Upfront repair costs canceling out cashflow for X years
Boston, MA · Member since 2017 · 74 posts · 8 votes
I'm trying to buy my first duplex. I have one under contract, and I'm trying to determine the initial repair costs.
I need to decide between keeping the slate roof and repairing year to year, or just replacing. I'm looking at up to 5k in other structural deferred maintenance, and I would like to dump 10-20k into improvements to raise rents. So maybe up to 30k-35k up front.
So if I invest all this money up front, I won't make it back until 3-5 years in. Keep in mind, I expect these investments to be strictly for cashflow, not for appreciation in my area.
Would that be concerning to you as a real estate investor? A concern I have is, what if it doesn't work out and I have to sell before I make that money back? I guess I just have to hold on to it for a while to reap the benefits of initial capex repairs and cosmetic improvements..
Up front repairs are considered part of your acquisition/cost basis....different than ongoing repairs and capex, but of course cuts into your cash.
Up front repairs are considered part of your acquisition/cost basis....different than ongoing repairs and capex, but of course cuts into your cash.
Ah, so, I'm looking at financing these initial repairs with a 3 year loan, which still amounts to a pretty high monthly payment. I'd feel better, perhaps falsely, if they could get rolled into the 30 year loan. I guess its an unavoidable fact of buying a place that needs work...
Pay 35k less for the house . You make it when you buy the property
Agreed with @Matthew Paul - I think your options to make the situation work better than it currently is working are:
Evaluate the NPV of the different projects using a DCF analysis. Ultimately, I think that you have to compare all the possible ways of executing the project using cash on cash return or NPV (I would prefer NPV for the complexity of this particular situation), and be disciplined enough to walk away if the numbers don't make sense.
$35k of repairs is a ton if it's not a rehab. Are these costs reflected in the purchase price?
Your post was vague - what exactly are they for? Are they increasing value?
@Jordan Grimstad The DCF analysis went over my head a little bit, I'll take another look, but I get the idea of running different scenarios. I'm thinking it might be a good idea for me to hold off on value increasing "nice to have" improvements and rent out the property just about as is.Then, as pieces wear out, I can replace them with nice stuff and gradually increase value and income, because the numbers work nicely with current actuals.
There are some things that I think I can very easily ask for- credit for repairing the current slate roof to get me a couple more years before I replace it, credit for cleaning/detoxing the unit currently rented by smokers, and credit for and foundation patching for erosion due to the unadressed grading issues (the seller provided me with a 2009 inspection, funny enough).
I was probably grossly overestimating, and including costs for an immediate overhaul of parts of each unit.
Any tips on getting a seller to accept these types of credit requests? I feel like I'm being reasonable by those things I listed, but is there language I can include that would make them agree that I am in fact being reasonable? Or do we just draw it up and hope he agrees?
@Thomas S. "You do not waste time asking for credits you simply lower your offer to compensate for the repair costs."
Why is a lower offer inherently more desirable than an equivalent "higher price with credit offset" offer? For example, from a seller's perspective, getting $200k and providing $10k worth of repair credits associated with specific repairs has the same net impact to their bottom line as getting $190k; and, from a buyer's side, paying a financed $190k means you still have to cough up $10k cash immediately to execute repairs, whereas paying a financed $200k and getting $10k in credits means you get to amortize the upfront cost of repairs over the term of the loan and only needing to set aside $2k in additional cash immediately to offset the additional loan principle. Seems like it could be an easier pill to swallow on both sides to propose credits rather than putting down a straight up 'firm and final,' but let me know what I'm missing.
@Brendan L. Negotiation tactics are seller/market/property dependent. Why is the seller selling? Are they trying to get out from it quickly or can they take their time? Is the seller an investor themselves? Are they the type that would prefer to deal with things in writing or are in-person discussions more likely to be effective? I'd probably talk it over with your realtor/a mentor or possibly start a separate thread to source people's thoughts on this one.
Regarding the NPV & DCF calculations, the pages might be a bit complex but the idea is generally pretty simple - if I tell you I'll give you $100 a year from now or $x today, what would x need to be such that you were indifferent between the two offers?
More broadly, DCF helps you get an 'apples to apples' perspective on projects that have differently-sized cashflows at different times. For example, if you have one project with a large upfront investment and larger periodic payoffs and another project with a smaller upfront investment and smaller periodic payoffs, one answer to which project you should choose depends on the sum of the present values (the "x" in the $100 vs. $x comment above) of the cashflows of each of the projects - this present value is dependent on the length of time you're investing and your expected yearly return, as a discount rate (although there are a couple of different ways to select an appropriate discount rate, that piece can be researched).
I would consider lowering your offer or walk away... of course, this depends on the market you are. Most likely there are other properties that you may have forced appreciation and get some cash flow. Not sure what was the actual cost of your property, but +$35K in rehab, plus interest, plus any other issue that may arise in the rehab process on top of that, I would reconsider.
The repairs need to add more value to the property than what they cost, with margin. If this is not the case, then your offer is too high. This is precisely the type of thing that gets overlooked when investors only look at cash flow and ignore equity from forced appreciation. Then if/when their cash flow projections don't pan out and/or they need or choose to sell they get stuck because they can't sell for what they have invested in the property. Your analysis is not perfect, your operations are not perfect, and the world is generally an imperfect place with lots of uncertainty, which is why you always need to maintain multiple profitable exit strategies each with adequate profit margins, and then reserves on top of that.
If your in a market where you can't realistically bank on appreciation be very cautious " upgrading " a property for the sale of "making it nicer"
Personally we invest heavily in these areas. We know from the start not to bank on appreciation and we address safety issues, roofs, and exterior problems immediately.
Once those issues are stable we only do what is needed to make the unit rentable in its market. We then enjoy some cash flow and save some for improving at a turnover.
We don't try to unrealistically push rent rates by improvements until we know the area and tenant base and what THEY think is worth paying more for.
If it works like it is why change it?
I struggle to understand what adds value to a huse. The offer is currently at 95k for a 6/2 3100square ft. In 2007, the height of the market, it sold for 137k in today's dollars, without replacement windows and some cosmetic upgrades. But then it got foreclosed on, sold for 60k in 2009, had some upgrades done, and that's who I'm dealing with.
Ive looked at recently sold comps and I think 95k is in the ballpark, but theres limited data. But when you're considering ARV, do you include capex in there? So if a place needs a new roof and boilers right away, to what extent does replacement contribute to what you could sell it for? Dollar for dollar?
I hope my post didn't confuse you. MY goal is to have the nicest appearing house on the block that is RENTABLE inside. I DO NOT CARE what it sold for in the past. I ADD ALL THE COSTS to have it in this condition and then compare with SALE COMPS for the area. I then study rent rates in the area and calculate how long it will take to REALISTICLY GET MY MONEY BACK. If I like the numbers I pursue the investment, if it doesn't I MOVE ON.
Be very careful over improving a property compared to the neighborhood. I sounds like a great idea but if no one else in the block tags along you can end up just overinvested. Sure the folks driving by say WOW but it might not make you any $$$$
I invest rehab to hold in working class areas mainly with cash so my ideas don't fit the " normal " here but if the theory fits use it.
Naw that makes sense. I guess I was wondering what people think is an acceptable time frame for making your money back on:
-capital expenditures that are needed right away
(e.g. drop 10k on roof and boilers to make it habitable, don't make that back until the end of year 2)
-improvements to units that boost income
(e.g. drop 10k to improve, boost rent by $100 = ~8 years to begin profiting)
And with immediate capital expenditures, how do you price those into the sale price? Is it, for example (comp sale price with good roof MINUS the cost a new roof EQUALS offer price)? And what is reasonable to ask a seller to credit you for? For example, this is an ancient slate roof that needs repairs after last winter, but I want to replace it- so I ask for the money for the repairs for damage during winter.
And with improvements, I like the idea of phasing things in as the current stuff wears out so as to not shock the rentability of the unit in a mediocre rental market.
@Brendan L., try thinking differently. I assume the numbers work out here either way, and your choice is to either repair all at once now, or piece by piece over the next few years. It doesn't matter, if the numbers work. What matters is how many calls do you want to get from tenants about another leak? How late do you want to stay up at night wondering if those structural issues will survive the next nor'easter? As far as a repayment period I like 3 - 5 years myself. If I can invest $xx.xx and it increases rents by $yy.yy and that means the difference covers my investment in 5 years on something that should last at least 20, then giddy up. If it doesn't increase rents then does it make the place easier to rent thus having fewer down months? That's worth it too. Otherwise, depend on your relationships and replace as you go. Faced with a choice of a $10k hvac job today my contractor, who we've built a good relationship with, tells me "don't worry, if it goes I can get it replaced in a few days so ride it til it dies...."