Is this worth pursuing

16 Replies

Hi Gurus,

This is a duplex with one unit having finished basement rented out to a Section 8 and anther side to a non-Section 8, both would like to stay. Here are the numbers:

Purchase price: $290,000 (I could spend $30K to finish the other unit's basement to increase the rent)

Mortgage (principal, interest, and tax): $1330/m

Rents: $2,350/m (If I finished the basement in the other unit so to increase the rent, I could get $3,080/m)

Down payment: 20%

Property Management: 8% of rent collected

The property is in decent shape but the roof needs to be replaced (but not immediately) which cost about $6,000.

Is this something I should consider or run away? After reading similar threads (Is this deal worth pursuing ...), I began to shift from interested to runaway mode. But it is really lack of any deal out there at all. 

Regarding "But it is really lack of any deal out there at all." I have this comment. Try not to become a motivated buyer. As others say, and I agree, a bad deal is worse than no deal at all. If you are shifting from interested to runaway mode, then perhaps you need to keep looking. 

@Sean Chen  Another way of looking at it is that your Gross Return is $3,080/m on a purchase price of $320k (ie. less than 1%/m). You will see from many other threads what investors think of THAT! Cheers...

Yes, I agree. This one does not meet the 2% rule (0.81% current and 0.96% with basement update). Using 50% rule, it does not work well either (negative $155/m current and positive cash flow $210/m after update). Even with positive cash flow, the income produced over the down payment and overall investment produces small return.

In the area I am looking to invest for passive income, you will occasionally come across advertised cash flow properties that do not meet 2% or 50% rule at all, except back in the period of year 2007 to year 2011. Appreciation is another factor you have to take into account when investing, otherwise, you would have to be sitting aside waiting for 5 years or longer till situation turns around. 

There may be pocket of areas down further south (Pueblo for example) where one can find properties meeting 2% and 50% rules but it is becoming rare. Even you find them, they probably won't appreciate as fast as the ones close to home. There has to be some sort of balance (cash flowing vs. appreciation) to be found to invest, or is there? I understand that these are general rules to help filter out non-performing investment, and cash flow is the king but these rules do not seem to be practical these days. I wonder what people's view on this. Do you determine your next investment by strictly abiding by these rules or you go off a bit with your instinct? Do you still think they are golden rule to guard against worst investment?

@Chris Martin, I like the comment "Try not to become a motivated buyer". It requires a bit discipline and self-control when you have some cash and ready to build your investment portfolio in real estate. Every day I watch many income properties went under contract and sold, I am asking myself why do they commit themselves to these properties at this price point. Did they see things that I did not see? Shall I follow? I have been stepping aside for a couple of years now, no deal is fine with me but I am sure anxious to land a deal.

@Sean Chen  You have been progressively answering all your own questions - quite impressively too! 

One thing is constant here at BP, for every "Rule", there are ALWAYS exceptions (except for this one?)...

@Sean Chen

What will your revenue be?

Rent Revenue: $3,080 x (1-vacancy rate) = ?

What will your cash expenditures be?

Debt Service: ?

Prop tax: ?

Insurance: ?

Management fee: ?

Regular Maintenance: ?

Avg CAPEX expense: ?

Income Tax: ?

What cash flow do you get when you add this all up? 

What % return is that on the cash you plan to invest (down payment + transaction fee + rehab cost not financed)? 

What would an acceptable return be?

Hopefully the people more experienced than me can correct me, but this is how I would think about it.

I was using the 50% rule to calculate the cash flow. Gross monthly income at $3,080, 50% goes to management, maintenance, and etc. then minus debt service $1,330 which includes tax, insurance, mortgage.

The 50% of gross monthly rental income should be able to cover my 8% management fee, 10% maintenance, 8% vacancy, 5% utility cost.

At this rate, the NOI on my 20% down payment and additional non-financed rehab $30K would be merely 2.9%. It just does not look good to me. But if property appreciates at 7% per year (Denver metro annual avg. appreciation rate about 11.5% in the last two years) with tax benefit from depreciation, it may beat having the money sitting tight in a CD account.

I plugged in average information to finalize an analysis based on what we are seeing in Denver and it looks like your ROI will be around 6 to 7%. That's tight for me, but the Denver market is tight to begin with. If you're looking for passive income AND will be using a property management company, why not look outside the state?

@Sean Chen if you are going to invest in Denver. You will not get the cash on cash returns that others are seeing in other areas. Rents are increasing as well. You mentioned appreciation but did not consider rent growth. That has been clipping along in the 8% range for the past few years. At the same time they are not building any more entry level units. You simply can't build a 700 sq ft one bedroom unit and turn around and rent it for $1,000 per month an make money. Same with 1,000 sqft two bed units at $1,200 per month. There will continue to be increased scarcity in those price points. It's not just the high wage earners that are moving to Denver for jobs. I am quite sure the buyers you are looking at are considering that when they sign on the dotted line.

Think about this, where would you be had you pulled the trigger back in 2011 when you started?

If you are a buy and hold investor and you are adequately capitalized to ride out the storms there is no time like the present to invest. Timing the market is a fools game. In 30 years the appreciation will eat up the price difference and the rent growth will double and triple or more your rent rates. We are not in a declining area like the rust belt.

Now if you are not tied to investing in Denver then I think there are lots of discussions to have. Personally I want to be near my real estate at least for now.

@Bill S.

Good point on the rent increase. It seems to have been the steady up trend for the past 4 or 5 years and no sign of immediate stop. 

I have found 2% rule never could apply to Denver area market (very rare but I did purchase one in 2011 that is a bit over 2%) but 50% rule is still relevant. Your view on Denver area is aligned with my view as well. I recently learnt from the news that Denver ranked 10th richest city, which reflects your comment about high wage earners moving into the area. 

I am not sure if present is the best time to invest using buy and hold strategy. I have seen the best time (as I mentioned before during 2007 to 2011) but it could still be a good time to invest considering the upward rent movement, steady appreciation and large pool of renter population with limited supply. 

There was time when Colorado Spring market became so attractive and beat Denver, I did not move in for the same reason you have: prefer to be near my real estate and home. I think I will continue to stick around Denver metro area.

@Sean Chen buy and hold is like planting a tree. The best time to do it was 20 years ago, the next best time is today. So while your 2007 to 2011 time frame is true, that cow has left the pasture. We are not likely to see those times again for another 20-30 years. The time before 2007-2011 was in the early 1980s if you were around or have studied real estate history in Denver. That seems to be the cycle. Do you have another 15-25 years to wait for the next home run derby while sitting in the dugout?

@Sean Chen

 I would say run from a deal like this. If it is appreciation you are looking for there are several markets where you can get better returns and as with cashflow. I dont want to get into numbers as so many others have analyzed the deal for you. 

Look into chicago, atlanta, cincinatti and indianapolis for better returns unless you really want to be next to where you invest.

Thanks
Vish

I disagree about running from this.  It all depends on how much the dirt will appreciate in a deal like this.  Plus you can self manage a property like this if your in the market.  

Not sure if you have a lot of properties under your belt but finding the perfect deal now is getting tough sometimes you need to pull the trigger on one to get in the game 

I agree with John Weidner and Bill S.  Denver is a hot market and you won't make numbers as written in books and prescribed by the rules.  But if you are in it for the long run, then start today.  I am in amazement of what the market is doing, how much it is appreciating, and how high the demand is.  80 people visited a home for sale last weekend which produced over 12 offers.  This is raising prices.

After living in Indianapolis for 6 years and selling our home to make less than 1% appreciation (over 6 years), the cash flow can be there, but not the appreciation.  And you need a trusted network in remote towns to give you comfort.  So for your local Denver buying, make sure you love the property and ready to play the long game.

I say look in your backyard

There are deals EVERYWHERE! 

Its just up to you to find them.

Thanks for all the opinions. It takes one to know the market and Denver is no doubt HOT seller's market right now. I pulled the trigger to play a long game for buy and hold. Comparing numbers with my previous several investments, this one would be looking really bad but even this kind of deal, you could have several buyers competing. 

Again I am staying at where I feel more comfortable, so no out of state investment even though you may find the numbers pretty impressive. Without a trusted team to run the whole 9 yards, I just do not feel confident that is my game. Within an hour or two hour driving distance may be possible but I yet need to find out if I will pull the trigger.

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