Wife wants me to buy her Grandparents' home to rent after 1 yr..

27 Replies

It's a family home in Richmond, Va that was purchased and renovated from a tax sale. This would be our 1st home, but we'd be relocating in 1 year.  Below are the rental calculations I've come up with. Before I break the news to my wife, if ANYBODY can tell me how this ISN'T an ABYSMAL deal I'd greatly appreciate it, thanks!!!

Monthly Income:      Monthly Expenses:       Monthly Cash Flow:      Pro Forma Cap Rate:
$1,550.00                     $2,248.06                       -$698.06                            2.35%
NOI Total Cash Needed Cash on Cash ROI Purchase Cap Rate
$8,124.00                     $20,349.00                      -41.17%                            2.35%

======Financial Projections========

     Total Initial Equity: -$334,650.00

     Gross Rent Multiplier: 18.55

      Income-Expense Ratio (2% Rule): 0.44%

     Typical Cap Rate: 2.35%      Debt Coverage Ratio: 0.49

ARV based on Cap Rate: $345,000.00

=======50% Rule Cash Flow Estimates=======

     Total Monthly Income: $1,550.00

     x50% for Expenses: $775.00

     Monthly Payment/Interest Payment: $1,375.06

     Total Monthly Cash Flow using 50% Rule: -$600.06

========Analysis Over Time==========
Annual Growth Assumptions
    3%                   2%                3.4%
Expenses         Income       Property Value
_______________________________________
                                        Year 5
Total Annual Income        $20,536

Total Annual Expenses      $28,645

Total Annual Cashflow      -$8,109

Cash on Cash ROI -39.85%

Property Value                 $407,776

Equity                              $111,347

Loan Balance                   $296,429

Total Profit if Sold            $49,939

Annualized Total Return       28%

@Theresa Harris thanks for replying. I actually showed her the numbers after I posted this, but just wanted a 2nd (3rd, or 4th) professional opinion on how viable this property is as a rental after living in it for a year. I posted the year 5 projections at the bottom to give an idea of how long it would take just to get to THOSE numbers.

So what do you think - go or no go?

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You’ve got at least one problem with your numbers. You’re cashflow is exactly your expenses minus income. I’m going to go ahead and assume you are forgetting the income that’s going towards paying down the debt. This will make numbers lol better. You also aren’t showing depreciation which will make your taxable income lower, another positive you’re missing. 

BUT, I would never buy in area where you think rents will only climb 2% per year while expenses will climb 3%. I expect 5% rent increases and have been rewarded with 8-10% more often. (Expenses are usually declining as only property taxes and insurance are increasing while interest is declining.) If this is accurate you might not be able to make it work in an area where you have expenses claiming faster than income. 

If you are literally only get $1550 a month for rent and the mortgage + taxes are what?  You have $1375 for mortgage, but does that include property taxes?  There is the emotional attachment because it is her grandparents home.  You'll end up paying to have someone live there.  If houses in the area are going up and there is strong rental demand, your rental income may go up faster.

@Bill Brandt thanks for reviewing my numbers. From my understanding, the income paying down the debt is the $1375 deducted from the total rent ($1550), unless I missed something. After investing in some additional research tools, I found that I would be justified in charging $1700 in rent, and also that rent increases since 2018 average around 5%. Even with those adjustments, I'd still be taking a monthly loss of $450+ after the 1st year.

Thanks for mentioning depreciation - I've calculated it at around $8900/yr [($345k - $100k)/27.5]. I understand depreciation reduces my tax burden against any income generated from the property, but I won't have any income generated, so what's the bottom line practical application of depreciation for me in this scenario?  

 


@Theresa Harris the $1375 does not include property taxes. You're absolutely right about the emotional attachment, which is nowhere on the list of reasons to purchase an investment property. I found out that median rents in the area increased by 10% since 2018, but the average rate of annual increase over the past 3 years is 5%. I think I'd have to education myself on city planning in the area to justify an expectation of sharp rent increases. 

If the mortgage is $1375, add in the property taxes and insurance and see where you are at.  I know there are other expenses and the possibility of appreciation, but your wife is going to have the emotional attachment, so ask her if it is worth paying $X a month to own the home.  Only the two of you can answer that question.

@Clifton Monte

You’ve got too many undefined numbers and maybe missing/wrong numbers. 

Write it out this way…

Income: Rent coming in

Guaranteed Expenses: prop taxes, insurance, mortgage interest (NOT the entire payment use an amortization table).

This is your best case. Then you can try to guesstimate the rest

Expected expenses Property manager? Repairs, capex vacancy, turnover, commissions, etc

The big deal was eliminating the entire mortgage payment from expenses and only including the interest. 

The depreciation expense will sit and pile up so the day you start making money it will be erased by the accumulated depreciation. My other point was you can have “income” without cash flow. 

Until I recently paid it off, I had a property with negative $850/mo cashflow that generated $16k/year in income that would have been taxable but I had $16,500 in depreciation. The point is to show that cashflow isn’t income and you could be taxed on income you didn’t put in your pocket but instead gave to the bank. 

If the above property hadn’t been a townhome and I could only depreciate 80% give or take of my purchase price ($13,5000) I would have had negative $10k in cashflow and owed income tax. Now that it’s paid off the income and cash flow skyrocketed to $30k and I get to use up some of that extra depreciation I wasn’t using before. 

Im located in Richmond VA if interested in discussing further about locations, rental prices, etc. I think your numbers can be better defined and the location is super important for appreciation. I saw 100+k in the past 4 years around 7% per year

@Bill Brandt ahhh income and cash flow are totally different things - duh lol. Wow, that's some tremendous depreciation, was your townhome was a rehab?. If you don't mind, how long did it take you to pay off your mortgage?

You're right, I'm using a lot of estimations. Honestly, I used the BP rent calculator, rules of thumb for variable expenses, and data from Rentometer.com, to get these numbers. I flat out created tax and insurance numbers in the absence of data. You think I should ditch the BP calculator?

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It was turn key no rehab. But it was a $460k townhome (being a townhome it was all depreciable since I don’t own any land). Bought with a 15 year mortgage I paid off in 6. Same tenant entire time with one year left at 10% rent increase to $3k. 

@Clifton Monte I think there is emotional baggage associated with ever renting out a property that was 1) owned by a family member or 2) once my primary resident. The problem in those cases is that it is really hard to make your decision on the property as an investor without feelings getting in the way. It can be done but it makes it hard...and in this case, you'd be setting yourself up for the baggage of both scenarios.

Outside of the family ties...is there a unique return on this property vs any other property out there? For example, if you were to use the same amount of acquisition capital to buy/live anywhere in the country or would you still choose that house? Taking the emotion out of it, if you could use the same capital for an investment house, could you get a better return elsewhere?

My 2 cents: I could be wrong, but from reading your posts it feels like you might ready be trying to talk your way into this situation as being a good investment choice just so you can keep the house in the family. That could indeed be the best choice but just consider - If it's already hard to treat this like an pure investment decision now, think how hard it will be once you get into it....

@Sunil Kurian thanks for the reply. It's more emotional on my wife's side. I'm pretty convinced it's a bad deal (that I will not be purchasing), but just wanted to get my feet analyzing a deal, collecting resources, filling in numbers, and getting feedback to see if any new conclusions can be drawn. It's a win-win learning experience for me that I can take to the next deal!

I agree that you should include her in the process of cruching the numbers. But her emotional ties to the property may prevent her from seeing the numbers as they really are.

One important part of the process of analyzing a deal is to divest yourself of any emotional ties. Its not about emotion, its about business and making money.

Don't buy it off emotion; it will end up hurting you both in the long run. You can go to the BP spreadsheet and find one that works for you to analyze your next deal.

Here is the link: https://www.biggerpockets.com/...

Boiling this down to basics, it appears to me:

1. You are buying this house for $335k. You are getting a loan for ~$315 and putting $20k cash into it. Your PI is $1375, no idea what your taxes and insurance are.

2. You believe you can rent this property for $1700/month (from later post) when you move out.

3. You are expecting expenses to rise faster than income, and property values to essentially mirror expenses.

Just based on that this property is at best a break-even, at worst a serious loser. Sometimes there's more to life than just finances - it appears there's a sentimental reason for looking at this house - but purely based on finances this property doesn't make any sense. Perhaps if it was a good marketable VRBO/AirBnB it might make sense, depending on vacancy rates and per-night averages, but for a long-term rental it rents too cheap to justify the purchase price and anemic growth.

When you say it was a family home purchased from a tax sale and renovated, what does that mean? Does a stranger currently own the house and your wife would like to get it back into the family? Was it auctioned from a family member, i.e. granny's family farm? How long has it been out of the family and what was the family connection? For me personally, finances aside, I would have a different opinion of purchasing my grandparent's lifetime home than I would one of the shacks we lived in for a year or two when I was a kid.