My first deal in Indianapolis, that wasn't

When I first started looking for real estate in Indianapolis, I immediately posted a question on biggerpockets asking for any wholesalers in Indianapolis.  Through this, someone sent me a house I was very interested in.  The deal ultimately fell apart and I want to explain why this deal would not work for me as a way of encouraging new investors to sit down and actually run the numbers.  

The house I was most interested in was on the South east side of the city (still my favorite part of the city) and the house was listed at 39K.  I offered 35K along with some minor improvements.  They came back at 37,500.  I came back at 35K with no improvements and they rejected the offer.  A few weeks later the owner of the home (I think he bought it outright but he might have just had it under contract) emailed and asked if we could reopen negotiations.  I said sure and asked him what his bare bottom brice was and he said something close to 36,900.   I might be misremembering by a couple hundred dollars. 

I walked away.  Why would I walk away when we were so close?  They had projected rent at 750 because I told them I would not buy a house in Indianapolis that doesn't hit the 2% rule (BTW, I still won't).  The problem is that I looked at the house on zillor right after his email and it was listed for rent for more than three weeks for 725.  This means, that I coudn't pay their price, especially because the home needed about 750 - 1000 dollars in work and a large part of the house was in light carpet meaning turnaround time AND COST between tenants would be high. 

So, let's do some math to see why I was, and am, such a stickler for the numbers.  I study portfolio theory a great deal and some of the main ideas is to reduce drag (costs) of the portfolio and compounding interest is amazing.  I will use layman terms here but if you are a finance nerd, like me, let me know and we can certainly talk more about my thoughts on modern portfolio theory.  

So, the problem with this house is that turn it over would cost approximately 2500 - 3500 dollars due to the need to replace a very large amount of carpet, and it never met the 2% rule.  

How much money does this actually cost me: 

Let's turn to a compound interest calculator.  The investment makes 25 dollars months less than I was told it would.  Over the 30 year timeline, assuming a 5% interest, it would cost me more than 20,000 over the lifetime of the investment.  

Look at it this way: 

If I rented it for 750 and took the first 25 dollars out of the investment and put it into an investment account that makes 5% annually, after 30 years there would be 21,000 +/- in that account.  

So, that is a big deal to me.  That is more than half the price of the HOUSE!

So, let's also now look at the high turnover costs because of the decision to just carpet over everything instead of putting tile which lasts longer and can usually just be cleaned (rather than replaced) between tenants.  

The high turnover costs me even more than the cheaper than advertised rent.  Let's figure out why.  

I got a quote from a local carpet store of 2800 for carpet for that house.  Let's assume I have to replace it all after every tenant.  Certainly an aggressive assumption but when looking at properties, I always assume that everything will go wrong.  Feel free to tell me how dumb  I am in the comments.  On top of that I have to have a cleaning crew come in (300 or so dollars) and other minor repairs.  The cleaning and minor repairs would occur no matter what the flooring choices were, so they won't factor into the difference between a house properly set up for a rental and one that isn't.  

In order to make the compounding calculation simple (if you really want me to do the 100% accurate math let me know and I can take the time to do it) I am assuming I just have to budget an extra 75 dollars a month for turnover costs.  Well, that equals more than 55,000 over the lifetime of the property.  

So, the simple decision to fudge the rent by 25 dollars and not put in proper flooring decisions for a rental means that I would have lost close to 75,000 dollars over the lifetime of the property (about 2 times what I paid for the house). 

This is all to show that the small differences (my wife laughed when I told her I would have bought he home if it had different flooring)  can make an enormous difference.  Modern portfolio theory can teach us just as much about real estate investing as it can about a stock portfolio. 

Lastly, I want to make it clear that if I had bought he house, I would have immediately put laminate in everything that wasn't  a bedroom.  The problem is that this would have cost a few thousand as I would have to remove the carpet the seller just put down and then install the laminate.  This could have made me further from the 2% rule I follow in that part of Indianapolis.  The deal fell apart, and that's fine.  Someone else can own it, be happy, and make a lot of money.  As for me, I'd pass on that deal every day of the week.