move-in ready. (Lower-Income Area)
SO, I'm trying to effectively calculate what I can offer for a cash buyer or a regular investor along with my assignment of contract fee included (let's hypothetically say 10K).
So help me out here --
Cash Buyer:
+ 38,400 = Potential Gross Income (Rent a Year)
- VARIABLE COST (Below)
- 8% Vacancy
- 5% Repair
- 7% Property Management
38,400 - 7,680 (20%)
= $30,720
- FIXED COST (Below)
- 7,000 = Tax
- 1,200 = Sewage a year
- 2,000 = Insurance
30,720 - 10,200
= $20,520 Yearly Cash Flow
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So based on that, what can I offer if a cash buyer wants 10% ROI and hypothetically I want a 10K assignment fee. Also if the mortgage has 140K and the seller's asking 180K.
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Investor Using Loan:
Now that looks great, but if it's not a cash buyer, they're going to have to factor in the monthly mortgage out of the $20,520. -- With the seller's HIGH mortgage due to refinancing the house, he pays about 1700 a month or around 20K for the year which would cash flow only 520 a year. When an investor buys the property, I'm assuming he'd get a way better interest rate than the motivated seller did but not sure how to incorporate that.
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I hope this makes sense and any advice/calculations would be great.
SILVER SPRING, MD - Maryland · Member since 2015 · 77 posts · 43 votes
11y
Just some thoughts below. Let me preface by saying it could totally just be me not understanding something, but:
1. $3,200 hundred monthly rental income sounds high for a property with an ARV of $152k, or even $175k. Are you sure your income numbers are right? Feel like hitting 2% off of a market rate ARV (not some good deal some investor bought from a motivated seller at a discounted price) seems unlikely but does happen in places like the mid-west. But that's usually off of much lower prices and rents, right? But you stated it's a lower income area so maybe it's a multiple unit property such that the rental income number makes sense.
2. If I'm an investor and I agree with your ARV of $152k for properties in that area of that type, not sure why I'd be paying something higher than ARV like what Jay is calculating. Now I'm sure Jay knows his numbers and his calcs are right. I'm just scratching my head at a mid 100s ARV and investor purchase prices at 200k or above depending upon cash or financing. My gut feels like maybe some inputs or assumptions are off, but I could totally be missing the boat here. Otherwise I'd just be buying houses at ARV if the net operating income numbers were that good because I'd be getting well above the assumed desired rate of return buying at ARV. To me, I'm usually needing to get a number well south of ARV to make the buy and hold numbers work.
3. People calculate them differently, but 5% for repairs with nothing for CapEx on the expense side seems very low. Even if the repairs to get the property rent ready mitigates CapEx and repairs in the short term it's still going to be there.
4. I usually see property management quoted as higher than 7%, but I can see it being possible in a particular area. If I was looking at this deal for myself, I'd want to recheck that to confirm.
5. I personally do vacancy at 1/12th or higher depending upon the area, quality of the property, and tenant quality. It's quibbling, but I might bump 8% up to 8.3% at least. In a lower income area I might want closer to 10% at least, but my definition of lower income might be different from yours.
Again, I'm not saying stuff is wrong here. Just that these are some questions about the property that come to my mind when looking at your write up and it could just be that I'm off base.
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
11y
If you assume an all-cash purchase for your end-buyer, if your buyer is going to cash flow $20,520 per year (per your calculations above), and he wants a 10% cash-on-cash return, then he should be willing to pay $205,200 for the property ($20,520 / 10%). And if you want a $10K assignment fee, you'd have to pick up the property for $10K less than that -- or about $195,200.
If your end-buyer is getting a loan, you need to know the terms of the loan before you can do any calculations. Let's assume something like:
- 30 year amortization
- 25% down
- 5% interest
Given that, and working backwards to find the purchase price that would have this deal generate 10% CoC for the buyer, it looks like he'd have to purchase the house for about $280K. You'd have to get it for $10K less than that to get your fee, so your purchase would need to be $270K.
Real Estate Agent · Jersey City, NJ · Member since 2015 · 110 posts · 53 votes
11y
Thank you for the great advice J and for taking the time out to respond. - That makes perfect sense.
Lastly, if the house needed 20K in repair, is this something I would normally deduct from the pricing in this type of situation? So getting it down to 185K plus the 10K assignment fee? Not sure I'm thinking this wrong. (Flipper/rental)
SILVER SPRING, MD - Maryland · Member since 2015 · 77 posts · 43 votes
11y
Just some thoughts below. Let me preface by saying it could totally just be me not understanding something, but:
1. $3,200 hundred monthly rental income sounds high for a property with an ARV of $152k, or even $175k. Are you sure your income numbers are right? Feel like hitting 2% off of a market rate ARV (not some good deal some investor bought from a motivated seller at a discounted price) seems unlikely but does happen in places like the mid-west. But that's usually off of much lower prices and rents, right? But you stated it's a lower income area so maybe it's a multiple unit property such that the rental income number makes sense.
2. If I'm an investor and I agree with your ARV of $152k for properties in that area of that type, not sure why I'd be paying something higher than ARV like what Jay is calculating. Now I'm sure Jay knows his numbers and his calcs are right. I'm just scratching my head at a mid 100s ARV and investor purchase prices at 200k or above depending upon cash or financing. My gut feels like maybe some inputs or assumptions are off, but I could totally be missing the boat here. Otherwise I'd just be buying houses at ARV if the net operating income numbers were that good because I'd be getting well above the assumed desired rate of return buying at ARV. To me, I'm usually needing to get a number well south of ARV to make the buy and hold numbers work.
3. People calculate them differently, but 5% for repairs with nothing for CapEx on the expense side seems very low. Even if the repairs to get the property rent ready mitigates CapEx and repairs in the short term it's still going to be there.
4. I usually see property management quoted as higher than 7%, but I can see it being possible in a particular area. If I was looking at this deal for myself, I'd want to recheck that to confirm.
5. I personally do vacancy at 1/12th or higher depending upon the area, quality of the property, and tenant quality. It's quibbling, but I might bump 8% up to 8.3% at least. In a lower income area I might want closer to 10% at least, but my definition of lower income might be different from yours.
Again, I'm not saying stuff is wrong here. Just that these are some questions about the property that come to my mind when looking at your write up and it could just be that I'm off base.
Real Estate Agent · Jersey City, NJ · Member since 2015 · 110 posts · 53 votes
11y
Hi Chin,
These are all great questions and really help me better understand the deal as well. -- To give you some background, it's a multifamily with two units that can potentially gross to $3200. Now, the 2nd and 3rd floor is one unit cash flowing at $1500. He has a partially finished basement (possibility for kitchen) that has a 1 bedroom, living room and brand new bath that he doesn't utilize towards his other rental unit. It can be added as an extension to the first floor level unit which is currently going for $1250 which is why I bump it to $1700 with all the additional space. That gets me to my number of $3200.
As for the ARV, it was difficult, I could really only base it off of one comp that was sold as a foreclosed in the 80K region, then renovated and sold at 152K. The 175K property I was informed about was something I could not find. But based on the almost move-in ready basement with added bathroom I do think that ARV could definitely jump up in value. I'm going to try and run the comps again and see if I get anything different. I do see exactly what your saying when buying above ARV.
For repairs, maybe I should consider it on the higher end of 5-10%. In terms of CapEx, I left blank as new roofing, siding, steps and the porch was recently redone in the last 2-4 years. A new heating sytem was also installed 5 years ago. But maybe I should be conservative and put 5%? For the Vacancy percentage I left it at 5% because he's already received 3 calls to come see the place and it seems like renting in that area is pretty vibrant.
I think something to note that maybe J didn't add or maybe I did not specify was a potential 20-30K in repairs that need to occur. So maybe deducting that from the 195K Making it 165K makes more sense. It's still above ARV or maybe in line but then to your point and calc methods, it seems abnormal to buy above or in line with ARV. Please let me know your thoughts.
Thank you for the great advice J and for taking the time out to respond. - That makes perfect sense.
Lastly, if the house needed 20K in repair, is this something I would normally deduct from the pricing in this type of situation? So getting it down to 185K plus the 10K assignment fee? Not sure I'm thinking this wrong. (Flipper/rental)
Thanks so much for the great input.
In theory, you are correct.
In reality, keep in mind that the $20K rehab costs may not get rolled into the loan, which would potentially mean the buyer's out-of-pocket is $20K higher, and therefore his 10% ROI is no longer 10% (since the amount invested has changed.
Investor · Lubbock, TX · Member since 2015 · 308 posts · 106 votes
11y
For a property less than 5 units, I'd only appraise it based on comps. If there are no comps, then the question should be asked, "what is the most I could sell this property for, in less than 30 days, a be sure I'd get my ask price?"
I'd take that price and subtract the repairs needed. Then I'd subtract out another $10-20k for my profit. The final number would be my maximum offer price. My strike price would be even lower.
This strategy gives you a strong exit strategy on day 1.
Your response has prompted some additional thoughts:
1. @Jonathan Towellis right. Now that we know it's a duplex, most investors will be buying based upon comps and not based upon operating income. You'll still calculate operating income and financing and such to determine whether it's a good deal, but commercial properties (5 units or more) are valued off of income and and 4 units or less are valued off of comps. That's the way banks will finance it and if you ever plan on selling the property later on, that's what your potential buyers pool will be looking at also. So that's two huge factors that affect how I would have to look at the property.
2. Your rental income number seems to include potential rents of $350 per month assuming some additional work is done. As an investor, you really shouldn't be paying for potential unrealized income. I'm not going to pay a seller for the value of that income if it's not already realized and seasoned as part of the operations. Lot's of sellers will say oh, you can easily raise the rents, or you can add a unit, or you can do an endless number of other things that in the future will increase your income, so you should pay me now for the value of it. It typically doesn't work that way. If I as the buyer am going to be the one putting in the time, money and effort to realize the $350 a month and take all the risks that accompany that including the risk that the idea totally fails, then that's my profit to be made and not something I'm going to pay the seller in advance for as part of the purchase price. Honestly, if it was so easy to accomplished, a good seller would have already done it. So that leaves you with either it's not so easy to do or realize or the seller isn't all that good or willing of a landlord.
3. Just to give you a feel about how the notes I made in the last post affects how I would view the project, I ran the deal through my calcs with your numbers plus some of the differences I noted in how I would view the property. That gets me to operating expenses of $21,848 and net operating income of $16,552, which is about $4,000 per year or $333 per month more expenses and therefore less net income that I'm accounting for.
But I'm also not going to credit the deal with the full $38,400 of rental income for the $350 a month that's never been realized and that I would have to work to try to get the property to earn that. So that changes my calcs to $34,200 of annual income, $20,574 of operating expenses, and $13,626 of net income, about $7,000 less net income than your assumptions. Plug that into J Scott's calcs above and you'll a very different potential purchase price.
4. The estimated repair charges would totally be worked into the sell price. Similar concept with flippers who do ARV x 70%/65%/60% (different fliipers use different %) -repair costs. But for me personally I probably wouldn't want to do a straight subtraction from my ideal purchase price that I calculated - my estimate of repair costs. I'm not a flipper and have done relatively little renovation. So I'm going to assume that I'm probably going to screw up something in the estimate or make a hash of something in actually getting it repaired, or for the hidden surprise the no one could have realistically planned for. Also, I'd expect some room for the fact that I'm actually doing the repair because my time money and effort in doing the repairs is worth something also.
So for all of those reasons I'd probably lower my ideal purchase price by something more than just what I estimate the repairs will cost. Maybe a pro like @J Scott who's a flipping ninja and could probably personally do the renovation blindfolded with two hands tied behind his back in one day and be finished in time for brunch would be okay just lowering his ideal purchase price just by his estimated repair cost, but I'm not that good.
Anyway, sorry for the long post. Just take all of the above as things to consider. You know the property better than any of us here and will ultimately have to use your own judgment and it should be a good learning experience.
Good luck and if you do happen to take down the deal be sure to let us know how it turned out.
Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
11y
@William Kwong, why wouldn't you take foreclosures and short-sales into your comps calculations? That is reality! There is nothing to say that those properties were in any worse condition than this one, and you can bring any low comps to your Sellers' attention when negotiating.
Maybe, the market value for this one IS less than he owes, so might end up as another short sale statistic anyway! And maybe, wait until then!? Cheers...
Real Estate Agent · Jersey City, NJ · Member since 2015 · 110 posts · 53 votes
11y
@J scott Thanks so much for the great advice.
@Jonathan Towell Good call , that makes a lot of sense and I will use that metric going forward in my searches. Thank you!
@Chin P. This is really great stuff. Going forward, you're correct in not adding the unrealized potential income. Also, this is a lot of good calc and it really helps me get good perspective on how the buyer sees things.
I submitted the offer at 165K however, my numbers were based on the unrealized income and set repairs number. - I also reran some comps in MLS and re-calced it up to 185K ARV with some help of some realtor friends working in that area. I got some good advice on this particular market that allowed me to add expand my search in an area very similar in that town that I could run comps on.
Nonetheless, even at new 185K ARV and my submission for 165K, that's only 11% under FMV which doesn't appeal much to investors. Plus I'll change my approach of not realizing the unpotential income which will make it less appealing when i show them the numbers. But if the seller signs, I'll pitch it to my buyers list based on the true numbers and if it falls through, then I'll chalk it up to a learning experience.
@brent coombs Good advice man, you're right, I'll take them into consideration going forward. I'll have to keep that mindset!
Thanks guys for your input! I'll keep you guys posted!