Is this a good investment?

Question

I am new to the business. I have an opportunity to buy two 10 year old rental houses for $110,000 each. They both appraised for $145,000. They were constructed with 30 year roofs and are solid homes. The renters in them now are currently paying $700/mo and have lived in each since built (the same extended family occupies each one). The insurance will be $740/yr and taxes $550 on each. Market rent in our area for these is $900...

Question: Is this a good investment? Depending on the market, I don't plan to keep them longer than 6 years because it will probably be getting time to replace things, and especially if it is not renting for 1%. If it is a good investment, how should I set up a mortgage (term and credit/points). Any help is much appreciated.

Jaysen Medhurst · Answer

@Curtis Bowery, yes, I'd do a 30. You can always pay it off like a 15-year, but you'll have more flexibility. A 15-year will bump up your debt service by $400-450/month. You'll likely be cash flow negative.

To be clear, unless you see very good potential for appreciation, I don't think this as a good long-term hold.

Jaysen Medhurst · Answer

@Curtis Bowery, my quick math shows a cash flow of ~$140/month total after you get the rents up to market. Obviously, you'll be well in the red until that happens.

If you're really confident in the ARV of $145, it may be worth considering holding them for a short amount of time and then selling them at retail. That raises the question, if they can get $145k, why isn't the current owner doing so? There must be a reason he's leaving $70k on the table.

Jaysen Medhurst · Answer

@Curtis Bowery, I'm skeptical of that explanation. If the tenants have leases, those would have to be honored by any new owner. Do your due diligence on the ARV (and everything else).

Jaysen Medhurst · Answer

@Curtis Bowery, maybe a way to make a quick $40-50k. I guess that's what makes me nervous. "Quick" money always make me nervous. Guess I'm conservative that way.

Curtis Bowery · Answer

@Jaysen Medhurst, thanks, that makes sense. I appreciate your input. I'm sitting down with the current owner today to go over numbers

Jaysen Medhurst · Answer

@Curtis Bowery, not to split hairs, but I would consider 6 years medium term.

I’m not following your logic. Remember, in order to cash flow, you need to get both units up to market rate. Even at that point, you’re at less than half what I would consider minimum cash flow.

What does “you and the renters parting ways” have to do with anything? You have no idea if that will be a day or a decade. It should have no bearing on your strategy.

Curtis Bowery · Answer

@Jaysen Medhurst, would holding it for 6 years be considered long term to you? I'm thinking I would sell it as soon as me and the renters part company or the renters possibly buy them. Thanks.

Curtis Bowery · Answer

@Jaysen Medhurst, thanks for your input. We think similar. If I didn't know the owner personally, I'd be a lot more skeptical, but this is someone who I trust. I casually told him I was interested in rentals and he thought this deal would be mutually beneficial. As far as the mortgage goes, would you do a 30 year since I don't plan on keeping it long-term?

Curtis Bowery · Answer

That's another part of this @Jaysen Medhurst... There are no leases. They have just been paying his mortgage payment. Where I got my ARV was an appraisal and comps from my realtor.

Curtis Bowery · Answer

@Jaysen Medhurst, that was one flag I saw and I talked with him about it; he is a builder and needs to free up these houses to make room for other construction. He has a good relationship with the tenants and knows that he would have to send them packing if he sold for retail. He would hope I can keep renting to them if I buy.

Is this a good investment?

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