We're newbies...go easy! :D
We're about to buy our first investment property, a duplex with excellent income. It has been on the market for 200+ days.
We're making an offer soon. Is there a rule-of-thumb for the initial offering price?
The seller is selling off some of his numerous properties in the area, so we're not sure how motivated he is.
Thanks for any input.
Littleivy,
In you post you say that it is a duplex with excellent income but you don't yet have a purchase price or even a price to offer. How do you know that it has excellent income without knowing the purchase price?
A general rule of thumb for maximum purchase price of rentals is to divide the monthly gross rent by .02. That will give you a general idea of the maximum you should pay if there are no repairs needed. Of course, you still have to do a cash flow analysis using real world expense numbers and you should also consider the equity situation.
Mike
Thank you for your comments, Mike.
We've done the analysis, and for our area this property looks solid.
Your figure does not apply to our area. It is an area of very inflated prices, one of the highest in the country.
I thought there was perhaps a ballpark strategy that you wise folks use in making an offer.
Thanks again for your help.
The math does not change because you live in an area of over-inflated prices. The property either cash flows or it doesn't. $1,400,000 for a duplex that generates gross rents of $8,800 per month sounds like suicide to me.
Mike
I'll have to second Mike....this is a loser. Run the other way.
Yowza! Let's do some quick math...
1.4M @ 7% for 30 years is over $9300/month!!!!
And your income is only $8800/month? Please do not buy this property! It has serious negative cash flow before factoring in taxes, insurance, and the 50% gross rents expenses. Insane!
Forget whether the math works for your area. Why would you ever buy a property like this? I don't see any angle where this could be anything but a HUGE loser.
Sorry to be harsh, but from your last response it sounds like you are not listening! No one wants to see you lose that much money...
Thank you for your concern!
I am listening, and we're crunching numbers.
I don't know where you live, but we can't buy a property with 0 down.
We'll be taking some equity out of our home, using some cash getting the mortgage down. After taxes, we're looking at positive cash flow.
Rents will be going up, and this community's property values are expected to keep rising, albeit slower than they have in the last few years.
We're thinking hard about this investment. I do appreciate your concerns.
Hi Little Ivy,
I have to jump in because this deal looks scary.
:shock: I don't have the experience in RE that I do in the stock market (there are far more experienced people on this forum than me), but there are just some common sense things here that put up big :protest: no flags to me.
Let me ask you. If you really could get $4,400 for each unit of the duplex, how many college students do you think would have to pile in to make the monthly rent? Have you factored in vacancy as an expense? Surely, students will be going out in the spring and back in the fall. Just 2 months of vacancy could be very painful. Incidentally, who is telling you $8,800 a month? This sounds highly inflated even for California! I have lived here all my life.
Looking at the bigger picture, before you spend a dime in expenses you will be getting a 7.5 percent annual return without a day of vacancy. Now start putting your debt service, taxes, insurance, maint., HOAs (if applicable), vacancies, adverstising against it. Wouldn't you do better in a Money Market Fund and not have the headache of being a landlord to tenants who tend to turn over frequently and could likely be very hard on the place?
One thing that too many people have learned the hard way, and I have come to realize as a fact since reading this forum is that you have to calculate 45 to 50 percent of your gross rent as expenses. I know that seems high, but over time it really does work out that way.
I hope you will take a deeper look before taking the equity out of your home.
Robert
We'll be taking some equity out of our home, using some cash getting the mortgage down.
Any deal will cash flow if you put more money down! Try putting 100% down on a property. That's not the point, obviously, and that's why analysis is done as if you are putting nothing down (even if you aren't).
If you really want to do analysis with factoring in money down, you need to charge yourself at least 6% interest, because that is what you would have been making if that money were in a CD.
My friend, you are absolutely not looking at positive cash flow. You are looking at serious, serious negative cash flow in this property. I didn't even get into an actual calculation of the expected cash flow because this deal was so clearly a loser. Average monthly expenses for a rental property are 50% (some braver souls use 40%) of gross rent. Quick calc in my head... this puts you at a $4900/month loss before factoring in tax benefits.
Thank you all!
Actually, the leases have been signed for the next year (begninning July 1), and were signed last January for the coming year. There are, I believe, 6 people signed in each unit (2 in each bedroom). Very typical for this community. They are year leases, which is typical for all the rentals in this unique community. There are usually no vacancies. I expect rents to continue to rise, and when my kids go to college in 2-4 years, they will be able to live there if they wish (and yes, they'll pay rent!)
Actually, the seller has disclosed that expenses are about 29% of GOI (about the same as other properties we've looked at in the area). This includes taxes and management fees. There are no advertising costs because this area is in extremely high demand (rentals are filled by February for the following July-July leases).In addition, values our area is expected to appreciate. This property was bought for 1.2M about 3 years ago (the beginning of the buyer's market). It appreciated 200K in those years. ...I know, I know, not great.
I haven't fallen in love with the property. ....I've fallen in love with the RE market here. I have lived here a long time and have seen my home increase in value from 275K to 1M in the 13 years since we bought it....and our first home, which we kept as a rental, has increased from the 195K that we bought it to being worth about 850K+.
There won't be. Our tenants will be paying off the mortgage on the property plus the mortgage on our home and all the expenses associated. We may break even or take a tiny profit to begin, but rents will go up. Luckily, there are some wonderful management companies....and parent co-signers...and we won't have to deal with the day-to-day headaches. And, yes, we've considered investing some of our equity, which we will also do! :DI don't want to seem argumentative...I certainly agree with all of you that real estate is a great investment. This may seem marginal at the moment, but I really believe that it will be a wonderful long-term investment. We aren't "flippers" for sure. We buy and hold. I believe our children will be very glad that we bought this property when they inherit it.
You all have made very good points, and we have looked and looked and thought and thought about it.
By the way, where do you all live, and what kinds of rents can you get on a $1.4M property? I'm interested!
Thanks again!
I wouldn't sign for a 1.4 mil property unless it produced about 21 - 28k in rents a month.
If you're ready to believe what a seller says the expenses are...well hey - I got a bridge to sell you too...
And never bank on apppreciation, especially in an overinflated market.
If the seller, who is trying to get rid of this property, is reporting that expenses are 29% of GOI, what do you think they really are?
The point he is making is that you clearly have a lot emotionally invested in this deal. We are giving you an analysis on the numbers alone and you are fighting us tooth and nail. Multiple people here, myself included, have nearly screamed in horror when you gave them the numbers. If you want to justify the purchase that badly, then why are you asking us in the first place?
(Yes, I realize you didn't ask us to analyze the property per se, but you asked for a reasonable offer price, which is absolutely tied to what will make the property a good deal, which of course requires analysis.)
Bottom line, if you are absolutely convinced that it is a good deal at 1.4M, then take it at 1.4M.
I also won the lottery the last time I played, so I figure I'll be a shoe-in for the next time I buy a ticket.
Have you seen this graph? Do you think the current market is continuing this trend?
http://graphics10.nytimes.com/images/2006/08/26/weekinreview/27leon_graph2.large.gif
You will absolutely have negative cash flow. Please make sure you have adequate reserves to handle this.
Some of the people here telling you this is a horrible (not "marginal") deal are buy-and-holders as well.
It sounds like you will buy this property. In that case, I very much hope we are all very wrong and the community you are looking at has economics so unique that it makes a hugely-negative-cash-flow property a good deal. Please be very careful, stay alert to the situation, and get out ASAP if you see signs that the advice here might have been closer to correct than you originally thought.
Good luck.
mwarden,
The FACT is that the vast majority of newbies fail. Someone must make up those statistics!
Mike
Interesting graph. Point taken.
I do know this about our area: it is highly desirable and there is no new building going on (or very little) due to geographical and political restrictions....as I outlined above, this student community is also unique.....I do think there are unique economics at work here.
Before we do purchase this property, we'll consider all of your comments. We've thought about investing in another area of the country, and we still have some trepidations about this. I'm not fighting you tooth and nail....I don't even know you; I certainly don't have to justify anything to you. I've been trying to present the facts as factually as I can.
Does every seller lie? Do you? Other sellers have given similar estimates of their expenses....should I disbelieve all of them?Can I hear from a few others about Cap rates and GRMs in your areas?
Also, another question.
You say that properties should be considered as 0 down and mortgaged to the hilt....and that there should be amazing income.
So, where does "investment" come in? Why doesn't every Tom, Dick and Harry in your communities buy (or, it seems, be gifted) investment property?
Truly....I'm interested in how this works in your communities.
You have a lot to learn about investment properties--like NOT counting on appreciation. GREAT if you get it but don't bank on it! Too many people go bankrupt running backwards awaiting big appreciation to fall from the sky.
So maybe? you won't EVER have a vacancy (no one will ever walk out on a lease--nobody ever drops out of college). How much will your taxes be? Insurance? 29 percent expenses may have occurred in good year. Sounds like the seller hasn't replaced a ROOF recently.What is property management costing? You do pay for advertising through them! You are clearly seeing the sugar coated side of this deal. 6 college kids in a unit!!!! Sounds like A LOT of abuse to your property. If you only take one thing away from this forum do bank on the 45 to 50 percent expense number--over time it WILL happen. People write in almost daily into this forum because they figured 30 percent expenses and ran negative--people with much better cap rates than you will be getting.
If you are thinking that $8,800 a month on a 1.4 million property is a good cap rate, you are dreaming. That right there is enough to get anyone who knows investment to run! That is about what rentals get in (rate wise) in my area and rentals don't cash flow. You are not immune to the math no matter where you live.
There are some highly experienced people on this forum trying to keep you from making the typical newbie mistake of greatly underestimating expenses--for one, but you don't seem to be listening. I know California markets well. Please tell me where things are apprecitating that will make up for the loss that you will take, if you get into this "deal".
I read this forum daily and this is one of the scariest deals i've seen!
Robert
Robert
Actually, I didn't say anything about amazing income. If you can find a property that generates over $100/unit/month income, you're doing pretty damn well.
It takes a lot of work to find a property that will cash flow. When you do, you have to assume debt. The more debt you assume, the more risk you assume* (and, in some instances, the fewer additional loans you can take on). There are also closing costs to pay, and in many instances you get stuck putting money down. And this is all before you even actually own the property!
That aside, if you re-read what I wrote, I said that analysis of properties is done as if you were putting no money down. This is so you're comparing apples and apples.
But, of course, in almost all cases you want to do everything possible to minimize your down payment.
*But this risk is nothing compared to putting more money down. If you default on a loan, you lose any down payment. And you clearly think it's impossible for you to ever default on the loan. So does everyone else, and that's why I'm profiting off of their foreclosures.
As far as I can tell, every Tom Dick and Harry is in REI! Or at least it seems like it. Then they buy a property at retail, thinking it's a deal because they used some bogus expense calculation method. Or, even worse, they think that they just need to find a property where the mortgage payment is less than the rent. (It seems surprisingly common for inexperienced investors to believe that profit = rent - mortgage.)
Default on loan and enter foreclosure or just get sick of losing money, depending on how emotionally invested they are. Either way, I eventually buy at huge discount. Wash, rinse, repeat.
littleivy,
Let's be real here! You didn't come here to learn anything. You came here for validation, which you didn't get. Everyone has told you that this is not only a bad deal, it's a TERRIBLE deal. For whatever reason, you've chosen to believe your delusion that this is somehow a good deal.
The good news for you is that you will get some education from this deal. The bad news is that you're going to lose a LOT of money - A LOT OF MONEY. You could be a lot of help to other newbies if you'll post your story of what went wrong after you fail. Unfortunately, most newbies simply fail and disappear, thereby denying other new investors these valuable lessons.
Good Luck (you're gonna need it),
Mike
Ronald Reagan had a saying during the cold war in regards to strategic arms reduction: “Trust, but verify”!
8)
People, I'm listening! I even listen to your sarcasm and try to see the nuggets of truth underneath! If it is any consolation, you've succeeded in scaring me. I'm not trying to justify...I am learning.
I'm trying to be factual. If I did the calculator correctly that you pointed me to, there is indeed a loss the first year and then with modest rent increases there is positive cash flow.
I wonder why the professional real estate investor bought this property 3 years ago, and 20 more like it in this student community (and no, he is not 80 years old who has held these properties for 50 years; he is a 50 year old man who has numerous properties here).
When the seller prepares the Investment Property Analysis, are they lying? When they disclose their expense sheets, are they lying? Are they pulling the wool over everyone's eyes, including experienced investors (or do they somehow know who is a "newbie" and who is a "veteran" when they send their disclosures?
Littleivy is going to dash off an email to her RE broker and ask some questions now.
A better question is: if this is such a great investment, why in the world would he sell it? I'm certainly not selling any of mine!
Garbage In, Garbage Out
No, they're not always lying. Often, they're just like you and don't understand operating expenses. If you don't understand them, you can't put them on a piece of paper. Moreover, if you don't have any cash flow, the business can't pay the expenses. So, the owner ends up paying a lot of the expenses out of their own pocket (off budget). The vast majority of rental properties are bought by mom-and-pop investors. The vast majority of these new landlords pay retail and don't have any cash flow. Then, they fail. You're not doing anything that the majority don't do. That's why rentals keep turning over. Buy, Fail, Sell, Buy, Fail, Sell. That's the pattern.
Mike
I've been watching this thread with some interest but have purposely not posted until now. I have my own way of analyzing ppties, cash on cash.
If I'm going to pay $1.4mm for a place I'm going to pay cash, I like to minimize my expenses.
In CA the MINIMUM ppty tax hit is 1%, although I've heard it's up around 1.1%. So ppty tax would be $14K MINIMUM.
I know CA insurance is cheaper than TX but I'm still guessing $2K MINIMUM.
That leaves me $89,600 on my $1.4MM. Even if vacancies, repairs, management and everything else are ZERO.
That's 6.4%.
I pass.
BTW, it sounds like the appreciation on your current house has been better than 10%, but the first one (you don't say how long you've owned) has not been that good. About a four bagger in something more than 13 years.
Out of curiousity, what have been YOUR EXPENSES on the other houses.
Yes, pro formas can be doctored, Form 1040 and 540 cannot be without some pretty dire consequences. No investor is going to be insulted when you tell him, to tell his CPA to send you CERTIFIED (by the CPA) copies of the appropriate pages from the last few year's tax returns.
Although just on the numbers I wouldn't have gotten that far.
all cash
Hi again! You must be feeling alot of information overload right now.:goofy:
As you get more experienced, these numbers will clearer to you. Hey! I am so glad you came to this forum BEFORE investing!:D You can't believe some of the numbers that come across here, after the deal is closed.
Maybe this will help clean things up for you. I want to go back to your original message page one, where you asked about a rule-of-thumb. Here is a very commonly used one that I have seen here and by others who are experienced. I don't know of any knowlegeable investor who will consider a property where the monthly gross rent is less than one percent of the price of the property. You still have to crunch the numbers, but it is a starting place. MANY will fail at that rate. Most investors want to see more like 1.5 to 2 percent. Keep this rule in mind knowing that it is a used a good way to eliminate properties quickly. Tell me what you get.
Let us Know what your realtor says. I think All Cash has some real good advice about getting the "real" information.
Some of this advice may be hard to read, but really! you were very smart to come here.
:clap: