whats the catch?

Question

I'm going on tuesday to check out a 5 bedroom rental property that is a short sale and listed at 85k.  However, the description says the house is valued at 185k.  How could this be?  How could a house be listed at 100k less than an appraisal.  Can I expect to see a house in need of dire repairs?  I've ran the numbers and if I can keep the house going at a 1400 dollar a month income from rents, and will be netting almost 400 dollars a month.  Is this deal still sitting here because it is a short sale and people don't want to wait long for it to close?

Tony Tomasek · Answer

Oh the part I forgot was after I finance out my repair money the cash flow will be 300-400/mo

Tony Tomasek · Answer

This looks a bit pricey for a rehab when you look at the cash flow.  To give an example of what I look for, I am closing on a property that is $30,000.  I have a bid of 10,000 for repairs, this I can inflate to 15,000 at least to get an accurate picture.  This property will bring in at least $1200 a month in rent and should cash flow about $300-400 a month at least.  Dont be afraid to make offers and move on.  In a declining market like SE Michigan, I would like to see a ton more cash flow.  Buy at a big discount or move on.

Jon Holdman · Answer

Yeah, I would never bet on 10% appreciation in this market.  I think we'll be lucky to avoid falling prices for the next few years.  We won't see appreciation until prices fall back in line with the long term, inflation driven trend line.  Fortunately for housing, inflation is increasing, so that trend line is rising faster than it has recently.

I do think you have to look at local factors.  If you know a major employer is moving in, for example, you have good reason to believe demand will increase.  Vice versa if a big plant is closing.

So, in your example, I would look for a deal with higher rents, a lower price, or both. Or, I'd want to have some confidence there's something local to drive appreciation.  In your specific deal, I might look for a way to do the deal with less cash on the table.  Hard money then refi, or some sort of rehab loan.

Keep in mind, too, that if you do get appreciation, that you don't need 10% to get a nice return.   Because of your leverage, appreciation is magnified.  So are falling prices.

Michael Rossi · Answer

I think it's interesting that you're talking about appreciation in a generally depreciating market.  We've had a runup in prices over the past few years that have been unprecedented.  We could easily have an unprecedented decline.

Mike

Alexander Ball · Answer

And does your 20% figure already factor in inflation?

Jon Holdman · Answer

Mike's method is to assume 100% financing, and see if the deal works.  What that means is that you're paying yourself the same return on the down payment as you're paying on the loan.  Too many times you'll hear "will cash flow with 20% down".  What the person saying that means is, "if you invest your down payment with no return, the property will seem to cash flow".

Another way to evaluate it is to compute a cash on cash return.  Take the annual actual returns after all expenses, divided by the total cash invested.  If this is 4-5%, forget it.  You can get that at a bank for no risk and no effort.  Stocks, over the long term will give you 10% with more risk, but equally little effort.  For real estate, I want to see 20% or better.  Or, I want to be convinced somethings happening that will drive up prices and demand.

Alexander Ball · Answer

"Buying cash flow with a downpayment does not change the quality of the deal. "

Definitely something to consider.

Michael Rossi · Answer

You missed a BUNCH of the expenses, such as vacancies, management (even if you do it yourself), advertising, utilities (at least during vacancies), legal fees, evictions, capital expenses (not technically an operating expense), etc.
                        
                        Moreover, the real cost of this rental is $80K IF the $20K repair estimate is correct.
                        
                        Here is how I see this deal:
                        
                        Gross rents:  $1,200
                        Operating Expenses:  $600
                        NOI:  $600
                        
                        Mortgage Payment ($80K, 30 yr, 7% NOO):  $532
                        
                        Cash flow:  $68 per month  (a little low for me)
                        
                        Buying cash flow with a downpayment does not change the quality of the deal.
                        
                        I would nail down those repair costs and then base my offer on an acquisition cost (purchase price + repairs) that would give me a cash flow of $100 per month.
                        
                        Good Luck,
                        
                        Mike

Alexander Ball · Answer

So I saw this property today.  Realtor, who is a buyers agent with her own rental properties, estimates repairs at around 20k.  Listed at 85k, but I am going to put in an offer of 60k.  Cash flow estimates are based on a 20% down (12k principal and 48k load) 30 year loan at 7.5%.  How does this look?
            
            Rental Income = 1200 (seller said he had it at 1400 before)
            
            Expenses:
            Mortgage - 335.62
            Taxes - 396 (gross I know)
            Maintaince - 25
            Repairs - 80
            Total -- 836.62
            
            Rent Income less expenses = 1200 subtract 836.62 = 368.38.
            
            Total investment = principal + repairs = ~32K
            
            32k for a 5bedroom house with comps at around 120k