Hi, I am new to the real estate world. over the past month or two I have been reading on BP getting educated and listening to the podcast, I am starting to feel ready for my first deal.
I spoke with a wholesaler/Friend who provided me with a few potential deals, there is one that seems really good. its in a very low income area but I am limited in what I can afford and this seems like the right place to start. I am looking for help doing my due diligence here, any input is appreciated.
the property is a duplex
9,500 additional yearly expenses (10% management, 10% vacancy, 10% for repairs and insurance, taxes, utilities)
Those numbers look great but low income areas has LOTS of other fun things. Like them not filling, high repair costs, etc. Plus getting a loan on such a low amount can also be hard. Are you leveraging or paying cash ?
We invest in class A putting that amount down (20%) and leveraging the rest. I would read posts about low income property. I think you are going to be surprised over the "unique" problems you run into that are going to run your expense up much higher.
When doing a pro forma, use actual numbers whenever possible, only use percentages as a last resort. Look up last years taxes, and adjust them upward if there was a homeowners, senior, or other exemption applied that you won't qualify for. Adjust downward if taxes are likely to be reduced based on a lower assessed value after the sale. Obtain a couple of property insurance quotes. Call the utility companies and verify the previous year's bill. On multi family properties, don't underestimate common area maintenance (ie. mowing grass, shoveling snow). Make sure you're not buying in a war zone, check the crime map on Trulia. Talk to a property management company or local investors to make sure your assumptions are realistic and that you haven't overlooked anything. This is all part of the due diligence process.
Maintenance expenses consists of two categories, actual repair expenses, and capital expenditures. On a practical basis, both should be escrowed monthly until you have significant reserves on hand (say 6x gross rents sitting in a savings account). For a property like this I'd suggest at least $100/mo for each. Make sure your rehab budget includes any capital expenditures that have less than 25% of the useful life left (ie. the water heater is 10 years old, the roof looks like it will need replacing in a few years). Don't forget to include appliances in the rehab budget (unless they are typically not provided by landlords in your area).
Lastly, keep in mind, lower end rentals are management intensive. Working class tenants do not have the financial wherewithal to withstand life's disruptive events to the same degree that middle class folks can. As a result, turnover is higher, repairs are more frequent, and collections more labor intensive. Most property management companies do not have the expertise or desire to cater to this niche. Lack of competence will be reflected in higher operating expenses. I believe this is the primary reason why many out of state investors don't achieve the high returns they expected.
Thank you for the great feedback. I have 50k cash to use toward this investment. I also have the property being recommended to me by a property manager that I plan to use, I have obtained references and spoke to people in the area there was no significant bad feedback. This property is in a really bad area I am looking to offset the dangers of the area by using a good PM.
Phillip, I invest in low income areas and can live to tell about it. Surprised a property manager is recommending a low income property, they don't get much out of it but grief. If this PM pulls out or isn't what they seem to be, what is your plan B? Look at threads on interviewing PM's - does this one have an in house maintenance staff that they will use your funds to keep busy? Not trying to be cynical. If you were a PM would you want a higher cut with less work, or a lower income with way more work? Vet them really well.
If you have $50k to invest you would probably be better off using that as a down payment on a higher quality property. Tying all your money up in a house that is in a really bad area sounds like a huge headache. Even a good PM won't be able to offset all of the problems you are going to have to deal with if the area is that bad.
Thanks, I am starting to see it that way.
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