First Deal Frustration: What did I do wrong?

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First Deal Frustration: What did I do wrong?

Derek Rocco
McMurray, PA · Member since 2016 · 50 posts · 17 votes

So here's my situation. Looking for some feedback on what I can do differently next time.

I found a multi-unit in a town where I grew up. Five units total, four currently rented. Vacancy rate is low. After getting some really good advice I ran my numbers with the Rental Calculator and I would have been clearing about $900 a month cashflow.

I did my homework, visited some smaller banks. I talked with a great resource I met here on Bigger Pockets.

The property

It is listed at 89,000. We found that it was under contract at one point back in October. We asked the realtor what happened, and he willfully told us that two days before closing the buyer backed out because they didn't have enough funds to close. He also said the property appraised for 85,000.

I visited the property and it wasn't in terrible shape. The apartments were clean, and the buildings maintenance guy walked us through. The biggest red flag was there was water in the basement. The sellers disclosed this, and the guy told us this has been going on for 20 years. I believed him for whatever reason and was willing to still proceed.

* Major footnote after first reading the seller disclosure I discovered the house was owned by my moms first cousin. I originally reached because of this to see if seller finance would be considered. This got shot down.

The Finance

So like I said I visited some banks, tried to understand what my options were. Really the same across the board. 25% down. I did talk to one bank that would do 20%. I have the cash for the down payment, but it wouldn’t leave me in a comfortable spot. So, one of the awesome folks on here I’ve met helped me work something out. He would finance 90% of the deal, I’d put down 10k with him. 12% interest and then I could re-fi out in 12 months.

The Offer

So, after running comps, I submitted an all-cash offer of 65k. I put contingencies on a inspections, and receiving the security deposits from the current tenants. Probably the wrong move, but I 1.) don't think the property is worth 89k. 2.) Know, according to the realtor, that it only appraised at 85.

Probably not a great first offer.

The rejection

The Sellers rejected it. In nice enough terms they said the offer was unreasonable. They said they would consider a lower offer, but they would not consider contingencies. I decided not to counter because I am not a seasoned enough investor to take on a 5 unit without an inspection.

So back to square one. This would have been my first deal, and I probably got too excited. I am a bit frustrated, but I did learn a ton, and honestly that’s better than nothing.

Any advice on how a more seasoned investor would handle? I would love to hear.

Thanks!

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Anthony Dooley
Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
9y

Those numbers are incorrect. 2175- 1614= 826. 826 x 12 = 9912 NOI. At a 6% cap rate that would give a value of $165,200. If you bought it for $85K, that puts it at an 11.6% cap rate. This means it's in a pretty bad area of town, but it is a great return. I would buy it, fix the water problem, and make gradual improvements for the next 10 years, then sell it for $165,000 after enjoying the income for 10 years, then buy something better.

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  • Derek Rocco
    OP
    McMurray, PA · Member since 2016 · 50 posts · 17 votes
    9y
    Originally posted by @Account Closed:

    @Derek Rocco You lost the deal with your low-ball offer.

     haha yea I think that is fair to say. Maybe 75k made more sense, but with the water in the basement, a new roof lurking at some point I felt the sweet spot for this was around 72.5k

    1Reply
  • Andrew PostellPro Member
    Lender · Fort Worth, TX · Member since 2016 · 8k+ posts · 6k+ votes
    9y

    @Derek Rocco were  you working directly with the sellers or was there a 3rd party involved in between you and the sellers?  It sounds like the sellers were at least open to having some discussion.  I would suggest, if possible, to do some sales 101 techniques.  What I mean is why is the seller selling a great property?  Whatever their reason to sell is what we need to focus on.  Understanding their position on this could lead to  you getting more deals closed.   You may not always be able to even speak with the seller and even if you DO know their motivation you still aren't guaranteed to close the deal but I believe it would lead to a higher success rate.  Hope this helps!

    6Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    9y

    The first question I have: What is the Net Operating Income? This determines the value. How much actual money is left when you subtract the monthly expenses from the gross monthly rent? This is NOI. Then subtract your monthly debt service from the NOI. This is cash flow. How much of a return will you get on your down payment? Look for at least 10%.

    After running the numbers, you may find that the value is actually more than $85K. 

    Then ask yourself: How can I increase the NOI? Can you raise rents, lower expenses, negotiate the insurance down, reduce the water bill, etc? By increasing the NOI, you increase the value of the property. Then when you refinance, you can get all of your down payment back.

    How much do you think it will be worth in 10 years?  Probably more than $85K.

    12Reply
  • Derek Rocco
    OP
    McMurray, PA · Member since 2016 · 50 posts · 17 votes
    9y

    @Andrew Postell thanks for the advice here. My wife is a realtor so she handled everything for me. From what we know they just wanted to be rid of the property. There is some "family" stuff there too that I won't go into.

    1Reply
  • Derek Rocco
    OP
    McMurray, PA · Member since 2016 · 50 posts · 17 votes
    9y

    @Anthony Dooley interesting points. Here are the numbers I had at purchase of 85k:

    Edit: The numbers above are with a conventional loan. These numbers are the private lender figures:

    2Reply
  • Rocky V.
    Rental Property Investor · Arlington, TX · Member since 2012 · 788 posts · 640 votes
    9y

    Wow!! That is some good monthly income on a $80K investment.  I'd resubmit at $70K with a 5 day inspection period and no other contingencies.

    7Reply
  • Derek Rocco
    OP
    McMurray, PA · Member since 2016 · 50 posts · 17 votes
    9y

    @Rocky V. I'm really torn about it. I was originally going to, what exactly is a 5 day inspection period?

    0Reply
  • Samantha Klein
    Investor · Monroe, WI · Member since 2015 · 691 posts · 610 votes
    9y

    Assuming you accounted for everything you better call the sellers back and get that property. You will soon learn that an asking price is just that, an asking price. I say that because many times even at full asking price, it may be a good deal but some investors want it for less and will then pass when they can't get it cheap. I lost out on a few good deals being penny wise and dollar foolish.

    8Reply
  • Rocky V.
    Rental Property Investor · Arlington, TX · Member since 2012 · 788 posts · 640 votes
    9y

    It gives you 5 days to inspect property and either renegotiate contract, stay the same or back out all together.  In TX this is the Option Period but I'm not sure how PA works.  I'd also offer them $100 for this right which will be credited to sales price or given to seller if you end up backing out. 

    0Reply
  • Derek Rocco
    OP
    McMurray, PA · Member since 2016 · 50 posts · 17 votes
    9y

    haha thanks @Samantha Klein

    0Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    9y

    Those numbers are incorrect. 2175- 1614= 826. 826 x 12 = 9912 NOI. At a 6% cap rate that would give a value of $165,200. If you bought it for $85K, that puts it at an 11.6% cap rate. This means it's in a pretty bad area of town, but it is a great return. I would buy it, fix the water problem, and make gradual improvements for the next 10 years, then sell it for $165,000 after enjoying the income for 10 years, then buy something better.

    13Reply
  • Brady Wolfgram
    Investor · Spring Valley, MN · Member since 2016 · 5 posts · 0 votes
    9y

    I agree with Rocky V. resubmit a higher offer with the inspection contingency and you can also throw on the deposit contingency if you want. Just don't go higher then the numbers will allow. I was always taught to never let your emotions cloud your judgement on a deal either, know when to walk away. 

    Another trick I have used is resubmit your offer every week. Eventually they might get fed up and finally accept your offer. 

    0Reply
  • Derek Rocco
    OP
    McMurray, PA · Member since 2016 · 50 posts · 17 votes
    9y
    Anthony Dooley not quite sure how my numbers are wrong that's straight from the bigger pockets rental calculator. I don't doubt that you're probably right though
    0Reply
  • John D.
    Rental Property Investor · Allentown, PA · Member since 2016 · 279 posts · 105 votes
    9y

    @Derek Rocco Increase your offer but keep the inspection contingency.  Once you complete the inspection and you figure out a more accurate figure for repairs, then you have some ammo to go back to the seller and renegotiate and have solid reasoning.

    I didn't mind the "low-ball" offer and in my opinion, neither did the seller because at least you received the courtesy of a response.  How long has property been on the market?  Like @Andrew Postell mentioned...figure out the sellers motivation.  

    Never fall in love with a property!!  If the final numbers don't work...move on to the next deal;)

    1Reply
  • Anthony Dooley
    Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
    9y

    @Derek Rocco I showed you the math. It's very simple. No special calculator needed to compute the NOI. Ask the listing agent to provide you with the trailing 12 months of income and expenses. The property manager can print this out very easily. If you are not familiar with how NOI, Cap Rate, and value are calculated, then you should get smarter on this stuff.

    3Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    9y
    Originally posted by @Derek Rocco:

    @Andrew Postell thanks for the advice here. My wife is a realtor so she handled everything for me. From what we know they just wanted to be rid of the property. There is some "family" stuff there too that I won't go into.

    If the Seller (family-related or not) knows it's worth $85k as-is, why SHOULD they take less?

    Perhaps the only thing you've done wrong is - not put in another dozen low ball Offers on OTHER properties since then, to increase your chances of success!

    Or, now you KNOW what your "sweet spot" is - Offer it - THEN - move on! Cheers...

    4Reply
  • Ian WalshBusiness Member
    Lender · Philadelphia, PA · Member since 2016 · 2k+ posts · 1k+ votes
    9y

    We usually find that it can take 20-30 offers on different properties before OUR low number is accepted.  Just move on to the next one.

    1Reply
  • Jason V.
    Investor · Rochester, NY · Member since 2016 · 477 posts · 426 votes
    9y

    @Derek Rocco - A couple of things to watch out for (that you may have already included, which I missed): 

    1. There's a difference between 'Vacancy' and 'Economic Vacancy'. If all 5 units are occupied all of the time, you have 100% Occupancy, and 0% 'Vacancy', right? But if you're looking at a 5 unit building in the Pittsburgh area in the $80k-$90k range (or anywhere in the 12-16 Cap range) I would guess that you're going to have a higher than average 'Economic Vacancy' - i.e. your tenants are going to pay late, under pay, or not pay at all. So you lose that first month's rent, and it takes a month to evict them, meaning you'd be out 1-2 months rent, plus repair costs after eviction (and there will be) plus time to get it re-rented, etc., etc. Thinking along these lines, the current tenants might have only stayed so long because they're being allowed to pay late, skip months, or otherwise cost the owners money - and the owners just don't feel like dealing with the hassle of an eviction to get more bad tenants. Economic Vacancy is a much bigger risk in these types of properties than True Vacancy

    2. I'm not sure I understand your reasoning with wanting to use a hard money lender versus a commercial loan on this deal. If you can just barely cover the down payment on it, maybe the smarter move is just to save up for a little while longer, rather than pay the extra interest and closing costs for hard money. Or bring in a more experienced partner for the deal (second set of eyes never hurts on a first deal.) My real concern would be that many commercial lenders won't be interested in this deal, for a couple of reasons. For them, it's a very small dollar amount to lend, so they won't make any money. Add that to the fact that it's a 12ish Cap deal, probably not in a great area, and I think you'll have a hard time finding a commercial lender that wants to take the risk. Apart from that, many times commercial appraisals and inspections are much, much more expensive than residential, and your closing costs are likely to be higher than you expect. So my worry would be, if you take the hard money to buy this, you're going to get stuck in it 10 months from now trying to get refinanced, and wind up "buying time" (to the tune of a couple of points) from your HML.

    3. You made an offer, it got rejected - why not make another offer? I know in some markets you "have to bring your highest and best offer" - but I really don't think you're seeing that type of competition for small MF in Pittsburgh (or am I wrong?) Not that long ago I offered $69k on a property that was originally listed at $153k. They were so angry about the offer that they "countered" with a higher than asking price number. After negotiating for several weeks, I was able to buy the property for a huge discount, with another separate parcel of land thrown in for good measure. Get used to hearing "no" - it's just part of the business. (Wait until the first time you're sitting across the table from someone and they completely flip out at your offer. If you want to get that property, you're going to have to "Peel them off the ceiling" - as we used to say in the sales world.) In some markets, this is the wrong approach, but I'm from the school of thought that says "Any first offer that's accepted was too high." 

    4. The "No Contingencies" statement is becoming more and more common, because there's a trend in Real Estate for buyers to make an offer, have it accepted, and then use a painfully meticulous inspection to try to hammer the seller to reduce the price further. I've seen some absolutely ridiculous things show up on inspections, and have buyers expect money off for them. In my mind, an inspection should cover major things - but if a buyer didn't notice some peeling paint behind a storm window, or old caulk around a bathtub when they walked the house and made an offer, I certainly don't want to give them another $1,000 off to have it painted or re-caulked. So I see this as an attempt to avoid getting nickel and dimed to death. Or there's a major structural issue they're trying to hide. Either-Or. (Have fun figuring out which!)

    5. I'd be wary of the thinking that this property is going to be worth twice in 10 years what it is right now. I could be wrong, but I also doubt you're going to see anything trading at a 12-15 Cap right now double in value any time soon. 

    6. I only see your returns from the calculators - I'd be much more interested in seeing what you put in for costs/expenses. In a 5 unit building with $2200 total rent ($440/unit/month) I would be estimating my expenses to be much higher than the suggested ranges on the BP calculator. And one bad tenant (out of 5) could easily cost you a year's worth of profit in a month - that's always the risk with these types of properties. 

    7. The Pittsburgh area is one where I would not be at all opposed to buying SFRs right now - especially using the BRRRR Strategy, considering you have a HML already lined up. I think this is an area that's going to grow quite a bit in the next decade (but that's just me.)

    Good Luck!

    12Reply
  • Annette Schneider
    Investor · Pittsburgh, PA · Member since 2016 · 41 posts · 12 votes
    9y

    @Derek Rocco I think its highly probable you will have economic vacancies for the building. Seems odd that they are selling the building if its still economically sound investment. There may be one pain in the butt tenants that is making life difficult or something else that's a major issue with the building they are not telling you. Is the building in a flood zone? If so, do you have correct cost of flood insurance? The low rents seem suspicious: have they not be raised in a while or is the area not growing or losing value? 

    My hunch is that its in an area slowly losing value. If it is only worth 85K now, it's probably not going to be worth much more in 10 years. This is going to be a cash cow that will slowly get milked unless the area successfully undergoes revitalization.  So many areas claim to be the 'new' South Side or Lawrenceville but there is not enough economic demand to revitalize all depressed areas of Pittsburgh.  If this area is going to stay a marginal area, do you know what it will take to deal with your likely tenants? You will need a strict lease and you will need to enforce rules: are you ready for that?  

    For your first income property, you might be better served with a duplex or triplex in a better area that can attract better tenants. You can find stable tenants that are paying low rents but it's tricky.   

    1Reply
  • Anthony Angotti
    Real Estate Agent · Pittsburgh, PA · Member since 2015 · 1k+ posts · 846 votes
    9y
    Originally posted by @Derek Rocco:

    @Rocky V. I'm really torn about it. I was originally going to, what exactly is a 5 day inspection period?

     Derek, don't do a five day inspection period in Pittsburgh. You might not have enough time to get it done and consider things. Standard contract says 10 and I always go with 15. If they are deciding to accept or decline based on the number of days in the inspection contingency then stick with 10. You'd need to have it scheduled before submitting the offer to execute on 5 days. 

    Also, have your agent say that the inspection is "for information only" that lets them know that you won't make them perform any of the repairs you just want to know that there is nothing major with the property.

    3Reply
  • Anthony Angotti
    Real Estate Agent · Pittsburgh, PA · Member since 2015 · 1k+ posts · 846 votes
    9y
    Originally posted by @Brent Coombs:
    Originally posted by @Derek Rocco:

    @Andrew Postell thanks for the advice here. My wife is a realtor so she handled everything for me. From what we know they just wanted to be rid of the property. There is some "family" stuff there too that I won't go into.

    If the Seller (family-related or not) knows it's worth $85k as-is, why SHOULD they take less?

    Perhaps the only thing you've done wrong is - not put in another dozen low ball Offers on OTHER properties since then, to increase your chances of success!

    Or, now you KNOW what your "sweet spot" is - Offer it - THEN - move on! Cheers...

     I agree with everything here :)

    0Reply
  • Andrew Johnson
    Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
    9y

    Agree with @Anthony Dooley on asking for trailing 12 months of expenses.  Hopefully that's what you did to come up with your monthly expenses.  I'd scrutinize those expenses as they could either be higher than you plan (potentially a reason they are selling) or lower than you think (potentially due to deferred maintenance).  I'd also ask for copies of the leases to see when they were signed, if they are all new tenants (i.e. significant annual turnover) or people who have reliable stayed a while.  If someone "just wants to be rid of it" it's likely not as "passive" as they would like.  More assumptions here, but that could be because of either constantly turnover/vacancies/market costs or significant/frequent repairs.  

    One thing that would concern me to a huge degree is water in the basement.  If it was under contract once, why didn't they fix it before putting it on the market?  Why not fix it when the first deal fell through?  I would posit if it was an easy/inexpensive fix they would have done it already to make their property more marketable.  The paranoid (or diligent) side of me says that requiring no contingencies and not allowing an inspection means they know something you don't.  

    Net result: let the property sit on the market another 30 days.  If it sells, it sells, if it doesn't you'll be into February in Pittsburgh with water in the basement.  I can't think that would constitute a "sellers market" and they might become more flexible on the price.  And you'll see if 30 days has allowed them enough time to rent out the last unit. 

    1Reply
  • Jack B.
    Rental Property Investor · Seattle, WA · Member since 2014 · 1k+ posts · 1k+ votes
    9y
    Originally posted by @Anthony Dooley:

    The first question I have: What is the Net Operating Income? This determines the value. How much actual money is left when you subtract the monthly expenses from the gross monthly rent? This is NOI. Then subtract your monthly debt service from the NOI. This is cash flow. How much of a return will you get on your down payment? Look for at least 10%.

    After running the numbers, you may find that the value is actually more than $85K. 

    Then ask yourself: How can I increase the NOI? Can you raise rents, lower expenses, negotiate the insurance down, reduce the water bill, etc? By increasing the NOI, you increase the value of the property. Then when you refinance, you can get all of your down payment back.

    How much do you think it will be worth in 10 years?  Probably more than $85K.

     Listen to this guy, he knows what he is talking about. Keep it coming, this is exactly what I've read all over the place and is 100% spot on.

    1Reply
  • Jasmine Wilborne
    Baltimore, MD · Member since 2016 · 57 posts · 17 votes
    9y

    Go @Derek Rocco for taking the plunge. 

    Lots of folks don't. 

    I'm buying my first triplex in 126 days and am learning as much as I can to get there. 

    Reading about your experience (and everyone else's response) has helped me understand just a bit more.  

    1Reply
  • Devin Woods
    Real Estate Agent · Pittsburgh, PA · Member since 2014 · 102 posts · 24 votes
    9y
    Derek Rocco I'm not sure what area of Pittsburgh this is, but as others have pointed out, it's likely not a good area with that valuation. I didn't see any vacancy rate included, or any of the details surrounding your expenses. On a 5 unit in a lower end of town, I'd assume at least $5k in maintenance / repairs annually, plus a 10% vacancy. Also, are you sure about the utility numbers, sellers will often underestimate what they provide to you for these properties. If this is on the MLS, which I assume it is, you have to assume there is a reason no "seasoned" investor hasn't scooped it up. In Pittsburgh, these smaller multifamily (4-12) are hard to come by, and any deals that are semi-attractive, don't last long. Personally I'd be weary of the property, without knowing anything else. Let me know if you want to discuss any further.
    0Reply
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