Potential deal on 5-units
Real Estate Investor · Erie, PA · Member since 2008 · 38 posts · 4 votes
I found a property near my home that is in a decent area. I live in an area where cash flow is fairly easy to come by but appreciation is low. The deal consists of two buildings on one parcel of land: a triplex and a duplex. The numbers look like this:
Property price: $47,000 (our offer)
# of units: 5
Monthly Rent: $1,900
Expenses (assuming 50% rule): $950
Down Payment: $10,000
Monthly Debt Service: $287 (20 years at 7%)
Monthly Cash Flow: positive $663 ($130/unit)
I've had the place inspected and it will take some money to fix it up. We can afford the renovations if we decide to purchase the property.
Estimated cost of renovations: $15,000.
To me, this seems like decent deal... but I'm still very new. What's your opinion? What am I missing?
Looks like a good deal to me. The deal itself looks like this:
$47,000 - purchase
$15,000 - rehab
$412/month - payment on purchase + rehab, 30 years, 7%
$1900/month rent
$950/month NOI
$537/month cash flow - looks good to me.
with your financing and calculations, you have a year 1 cash-on-cash return of 32%. Also very good.
Wheatie,
First off, thanks for the response. I have 2 follow-up questions if you have time.
(1) I'm sure this was probably explained somewhere else, but I can't find it. What is the logic behind using the purchase price + rehab costs to calculate your monthly mortgage payment?
(2) Is there ever an advantage to taking out a shorter term mortgage (maybe 10 years)? I understand that it cuts down on immediate cash flow, but is there a long-term advantage?
1. Because you are doing calculations on the Total amount of money invested into the property itself and want to determine it's true cap-rate.
The Cap-Rate is the amount of money you earn each year on the total amount of money invested into each investment.
2. The way I see it is there is no advantage to taking a shorter term mortgage in most situations. But this can be an even more profitable deal to you than what you have before you, let me explain.
Now what you can do is get and ARM program that has a four option pick a payment plan (don't get worried just yet) and choose to make the interest only payment. Mind you you will have a fix for some time until the payment itself adjust accordingly. If you do this your interest rate will go down a bit and will be around 5% and a payment of $332 a month.
Now you have more money in your pocket and you can put it into an IRA account to build interest on the money that would have gone to the principle. Instead of letting the lender profit off your money why not let it work for you, and now your money will gain an interest of 9%.
You can drag out the loan itself and make the ballon payment when your 30 years is up. And the best part is you will have a huge chunk of change in you IRA account even after paying off the loan. Remember that IRA's gain interest tax free and can be taken out tax free (if taken out before the age of 59 yrs 6 months you are subject to a 10% penalty tax). And if something bad happens you will have much cash reserves in your IRA to make sure you can sustain any problems.
Thank you for your time.
Calixto's correct about why I was including the rehab costs. You want to look at the deal by itself, so you should include all costs. Sometimes people will say "this will cash flow if you put down 30%". Thats a line of bull to convince you a bad deal is really a good one. The hidden assumption there is you're willing to put money into an investment that returns NOTHING. If I put money into an investment, I want a return on that money.
Cash-on-cash is really the better way to look at a deal, IMHO. Banks will pay 4-5% with zero effort and zero risk. Stocks should return about 10% with minimal effort and some risk. Real estate takes a lot of effort and has pretty high risks. Leveraged real estate also has the nasty attribute (as MANY people are finding) that you may have to pay to get rid of a bad investment. So, I want a really nice cash-on-cash return for property.
I think shorter term loans make sense if you're intention is to hold the property long term. Especially if you're building a income producing portfolio. If the property is a good deal, the paying cash makes sense. After all, you pay cash for almost all other investments.
I don't care for the ARM scheme Calixto describes. Every dollar I pay in interest is a dollar out the door. Even with the tax deduction, its some large fraction of a dollar that should have been mine and isn't. Your scheme, Calixto, amounts to borrowing money (the principle payments you would have made) and investing it elsewhere. If it works, you're borrowing at a low rate, further discounted by your tax rate, and earning a higher rate in an alternative investment. An IRA is not tax free, just tax deferred. You pay tax on that money when you take it out. Money going into a Roth IRA is taxed first. So either way, there is still tax, and that reduces your effective rate.
Getting an ARM also exposes you to higher rates in the future. A marginal investment (good only because your IO payments make it acceptable) could quickly turn into an albatross. Interest rates are quite low right now. IMHO, it would be dumb to get anything except a fixed rate loan. I believe there is much stronger likelihood mortgage rates will go rather than down. If they do go down, refi. An ARM has lots of risk. A fixed rate loan minimizes your risk.
This scheme sounds like some sort of guru or seller nonsense to convince you bad deals are really OK. "Here's a deal that won't cash flow with a 30 year mortgage. But it works with IO. So, invest the difference between the IO and 30 year loan payment (where does that come from, if the deal doesn't work with a 30 year note) and earn some more money on that". If the alternative investment is the better deal, why not invest the whole payment in that deal?
Could not have said it better myself Jon, too many people get caught by maketing schemes and end up biting it hard in the end.
I would not call it a Scheme for that word sounds too harsh for the investment idea I had in mind. And the way I see Jon is that you have to spend money to make money, for all that interest you pay is for an investment purpose and is 100% tax deductable. This is a very good way to leverage your income at the end of the year when tax season comes along my friend. Yes it amounts to borrowing money (if you want to simplify the meaning), but that is what the banking insitution you pay the principle does to it anyways so why not.
Yes and IRA is not tax free it is tax deferred and you do have to account for taxes on the money itself before you contribute to the account.
Tax-Free Distributions. Qualified distributions from a Roth IRA are Federal income tax free. While your contributions to a Roth IRA are never tax deductible, your distributions are free of federal income tax. If you have owned the Roth IRA for at least five years and meet one of the four qualifying events outlined below:
You are at least 59 1/2 years old.
Your withdrawal of up to $10,000 (lifetime limit) is applied to a first-time home purchase. (You may qualify for the "first-time home purchase" if you have not owned a home for at least two years before the date on the purchase contract or the date when construction started. You, your spouse, or a descendant or ancestor of either may qualify as the buyer.)
The withdrawal is made to a beneficiary or to your estate as a result of your death.
The withdrawal is made because you are permanently disabled.
Withdrawals. The taxable portion of a nonqualified distribution may be subject to a 10% early withdrawal income tax penalty prior to age 59 1/2. If you make withdrawals that do not meet the rules for a qualified distribution, you’ll owe ordinary income taxes on the portion of the withdrawal that represents earnings, and you may also have to pay a 10% income tax penalty if you are under age 59 1/2. Withdrawals prior to the age 59 1/2 that are used to pay for qualified education expenses for you or other family members are not subject to penalty tax, but you will have to pay ordinary income tax on the taxable portion of the distribution, however.
I am not a Real Estate guru nor am I caliming to be one I just thought it would be some nice information to know. It is not my job to convince the man that my way is the best nor is it your job to convince him otherwise. If you do not like my idea then tha is fine Jon you have stated your opinions and I have stated mine. And I think we should leave it at that my friend, thank you for your time and have a wonderful day.
Guys, I appreciate your opinions and the information that you've shared. It's obvious that you both are much further along than me and I'm learning as much as I can every day. I'll consider all of what you've said before making my decision and let you know how it goes!!!
Get that deal done!!!!!!!!
That's all I will say, seems like a great deal, I would jump on it in a heartbeat!
Felix, you received some good advice here on the evaluation of your deal. It looks great to me as well. One thing to consider here: The up-side potential which can be very beneficial to your bottom line. Buying multiple buildings on one tax parcel allows for the divide and conquer tecnique. If you were to get approval from the city.county, re-plat the lot and subdivide it so that the tr-plex sits on one parcel, and the duplex on another, you could sell them individually and they would become residential properties (4units and belwo) which are valued based on comps and not cap rates. This could mean receiving higher sales price.
Again, your deal looks good, and if you decide to pass or want to assign the deal let me know. I may be interested in it.
Good luck.
I worked out the details with the bank yesterday. We are purchasing the property for $47,000. I guess the next step for me is negotiating the best terms with the bank. Any suggestions?
Felix-
This all depends on what lender you decide to get financing from and what you have that will be of use to you. for example you credit score a real big plus if you have a 700 or above. You can also get a better rate with reserves in the bank that have been seasoned for 60 days or longer. (in this case I would have to say $5,000 or more in the bank) Also do you have any other assets that you can use to help leverage a better rate on the loan itself, you see the less likely it is for a lender to lose their money the better rate you will get.
Thanks for the response. One advantage we have using the bank that we are using is that my dad owns a successful business and has always had his accounts at this bank. It's a small town so everyone knows everyone and thankfully my dad's name carries some weight at the bank. They are certain that they'll get their money back so I should be able to negotiate pretty good terms.
As for my goals, I'm looking to rent for awhile and then sell in about 5 years (depending on the market). Any advice on what terms I should shoot for?
This is a deal but you would need to find out your repair cost and what other problems that you may run into.So before you go to the bank I think that you should take $350.00 and get a "Inspection" done because with old homes come old problems a licencsed inspector can come out and give you a complete overview of what is wrong with the property.After that is done then have a contrctor come out and bid on your rehab job so that you can accurately estimate your cost of repairs.But good job on your first time out.
GET THAT MONEY MAN!
I actually did have the place inspected. The inspector and I sat down and came up with an estimate of $10,000 to $15,000 in repairs. I've also talked with several contractors to verify the home inspector's estimates. We're supposed to close this week.
As a follow-up to an earlier suggestion, is there any downside to subdividing? What's the risk vs. reward?