All Forum Posts by: Troy Hebert

I guess the TL;DR is how do we convince an appraiser to factor in rents when appraising the property (particularly when the entire value of market in the area is based on rental performance).

Hi all,

I am selling my first investment property here in the outer banks which is an insanely hot market right now.

For the same reason I bought my place there, the rents are very strong in the area and beachfront or close to beachfront property is all very cheap when compared to other areas nearby (think jersey shore, Long Island, etc.)

My house booked $162k in rental income for the upcoming season. I had two offers come in above my asking price within a couple days. One was at, the other was $25k higher and after we did best price one of the buyers went up $125k!

The unfortunate thing is that we actually went back and negotiated a lower price in exchange for a higher non-refundable deposit ($7500, so nominal amount).

We are most concerned about the appraisal as the market has gone out of control there and I actually bought the house last august (yes, crazy returns).

The problem is that apparently the appraisers don't take the rental income or NOI into effect with their appraisal. Which is completely stupid. It did $150k last year and $165k this year. The value of the property to an investor is going to clearly be based on its financial performance. With $97k in NOI, the $1.685mm purchase price we have actually isn't bad (6% cap rate 1 road literally right off the beach, 5 min walking with beach views). It still produces about $20k in cash flow after debt service at the new Buyer's purchase price.

So the question is how do you navigate this? I feel like we are going to get stuck with an unsaleable property because the appraisals are all going to come back too low. Market is very hot but looking at my house, which is 11BR and almost 7k sq ft, there aren’t as many comps and I’m not on the oceanfront. The comps are actually quite bad as the prior owner and I have put a ton of renovations into it to make it really high quality (particularly compared to other houses that get beat up from the rental season and/or run down from the ocean air and wind).

So are we just stuck with this property likely unless we want to sell for a much smaller gain? Insane that someone in willing to buy it for more and we’ve already come down because we know we are way off on the appraisal.

Also, now is the time to sell before the rental season starts, so it’s likely that we’ll chase this issue down, find out there’s a problem and I’ll miss the window to sell it big. Who knows what next year brings with Covid and everything across the board changing.

I’d also add that historically, one of my personal weaknesses is being too analytical / diligent. Works great when you’re an associate at a PE firm and ultimately do all the work for the partners to make the decision to invest, but analysis paralysis is a real thing.

One thing that I would LOVE to do is to syndicate this. But it has to be my primary residence at closing and 60 days thereafter (I already have this worked out as my wife and I are fully remote employees now). I can’t really syndicate ownership in the home as it’s not an investment property loan with the bank. I don’t believe at least.

I'd also love to quid claim the deed into an LLC but would definitely violate my loan agreement. I've read that lenders really won't enforce the acceleration on the loan in that case, not sure if anyone has done this. But ultimately having it in the LLC would be great even just for the sole fact of being able to deduct all my opex for running the rental property for tax purposes.

If I don’t do this deal, it’ll be that I can do 3 deals with the same Capital with the private equity firm. Their returns are 20%+ across 100 real estate deals and 33% on value add multi family.

 This is great! I appreciate the input. I agree, it makes the most sense.

My biggest concern, I suppose, is that there is a lag effect from unemployment and this becomes a longer lasting recession. $10k for the week is something that at least I personally would just cancel until I got my job back. I am maybe being overly concerned and careful just because the sizing is uncomfortable for me. My fear is that market values these at 11% of rent roughly at this price point. If rents go from $140 to $90k, not only do I cash flow negative for the year at $30k (after paying P&I which includes, obviously, some equity in the property), the price of the house would go to about $825k ($90k/11%=$818k). I’d basically be entirely wiped out and have to file for bankruptcy if I default and have to sell the house.

Again, seems a bit crazy but then again when was the last time we saw a pandemic with 20% unemployment, with fiscal stimulus aimed at simply bridging a short term gap, with no long term plan in place (ie vaccine takes years to both develop, manufacture, and distribute globally and 70% of domestic GDP is based on the service side of the economy).

So the $24k includes $7500-$8k in annual capex spend. If I don’t spend it, it builds into reserves. Property manager thinks $5k max. I think it’s reasonable.

On seasonality, yes definitely an issue. I had to rebuild my model to be monthly. I go line by line and allocate a % of full year expense to each month. Ie linen and turnover expense is tied directly to weeks rented. Capex spend occurs in off season. Etc.

I show a negative cash balance of about $25k in May going into the season next year. I hadn't factored in deposits, which is interesting and definitely a real factor that should be considered. My cousin who purchased an ocean front property down the road told me that folks pay 50% of it up front in advance, and some are booking the week after their stay for the next year. But the monthly model definitely shows large fluctuations MoM in cash balance. IRR pretty significantly impacted, if sold in the short-mid term, depending on the month. But I do believe I could sell it for $50k more going into the season (70% of NOI) in a base case that would offset the expenses incurred during the off season (net of the incremental 5% broker fees on the $50k).

One thing with this one as well that’s super important. The property manager doesn’t have any reviews on it. It was purchased out of foreclosure in November last year for $720k. They put $200k into it, have rented it out for the season at an impressive $140k, and seem to be flipping it for a nice profit. Can’t help but feel I’m the bag holder buying it at the top. But at the same time, it has the best numbers out of any that I looked at and I got them to come down from $1.2 to $1.1mm. I assume because they are still making a great return. But there’s no historical data besides 2020 with this one given the history. Also, I haven’t been able to get an answer to the question as to who defaults / forecloses on a property that’s capable of cash flowing so much? Why wouldn’t you just hold? I don’t know.
 

Will certainly share my model with you. PM me and I’ll get it cleaned up. Also happy to have a call on it to answer any questions. Some of the formulas can be a bit complex to have everything flow through (ie holding period and which mortgage balance to pull at exit uses index match functions)

Agree with the thought that higher priced homes are the best investment properties. That’s why mine is $1.1mm, I ran a bunch of numbers for the $550-$800k range and they just barely work.

I have approval for 80/10/10 but also 90/10 jumbo via primary residence. 3.5-3.9% rates depending on which one. But returns are really the same through all periods with either cap structure.

I guess I’m confused as to the insurance risk here. Are folks saying that if there’s a hurricane that wipes out my property, they will only cover the lender’s exposure? 

Agree on buying in a hot market. I've been looking at it as a rental cash flow deal which is quite good. $24k/year after debt service on $118k down (including my closing costs). That's a pretty solid CoC and the area is definitely ripe for potential appreciation. I spent a couple weekends there and everything is full capacity and seems like everyone wants a property down there.

Thought this post was dead!

Is the concern with flood just that flood insurance goes up in the area? I’ve confirmed insurance will cover lost rental income, including unhooked rental income, which is great.


Other concern is that this area seems overheated. SO many buyers coming into the market and buying properties up. It feels like a bad time to buy. Agents will tell you that prices haven’t reflected the crazy demand yet, but I don’t know.

Im this close to walking from my deal. Still working to get rental performance through the last cycle to see what happens. I’m concerned that although 2020 was the highest performing year for rentals in the area, that’s because most of the bookings were prior to Covid and 50% deposits so folks still vacationed. But next year could see a big drop off. Just speculation.

I guess my biggest fear here is that if I ever need to sell the house for $700k, it’ll bankrupt me entirely. While that does seem like a low probability, it’s a pretty catastrophic scenario. 

The scenario I envision is some wide scale depression that impacts people’s ability to pay for expensive vacations. I’m trying to get data from 2008-2013 from my agent with regards to rental income in the area. This summer was crazy and despite Covid and unemployment the island was 100% booked and at pretty crazy rates. But the fiscal stimulus has bridged that gap for the time being which enabled forbearance and stimulus checks, etc. People also planned their vacations in advance, so likely just went anyways.

If rental income falls to $70k, which is what a lot of homes on the island actually do (albeit much smaller 6BR type homes and maybe not right on the beach), then considering the 10% rule the value of the house would be $700k, or probably even less just given it’s size and higher natural operating expense structure (electricity will still be $7k/year no matter what).

That scenario doesn’t seem too absurd. I guess with vacation rentals though, it’s not my primary residence, and as long as it does rent some to cover most of the expenses during that period (expenses are $50ishk in the downside case as some of the variable expenses like management fees would fall), I’m cash flow negative of about $10k/year due to the mortgage. So I’m still building equity in the property despite coming out of pocket $10k for the whole year. So just hold until the market comes back.

Then again I’m assuming the market comes back. I’m sure there are areas of the country that never recovered from 2008-2010.

Stuart,

confirmed that the insurance will cover loss of rental income even if not booked. They look at prior year from the management company. I think there is a maximum of 26 weeks booked, however. Works for me, but just an interesting nuance