@Thomas S. I agree with you on the pool, as a rental a pool is a liability. Realistically, this pool will need to be filled in. Note, it will need to be properly filled in with the side walls being collapsed and dirt compacted, not simply throwing a bunch of dirt in the pool and calling it good. Any investment in real estate comes with risk and liability. Holding assets in separate legal entities is one way to mitigate the risk. Additionally, proper disclosures, pool addendum and safety compliance are all ways to reduce the level of liability as well.
As for saying it is a poor rental investment, there was not nearly enough information given in this post to determine that. You have to take into account the owners tax bracket, their capital constraints and access to capital, the overall health of the localized market and most importantly the investors short and long term investment goals. You do not build wealth by flipping from one property to the next. From simply the return numbers, I hear what you are saying. Investing based on Cap rates is a great strategy, but other factors have to be considered. Side note, my team just launched expansion into Kansas City because Cap rates in Tucson have been drastically compressed recently. First deal we did there just got leased and we are at an 11.2 Cap (pre-leverage).
Back to why this deal makes sense to hold for 12+ months.
We just finished (for a client) a full knockdown renovation where we kept 2 walls and rebuilt the entire house, including pouring a new 1,000 sqft slab. That house is set to close early Jan for $350,000. Going to use those numbers below as an example.
Simple Math: Total investment with acquisition and remodel $236,000 (assuming $140k on the reno) and lets say it sell for $350,000, after closing cost and R/E Fees you end up with roughly $89,500 profit. Absolutely, would love to take that to the bank and run! Unfortunately, we have to pay taxes (going to use 2017 Tax Code although this project will occur in 2018 and there are changes to long term capital gains in the works. Also not going to look at state tax ramifications). The difference in Long Term Capital Gains vs. Short Term (ordinary income) Gains is currently 19.6%. Simply by holding the property for 1 year as a rental and then selling you save $17,542 in taxes or 7.4% return on total investment. Holding for a year on this when the rental income is decent and owner is in a high tax bracket might be worth it.
Additionally, with the property renting at $2k per month and assuming a 35% expense multiple we are seeing a true pre-leverage Cap of 6.6% (I know not great! but bare with me). If the house appraises for $350,000 and you do a cash-out refinance you will end up with $262,000 capital returned. With a rent of $2k per month it would be very close to a complete break even with the mortgage payment, but I now own an asset, have an addition $26,500 on top of my initial investment and am paying close to $400 per month down on the principle. This means I am making $5k per year (recouped when property is sold or at a future refinance) plus the depreciation write-off on my taxes each year. Again, depending on the investors goals, this may actually be a home run situation.
Lastly, and this is what I am doing with the property, you can add to a revolving credit line to open-up complete access to the capital with a local bank. They will lend at 65% of the appraised value and I will have access to the capital if/when I need money to do a project, and when I am not in need of capital I will pay down the line and receive a 6.6% return rather than having my money simply sitting in a checking account until I find my next deal. I will not have to pay a large tax bill, will get depreciation write-off and hold an asset in an area I anticipate to appreciate 6+% over the next year or two (Yes, I am aware the market could have a massive correction any day. Another one of those risks in real estate).
As for the comments on the cat smell issues, when I say we are renovating that basically means taking this property down to a couple walls. We will utilize the existing utility connections to minimize on impact fees and development fees but for all intensive purposes this will be a new build. As for the slab we will be treating the existing area of the slab with Enzymatic Cleaners to remove the smell. If it is not possible to remove the smell we will demo the slab and increase the pour from a 1,000 sqft addition to a full new slab at 1,800 sqft.
Greatly appreciate all the thoughtful comments!
Have a purposeful day!!
