Income Real Estate Investors: Learn How to Analyze a Property before you Get Burned!
Author: Joshua Dorkin • URL: http://www.biggerpockets.com/July 27th, 2007 •
I noticed a property listing on Craigslist, titled “$150000 THIS IS THE BEST DEAL IN TOWN” and decided to take a look. Since I was about to find out about the best deal in town, I was really anticipating what was to come. Sadly, what I found was just another loser property. If you’re new at investing in income properties, this post should be quite helpful to you. With that in mind, I thought it might be interesting to find out just why this deal was so good and decided to ask the poster . . .
The description:
THIS IS THE BEST DEAL IN TOWN AT $150,000.00 EACH OR BUY BOTH FOR $300,000.00! LIVE IN ONE AND MAKE MONEY IN THE OTHER, RENTED NOW AND INCOME OF $900.00 EACH CAN AND WILL RENT AT MARKET $1,200.00 A MONTH . THIS IS A CHARMING VICTORIAN DUPLEX, GORGEOUS INSIDE AND OUT! IN PRISTINE SHOW HOME CONDITION AND EVERYTHING IS RE-DONE TO BRING BACK THAT OLD WORLD CHARM! EACH SIDE CONSISTS OF 3-BEDROOMS/ 2 FULL BATHS: MAIN FLOOR: ONE BEDROOM, FULL
RE-MODEL BATHROOM WITH BODY SHOWER AND UP TO DESIGN SHOW BATH ROOM! LIVINGROOM WITH NEW CARPET AND WOOD FLOOR ENTRY, FIREPLACE WOOD BURNING, DININGROOM WITH NEW GLOSS WOOD FLOOR AND DESIGN LIGHT FIXTURE, EAT IN KITCHEN WITH NEWER APPLIANCES AND LARGE PANTRY NEW FLOOR AND COUNTER TOPS AND RE=DONE CABINETS, HALL WAY WITH THE LARGEST CLOSET SPACE THERE IS IN HOMES TODAY! DOWNSTAIRS: TWO BEDROOMS WITH NEW CARPET, LARGE FAMILY ROOM NEW WOOD FLOOR WILL BE PUT IN, FULL BATH WITH NEW EVERYTHING!! LARGE LAUNDRY ROOM WITH WASHER AND DRYER! BACK YARD FENCED IN WITH ONE CAR GARAGE FOR EACH HOME AND PARKING NEXT TO THE GARAGE ON EACH SIDE, FRONT YARD HAS MANY FLOWERS AND 8 FOOT SUN FLOWERS FENCED IN, FRONT DECKS AND WONDERFUL CHARM! EVERY ROOM IS PAINTED IN DESIGN COLORS! THIS DUPLEX IS WONDERFUL AND A MUST SEE, THE PRICE IS RIGHT AND 5280 MAGAZINE FEATURED THIS AREA AS THE NEW AND UP AND COMING TOP INVESTMENTS! CALL (names & numbers removed) FOR A WONDERFUL SHOWING!
I was immediately impressed by all of the CAPITAL LETTERS used in this ad. It must really be something special!
Upon looking into the ad, I noticed that this was a duplex selling for $300,000. The agent selling the property is also trying to sell the units independently (as in condos?). Intrigued, I wanted to find out why this was the best deal in town and decided to crunch some numbers. I sent the following email to the agents listed:
(names removed) -
I just wanted to make sure that you saw that the deal you are offering as the best in town is a money-losing proposition. Why is it being offered so high?
Analysis:
Cost of both units = $300,000
Gross Annual Income = $28,800
Expenses = $14,400 (average rental expense approaches 50% Gross Annual Income)NOI (net operating income) = $14,400
Even with 20% down ($60,000) with a 30 year loan of only 7.25% , your monthly debt service would be $1637/month.
This property would lose $437/month
What kind of appreciation is the area seeing to make this the best deal in town?
I look forward to your thoughts.
Best,
Josh
First, I was astounded that I’d heard back from these people. I was further impressed by the response (I hope you sense my sarcasm by this point):
Hello,
Thank you for your input and thoughts, always good to hear from others. The average price in this area is $165,000.000 for a home of 2-bedrooms and one bath and one living room. The duplex has 3-bedrooms, family room ,2- full baths in each and both have been full upgrades, with the market in Denver for a condo going between $200,000.00 and $450,000.00 and it being only a one bedroom, I would say the duplex is priced as the best deal in town. Also keep in mind that the area was zoned for many years as commercial and not residential.. as of August 2006 it is now zoned as residential. As stated in 5280 and many other resources this is the area to buy now! With a market of many homes for sale, and to be honest they are ,let’s say, not worth walking in the front door!, it is refreshing to see a home or homes in this matter, that are show home design. One can always add up a guess of what the cost and profits would be, but it all is set on ones credit with a mortgage and the rates one will get, what kind of residents one has in the homes and how one approaches the matter! The current owner has 16 years in property management, property marketing and sales and turst me, owners do not spend 50% of the year income by far. Market plans are: monthly fee for garages, resident pays electric, water/sewer, gas and rent and the year dranage cost by denver about $45.00 a year. So to end, 6- bedrooms, 2- living rooms, 2- family rooms, 4- full baths, 2- dining rooms, 2- kitchens, A brick home and 2- car garage and 2,900.00 SQ feet. I would say THIS IS THE BEST DEAL IN TOWN!
Thank you
Sincerely
(name removed)
Essentially, his USP (unique selling proposition) is that a magazine and other sources which are un-named, say that it is in an area which you should buy in, and that the property is in showing condition. He compares the property’s price to that of SFHs (single-family homes) and completely blows off my simple and dirty analysis of the property. In addition, he provides no solid numbers on appreciation (I requested those), and the only real number he mentions to me is a drainage cost of $45/year. It seems that my “guess” of what operating expenses are (I used 50% for simplicity - as do many other experienced investors - over my experience and that of others that I trust, these costs typically range in the mid to upper 40% range) were WAY OFF. He tries to explain that cost and profits are determined by mortgage rates and “what kind of residents one has in the homes and how one approaches the matter.” Why then, does it matter what the property can rent for? The logic just makes no sense.
Even if I used a much better mortgage rate of 6.00%, debt service on this property with 20% ($60,000) down is $1,439. Since his argument was that some people can get great rates, I’ve accounted for that, and the property still results in a monthly loss of $239.
If we were to drop expenses to 45%, we’d see annual expenses of $12,960, leaving NOI at $15,840 or $1320/month. With the 20% down, 6% loan scenario, this property loses $119/month.
Is it still the BEST DEAL IN TOWN???
Remember, that the role of an agent is to SELL. There is a reason that real estate agents have “Real Estate Sales” licenses. This one may or may not be experienced in working with investors or investment properties, but it certainly doesn’t sound that way. If you’re dealing with these kinds of properties, make sure that you fully understand basic property analysis before going and getting sold on an income property that just doesn’t cut it.
If you want to learn how to analyze a property quickly and easily, join our Free Real Estate Investing Forums to find out how!
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Joshua Dorkin
Charles Feldman
Ted Karsch.
Richard Warren
Hey Josh,
Great post. Kind of funny seeing how a real estate broker will “twist” the facts to put a slightly better light on it huh.
The realtor didn’t say… but his thoughts seem like he is saying it’s the best deal in town for someone who decides to live in one unit and rent the other out (still not that great of a deal).
When you compare it to a SFH like he is doing, a person living in a SFH for a comparable home may be paying something like $1k to $1500 a month (mort., expenses, etc.). So, I guess that versus the smaller negative cashflow that the duplex produces makes it a “good deal” according to the realtor. Terrible logic on his part… but for someone who wants to live in one half and doesn’t care about living in a duplex… it may be a better deal than buying a SFH.
Anyhow, like you said, realtors are there to sell real estate and it is up to us to determine what the right price is for our objectives. While I definetely wouldn’t touch this deal as an income property investment… it may be a good deal for a first time home buyer looking to get into a home and decrease their monthly payment. (still need to be ready to make the full payment though when the other unit is vacant)
Nice work on calling out the realtor by the way
Trevor M.
Just to bring in a different point of view on this Craig’s List ad I’d offer the following…
In my market, North Central Massachusetts, but I think it applies to a good portion of Central and Eastern Mass. as well, investment in multi-families including duplexes has been crazy lately.
When it comes to marketing duplexes and multis such as three and four families, more times than not the debt service isn’t even part of the equation. 90% of multis are selling to investors that are basically looking for an investment where they can park their cash and earn a decent return on it.
Investors are not taking out 80% or even 70% mortgages, they are putting 50% and usually more down as the result of a 1031 exchange so their debt service is very low. Less important than monthly income is long-term appreciation and avoiding paying Uncle Sam.
I’ve seen properties selling that basicaly break even cash flow wise but the buyer is able to sell a property he has owned for years and cash out and put his money into a solid multi with good tenants and he can make a solid 8.5% return on his investment.
If an investor was cashing out and had $100K plus to invest, the numbers look a lot different…
Just something to consider….
I agree with most all of your points. The average investor these days does not know how to properly analyze an investment property. I built my own excel spreadsheet to do it for me. If anyone wants it e-mail me at: Jfox [at] highriseloan.com -Jason in Las Vegas
[...] Dorkin of BiggerPockets.com had a great analysis of a property advertised as "the best deal in town". You can learn [...]
I think this is a great post and points out that especially in investment property it is “buyer beware”. I think this also speaks to the importance of getting a real estate agent to work for you on the buying side of the transaction. The selling agent does seem to be stretching it quite a bit, but they don’t work for the buyer. Get a good agent who can weed through the junk like this one and your life will be much easier.
The response of the agent was not surprising. For many less-savvy investors, this would have seemed like an incredibly attractive deal. Their response shouldn’t come as a surprise, though- I just dealt with several brokers in NYC, and very little of what they say can be believed. Keep up the great work on your blog!
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This is really a great post. This will definitely help out in analyzing the property and save you before any mishappenings.
Current real estate markets nationwide have created countless opportunities for buyers looking to purchase real estate priced well under market value. Many buyers have turned to short sales, foreclosures and bank owned (REO) properties hoping to be able to purchase real estate for pennies on the dollar. The buzz in distressed real estate has been perpetuated by urban legends; someone’s brother’s, friend’s, uncle’s, co-worker’s dog who bought a home at 10 cents on the dollar. This buzz is further fueled by late night infomercials filled with testimonials of people who “bought a $500,000 home for $12″ and then try to sell you the secret program that teaches you to do the same.