How Far off in my Thinking am I? :)

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How Far off in my Thinking am I? :)

Jay Oliver
Real Estate Investor · Ocala, FL · Member since 2008 · 4 posts · 0 votes

What an interesting, informative and exciting site! I have been lurking and learning here for weeks now. Thank you to all of you who share your expertise, experience and wisdom.

I have been actively looking for my first investment property - single family home - and am having a hard time finding anything in my area that is far enough under market value to produce $100 after OE.

My plan is to buy and hold and most of what I find looks like the figures below, which is actually an REO I am going to make an offer on on Monday:

3/1 and 984 SF
Listed for 77,900
Estimate Appraisal: 93,500 - 114,000
Sold in 2006 for $110,000 - but that was during the boom...
Will Offer: 69,000
Bank Loan: 80%
Down Payment: 20% - best my area offers
Taxes: 1693.00
Insurance: 1,100
Repairs: approx 6,000
Will probably rent for about $750 - rents not = to the 1% rule in Ocala.

After I figure the taxes, insurance, 5% vacancy rate, 8% of income for maintenance (don't really know how to account for this as I'm a newbie), $210 electricity/water holding costs till rented per year, $200 for advertising to rent it per year, my OE are at 48% of my operating income . 8,400 - 3855 = 4,209.

I will have 4,209 left to pay P & I, and I will be negative a couple hundred dollars the first year. (After taxes and depreciation I will be + 300 or so). At this rate, it will take me 7 or 10 years to make $100.00 per door at 4% appreciation and debt reduction...

I figure the numbers mean my original offer is too high and I need to offer less. However, I've read that banks don't usually go below 10 to 15% of Market Value (or is it listing price?) on REOs.

I'm so new that I figure I'm leaving something out or just going at it the wrong way. I certainly don't expect to get rich quick off of real estate - but do want to begin making smart investments that, down the road, are going to allow me to retire VERY well... :D

Any input would be greatly appreciated.

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y

    That's right. Your offer is too high and you need to offer a lot less. It doesn't matter what banks will take; what the seller wants; or what the seller owes. The only thing that matters is whether you'll make money or not.

    There's some faulty logic here. Appreciation and debt reduction aren't going to improve your cash flow one penny in the next 7 or 10 years. If rents increase and expenses decrease, you could have an improvement in cash flow. On the other hand, if rents increase but expenses increase faster, the cash flow could actually get worse.

    The bottom line is that you should buy so that you have significant positive cash flow NOW. I don't know about you, but I'm in business to make money - not lose money!

    Mike

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  • Jay Oliver
    OP
    Real Estate Investor · Ocala, FL · Member since 2008 · 4 posts · 0 votes
    18y

    Ahhh....of course. Appreciation and debt reduction build equity but do nothing for cash flow. Thanks for pointing that out.

    So basically, I just need to offer the figure that will give me an adequate amount of cash flow and not worry about how far below market value it is.

    With my first post...am I missing any obvious expenses that I should be considering? (I know I didn't put 10% for a property manager...I plan on doing this myself as it is my first investment property.)

    Thanks for the response. I appreciate it!

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y

    Do you work for free? I don't!

    Mike

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  • Jay Terpenning
    Real Estate Investor · Mapleton, UT · Member since 2008 · 4 posts · 0 votes
    18y

    I am sort of new yet so don't take my word for this do the research, but are you looking to have residual income or are you willing to make a profit in a year or two?

    In my opinion (IMO) now is a great time to be renting w/ option to buy. In your contract you make the purchase price for what the appraised value is today. Set up the amortization schedule at what they will buy it from you in a year or so and also a % higher then what you are paying the bank. This way they are making you payments as if you were the bank. You are now making profit! You no longer have to worry about fixing things or such as well because you are the acting bank for them because they have bought the right to buy the house. That's the other thing, in the agreement you sell them the OPTION to buy the house for like $1500 - $3000. You keep that safe somewhere making interest and give it back to them in the closing cost as part of the agreement when they buy the house. If in the end they don’t buy the house EVEN BETTER, you keep that deposit, and start over again. You now owe less on the house, made a positive cash flow from day one + the deposit, and hopefully things have changed in the market and the house has appreciated.

    IMO this way you can do more deals too... and I agree with what has been said, you still need to offer less for the house.

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y

    Fig, that sounds nice, but unfortunately it is ILLEGAL in most places. Most places have a habitability standard that requires the owner to do the maintenance. If you make the tenant (lease-option buyer) do the maintenance, that can come back to haunt you in court in a BIG way. In addition, what happens if the tenant gets hurt while working on your property? You will be sued and you will lose. Furthermore, the tenant can argue that you were acting illegally as their employer by not having worker's comp or properly withholding taxes.

    The fact is that the majority of lease-option buyers never buy the property. In addition, charging a % over your mortgage payment does not mean you have a profit. You still have most or all of the operating expenses that a typical rental has.

    The gurus make "lease-options" sound wonderful, but the reality is quite different. The truth is that you still have most (or all) the normal tenant issues with lease-options that you have with normal rentals.

    Good Luck,

    Mike

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  • Account Closed
    OR · Member since 2008 · 1k+ posts · 845 votes
    18y

    Jayo, Mike buys in a state where nobody wants to live, and he buys in marginal areas. What he does works very well for him in his area.

    What he does might or might not work well in Florida.

    I suggest you find out what the locals guys are doing to make money with real estate.

    One thing that Mike says that is true all over is that expenses are high as you average them over the years. So you must be realistic about expenses and be sure you know where the money is coming from to pay those expenses.

    My suggestion, if you are certain that the house is a good one to own, is that you make your first offer to the bank lower. They are going to want to negotiate and they aren't going to approve your first offer. Leave yourself some room to come up.

    When you are buying to hold, "cheap" is not the only consideration. How solid is the neighborhood? Don't buy to hold in a neighborhood that is sliding into slumhood.

    Do people with incomes want to live in that neighborhood? Are there jobs in the area? Is the location commutable to work -- consider the high price of gasoline.

    Two different things that are important when you buy to hold: 1- who are the renters going to be? Cant they afford the rent? Will they want to live in your house; remeber thay have many options for a place to live.

    2- who is the eventual buyer going to be? Can your buyer affod the house? Can he get to work from there? Will he feel his children are safe? How are the schools? What are the features of the neighborhood that will be attractive to your eventual buyer?

    Buying it is only the first part of the equation. You also have to be able to rent it and/ or to sell it.

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  • Timothy W.
    Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
    18y
    Originally posted by "PNW":
    Jayo, Mike buys in a state where nobody wants to live, and he buys in marginal areas. What he does works very well for him in his area.

    Hang on a second. You can disagree but the attack is completely unnecessary. It's not a good philosophy you say "nobody" wants to live in a particular state with a sustainable population. That kind of attitude assumes your personal opinion is what the market "should" think. This is not good business and is counterproductive to true real estate investing that profits off of what a local market does think.

    And as a further side note, for a 3/1 sfr in Florida to be listed at 77,900, it's in an area that's a lot closer in culture to Ohio than you would ever think.

    Tim

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  • Jay Terpenning
    Real Estate Investor · Mapleton, UT · Member since 2008 · 4 posts · 0 votes
    18y

    Mike-

    Thanks for your advice. Like i said don't take my word for it i am still really new, though, I didn't hear any of what i said from gurus. I did the research myself when i helped a friend get into a house. We had a lawyer write up the contract on how things were to proceed with the deal.

    In the contract he agreed to be responsable for maintenance of the property and other things. The terms were agreed upon with buying the right to buy the house in a determined amount of time which was 1 year. Because of his credit he paid me a higher interest rate then i was paying the bank and he was buying the house from me for the appraised value and not the price i was able to nagociate. I made $87 a month after everything was said and done. I put all that away incase of emergencies and the deposite for the option. Over the year we worked on his credit and put money away for the future down payment. He baught the house from me at 15 months and i made overall a little more then $10k.

    I am not saying this is right... i am new and maybe there's something i don't know, but as far as i know everything was done legally and safely. I didn't do it in an LLC though which would have been safer, but i have one now and was planning on doing a few more of these kinds of deals. Let me know if i am missing something or if i was right doing everything the way i did.
    Thank you.

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  • Jon Holdman
    Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    18y
    Originally posted by "jayo":
    ... at 4% appreciation and debt reduction...

    I seriously doubt you'll see this much of anywhere in the US over the next 10 years. We most likely have a number of years of continued depreciation in prices, especially in CA, LV, and FL. We may see flattening, or perhaps even appreciation at some point 3-5 years in the future. If we see 4% annual depreciation for five years, the 4% for five more, prices will be right where they are right now, in nominal terms. In inflation adjusted terms, they will be lower.

    Now, if there are specific local drivers, the story may be different. I'm sure some places will see appreciation where there are factors that are driving job and population growth. Is there something happening in Ocala along those lines?

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y

    PNW, unfortunately, that's completely inaccurate. Ohio has a population of 11,500,000 and has the 7th highest population of any state in the U.S. In addition, Ohio's population continues to grow, although slowly in the past 3 years. So, to say that nobody wants to live here is ridiculous!

    Mike

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  • Jay Oliver
    OP
    Real Estate Investor · Ocala, FL · Member since 2008 · 4 posts · 0 votes
    18y

    Thank you everyone for your thoughts, advice and questions. It is all very helpful, eye opening and thought provoking.

    Hi Wheatie,
    I searched several reports and yes, appreciation rates have certainly slowed and fallen in Ocala. In answer to your other question, job growth has averaged 5.8% in the past two years. Less than a year ago, Ocala was rated the best performing city in terms of sustainable jobs and economic growth (out of 200 metropolitan areas in the United States) by the Milken Institute in California.

    Ocala has a stronge manufacturing sector that has grown 70 percent over the past five years, outpacing nearly all the rest of the nation. Our unemployment rate is also 1.1% below the US average, and we our the horse capital of the world. :)

    Our low cost of living is probably a factor in our population growth, which has been 22 percent over the past 5 years. Don't know if all that will help or not.

    The low cost of living keeps rents low, but property taxes are high. 100,000 house will usually rent for no more than about 700 - 850 tops and the taxes can be anywhere from 1,000 to 2,200.

    Maybe it is not the best time to get into this after all... Or maybe I need to look for another slant. But most of the pre-forclosures and REOs are in parts of town that rent for the above. I've thought about purchasing houses for $30,000 - $50,000 on the West side of Ocala where the property taxes are very low, but it is a rough part of town and being a woman, I thought better of it.

    Thanks PNW - I love the suggestion to find out what the locals guys are doing to make money with real estate. That's a good next step for me.

    Thanks for listening!

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  • Kathy Potter
    Real Estate Investor · AZ · Member since 2008 · 58 posts · 1 vote
    18y

    Jayo,
    Mike is right, purchasing a buy and hold type investment in this real estate climate we all need some certainty. The only certainty is the cash flow you can get right now. Appreciation? Debt reduction? Crystal ball?

    In many areas rent $$s are increasing as the demand increases with more bad credit, tougher lending guidelines and buyers with good credit afraid to buy. Some area may have a glut of rentals at certain price points from owners deciding to rent since their property won't sell. This will tell you if your rents are likely to go up or down over the next few years. So know this about your market.
    What somebody in this thread said about evaluating if the area is on the upswing or the decline is really important too. Neighborhoods on the decline will likely depreciate and less buyers(investors) will be interested in that enviroment later when you may sell, and the quality of the tenant you can atract will decline too.

    The $6000 repairs is that what it needs right now to make it rentable, or an annual amount you are allowing for? Annually that could be high? That expense might be less.
    Good luck! I hope you make a deal!

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  • Jay Oliver
    OP
    Real Estate Investor · Ocala, FL · Member since 2008 · 4 posts · 0 votes
    18y
    Originally posted by "azlandlord":
    Jayo,
    Some area may have a glut of rentals at certain price points from owners deciding to rent since their property won't sell. This will tell you if your rents are likely to go up or down over the next few years. So know this about your market.

    This is exactly what is happening with my area. I am assuming that this means rents will likely go down over the next few years.

    Originally posted by "azlandlord":
    What somebody in this thread said about evaluating if the area is on the upswing or the decline is really important too.

    I thought that was a great comment too; how does one go about finding out whether an area is declining?

    Originally posted by "azlandlord":
    The $6000 repairs is that what it needs right now to make it rentable....

    Yes...that is to make it rentable - not what's needed each year. It may be a little high, as I priced things out on the high side and then add 10% to be safe...

    Can anyone tell me...when you get a loan, how do you factor in the cost of acquiring the loan since it is a one-time cost?

    j

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  • Aly W.
    Investor · Middletown, NJ · Member since 2008 · 2k+ posts · 1k+ votes
    18y

    Hi Jayo,

    I just purchased my first rental SFR last month and it's been quite the learning experience. My house also needed several thousand to get it rentable. Two initial estimates were the same, but actual costs ended up being more than double, and took twice as long. For every item I knew needed to be fixed or replaced, 4 more unexpected items turned up. If you budget $6K, double it.

    If you plan to accept Section 8 tenants, get a copy of their Housing Quality Standards. Ensuring your house will pass a Section 8 inspection may require additional items.

    Even though I got a credit from the seller to fix a broken pipe, I still overpaid, given what I ended up spending. And having spent close to $200 in advertising costs in a month (in addition to placing free ads online, in local stores, in the city housing office, etc.), I still don't have a tenant. Plenty of responses to my ad, but no tenant.

    I'm not discouraged (yet!) but am glad I have a cash cushion to fine tune this experience. The purchase of the next property will be a different story.

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  • Kathy Potter
    Real Estate Investor · AZ · Member since 2008 · 58 posts · 1 vote
    18y

    Jayo,
    To tell a neighborhood is declining you normally can just drive thru and look around. If it is pretty much consistantly ratty looking, if over half the homes on a block are kind of yuck and the rest are not too great (Hope my adjectives make sense). Weeds in the yards, junk cars, what your gut tells you (the best judge). If commercial or retail is close by, how does it look, is it vacant or doing business and the condition of it and what type of businesses. Check the web for crime stats and sex offenders. But compare those to your own neighborhood, since sometimes they can look worse than they are.
    On the upswing you might see some yuck but some that were yuck being rehabbed and owner occupied. New construction pockets of residential, multifamily, apartments, retail, etc.
    Or some neighborhoods can be just staying the same, not declining or improving. Those are ok too. Predictable.
    If you are not comfortable with your ability to judge, ask your real estate agent or a real estate agent or other landlords in the area.

    For your closing costs, your prepaid interest & monthly interest, taxes and insurance are expense against your profits annually the rest are added to your "basis" , the value you use for capital gain or loss when you sell.

    Hope this helps!

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  • Kathy Potter
    Real Estate Investor · AZ · Member since 2008 · 58 posts · 1 vote
    18y

    Jayo,
    Maybe look at multifamily to get the cashflow you want?

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  • Timothy W.
    Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
    18y
    Originally posted by "azlandlord":
    Maybe look at multifamily to get the cashflow you want?

    If you do get a multi - get them in the best part of town. I have a multi that is far and above in the better part of town than my sfrs and it's still harder to keep tenanted than sfrs in the lesser desirable parts of town.

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  • Kathy Potter
    Real Estate Investor · AZ · Member since 2008 · 58 posts · 1 vote
    18y

    You may find multifamily in the better part of town won't cash flow either right now. It won't here, but you could check your area.
    A couple of rungs up from what I call "the bottom" might be the best bet.
    Affordable, in town, so big tenant pool, but not fearing for your life or tenants who are too undesirable. Keep it clean and do maintenance as needed and your tenant retention will be good.

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  • Timothy W.
    Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
    18y
    Originally posted by "azlandlord":
    You may find multifamily in the better part of town won't cash flow either right now. It won't here, but you could check your area.

    If you find one where an overworked REO realtor screwed up and listed it as a single family you might do fine. :wink: I see one of these on average every 6 months.

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  • Kathy Potter
    Real Estate Investor · AZ · Member since 2008 · 58 posts · 1 vote
    18y

    Jayo,
    IRS info in regards to closing costs question you asked. Scroll to second question on the page.
    http://www.irs.gov/faqs/faq-kw26.html

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  • Michael Rossi
    Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    18y

    Jayo,

    You've got a lot of different suggestions in this thread - multis, SFHs, good areas, lower income areas, etc. Here are mine:

    1. Do whatever it takes to understand operating expenses BEFORE YOU BUY ANYTHING. Failing to account for the real world operating expenses is the NUMBER 1 reason that the vast majority of newbies fail. Check out this thread http://forums.biggerpockets.com/viewtopic.php?t=19967 It is long and got a little contentious but thoroughly covers all aspects of the subject.

    2. Become an EXPERT in your market. I would suggest getting out of the house and looking at a minimum of 100 properties (inside and out) for sale in your target area. You need to look at enough that you KNOW the value of the property by simply looking at it. It's YOUR business, and you must know your market if you want to succeed.

    3. Join your local REIA and make friends with the SUCCESSFUL investors in your area. Your new friends will know all the ins and outs of your market and will even know of deals from time to time.

    4. Start with SFHs if at all possible. SFH rentals are a lot more forgiving than multis.

    5. Don't work for free. Your rental should generate positive cash flow from day one and you should be paid for whatever you do.

    Good Luck,

    Mike

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