Deep Dive into The Deal That Never Was (Thankfully!)

Sometimes the deals that don't go through are still wildly beneficial! They can provide opportunity to learn about the process, your market and yourself. I recently had a deal like this. It started with exciting visions of longterm cash flow and ended with a contract termination. A huge bummer in the short term, but a gigantic advantage in the long term. Let's do a deep dive. 

THE DETAILS OF THE DEAL

Property Specs:

• Triplex (3 units under one roof) with average rent at $575 ($1725 per month)
• Original List price: $142,000
• Contract price (price the seller and I agreed on): $135,000
• Annual Net Operating Income (NOI): $12,957 *Details on calculating NOI at end of post*
• Cap Rate (Annual NOI divided by contract price): 10%

Purchase Offer Specs:

• Contingent on results and my satisfaction with property inspection
• Contingent on my ability to secure adequate financing
• Contingent on seller providing current leases, rent roll and financial records (income and expenses) for the following year
• **This is all what investors call "Due Diligence" and is a good idea on most deals.**

Due Diligence Results:

• Document Inspection (current leases and rent roll): Never got 'em! That was easy (and suspicious).
• Financial Inspection (prior year's income and expenses): Never got 'em! Easy again.
• Physical Inspection: We expected some issues given the price. Here's a short synopsis: Roof in need of replacement; gutter system inadequate and causing foundation moisture and bowing; broken or missing windows; cockroaches; 2 of 3 furnaces in need of replacement; electrical safety issues throughout; leaking waste pipe; missing appliances; clogged and leaking toilets, sinks and showers, etc., etc., etc....estimated $30-50,000 in repairs/rehab. 

Updated Offers Based on Due Diligence: 

• The original contract price no longer made sense. The annual rate of return was now below 8%, the After Repair Value (ARV) would no longer support a viable exit strategy given the initial outlay and the property wouldn't actually cash flow (depending on which financing route we chose). So, we gave the seller 2 offers. 
• Option 1: $99,000 purchase price. The seller would not be on the hook to do any repairs or put any money into the deal. 
• Option 2: $135,000 purchase price plus $50,000 ($185,000 total) financed by the seller at 4.5% per year and ballooning in 5 years. We thought $50K was enough to rehab all units and appreciate the rent within the 5 years thus increasing the ARV and allowing a profitable sale or refinance after year 5. 

Survey Says?!

• Nope! Seller wanted nothing to do with either offer (even though his annual ROI on the seller finance option would have been pretty handsome). 
• We spent $725 for the property inspection. 
• We avoided what could have been a costly (and probably unprofitable) venture with multiple headaches and endless latent defects. 

In the end, it cost us $725 to go through this process and learn more about different financing options, increase our understanding of our local market and see ourselves act extremely unemotional in the midst of a failing deal. A successful deal? No. An overall success? Absolutely. The property is currently back on the market. Who knows, maybe the seller will come back around to us...

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Net Operating Income (NOI) Mechanics:

1. 1. Start with your annual gross rental income (monthly rent X # of units X 12) - For this deal it was $20,700. 
2. 2. Add estimated "other Income" like pet fees, late fees or additional rent if you plan to rent the garage out for an extra fee for instance - I estimated $800 for the year.
3. 3. Subtract vacancy loss. This is an estimate for how often you think the units will be vacant and not generating income. Most people will recommend a minimum of 5%, but it should be specific to your area. I estimated 5% or an annual expense of  $1,075. 
4. 4. Then you have your Gross Total Income (Total Income minus vacancy expense before operating expenses). In this case, $20,425.
5. 5. Now estimate and subtract your operating expenses including, but perhaps not limited to; Real Estate Taxes, Property Insurance, Payroll, Administrative Costs, Utilities, Repairs and Maintenance, Management Fee and Reserves for Replacing big expense items. I estimated $7,468.25 of annual Operating Expenses.
6. 6. Arrive at your Net Operating Income (NOI) by subtracting your estimated annual Operating Expenses from the Gross Total Income. I arrived at about $12,957. 
7. **NOTE: This, of course, is an estimate. It is based on assumptions, data from the seller and public records. You should be able to find annual taxes on the website of your local government and a good insurance agent should be able to quote insurance coverage for the property. Utility data and repairs/maintenance could come from the seller if she kept records. Estimate management fees to be around 5% (even if you plan to self-manage) and about $250 per unit per year for replacement reserves.