Is it worth overpaying for good cash flow? Need vet advice!

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Is it worth overpaying for good cash flow? Need vet advice!

Mark McNutt
Philadelphia, PA · Member since 2017 · 8 posts · 2 votes

This could potentially be my first investment. I have been looking for multifamily properties for months now and to my knowledge and experience, nothing that fits my personal situation has come up yet but i do find myself faced with one potential opportunity. 

Right now Im paying 700/mo in rent. (This will be relevant information shortly)

The property that Im looking at is a triplex being sold for 120k in an area that my realtor said should be selling for about 110k. The lowest the seller is willing to go is 115k because thats how much he still owes on the property after buying it about 5 years ago. After i do some minor repairs and adjustments through my FHA 203K mortgage (I will be living on the property), It will probably be at an estimated 135k that im buying this property at. My realtor advises that this building will likely not appreciate very much at all in the long term but i could profit about 4 or 500$ after mortgage and expenses are payed.

My question is Would it be worth overpaying slightly for this property to free up the 700$ im paying in rent plus adding an extra couple hundred dollars to my monthly income? Or is it absolutely stupid of me to overpay for a property that i will likely never be able to sell for a profit?  

The building is in good shape that i know of and its in the Philadelphia PA market and from what i gather, properties are being sold for about 20% higher over market value anyway. Im not too hung up on the specifics, I would just like to know if it would be worth prioritizing cash flow over appreciation from a veterans point of view. Thank you for taking the time to read this!

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Roy N.Pro Member
Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
9y

How long has the property been on the market? and how many price reductions?

How much interest has there been in the property?

Any prior offers?

If this is a listed property, the Realtor.com site or your agent should be able to answer all of the above.

I know you said the owner needs $115K to retire his debt, but if the property has been listed a long time with little interest, that's a good indication that your agent is correct and it is over priced.   At some point the owner will be inclined to accept less.

You can always start by offering $100K and see where the vendor comes back.

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  • Roy N.Pro Member
    Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
    9y

    @Mark McNutt

    Others will have to chime in on the Philly market, but if you "overpay for good cashflow" then it is less likely to be "good cashflow".   

    Ideally you want is to find a 3-4 unit property that will carry itself with you living in one {the least profitable} unit and not paying rent.

    1Reply
  • Austin Fruechting
    Investor · Kansas City, MO · Member since 2017 · 791 posts · 1k+ votes
    9y

    @Mark McNutt - how many units, what are the rents per unit? 

    Preliminary if your numbers are right and you can live for +$400 a month instead of -$700 a month I wouldn't worry about the extra $5k in purchase price.  Even if you paid an extra $5k in cash to get it, you only have to live there 5 months to get it back, but the majority of that will be financed anyways.  So if you can make a swing of over $1k in your monthly expenses the sooner the better. 

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  • Mark McNutt
    OP
    Philadelphia, PA · Member since 2017 · 8 posts · 2 votes
    9y

    @Roy N.

    I agree and thats exactly the game plan. I forgot to mention it was a triplex so thank you for that. But I do plan on living in the smallest and least profitable unit and making that sacrifice for myself for at least a couple years. It being an FHA mortgage I have to live on the property for at least a year anyway. also my mortgage would be higher and thus less cash flow because im putting 3.5% down. Im looking at an estimated 900$ between mortgage, insurance, and taxes and i could do the first unit for about 850 and second unit for 650/700ish.

    With my limited ability and experience to recognize a good deal when i see it, This situation seems a little better than a few of the other properties that i have had the option of buying but I am concerned about screwing myself over before ive even started by overpaying for a building. 

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  • Roy N.Pro Member
    Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
    9y

    How long has the property been on the market? and how many price reductions?

    How much interest has there been in the property?

    Any prior offers?

    If this is a listed property, the Realtor.com site or your agent should be able to answer all of the above.

    I know you said the owner needs $115K to retire his debt, but if the property has been listed a long time with little interest, that's a good indication that your agent is correct and it is over priced.   At some point the owner will be inclined to accept less.

    You can always start by offering $100K and see where the vendor comes back.

    2Reply
  • Mark McNutt
    OP
    Philadelphia, PA · Member since 2017 · 8 posts · 2 votes
    9y

    @Austin Fruechting

    3 units and I would be living in one of them. Down the road i could probably rent it for 500$

    Unit 1 850

    Unit 2 650

    After the repairs (The kitchens need new appliances and cabinets and bathrooms need a little work) I would probably end up buying it for almost 15 or 20k more. (repairs are built into the mortgage). Should I be a lot more concerned about overpaying by about 20k? 

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  • Adam M.
    Lawrence, KS · Member since 2017 · 175 posts · 51 votes
    9y

    Not familiar with the market but it sounds like he overpaid, which isn't your problem, but at the end of the day you can't force the seller to eat a loss like that. As long as the numbers work for you then its good. Like Austin said the $1k swing in expenses is huge. You should take into consideration though that you are living with tenants and that brings about its own issues.

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  • Roy N.Pro Member
    Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
    9y
    Originally posted by @Austin Fruechting:

    @Mark McNutt - how many units, what are the rents per unit? 

    Preliminary if your numbers are right and you can live for +$400 a month instead of -$700 a month I wouldn't worry about the extra $5k in purchase price.  Even if you paid an extra $5k in cash to get it, you only have to live there 5 months to get it back, but the majority of that will be financed anyways.  So if you can make a swing of over $1k in your monthly expenses the sooner the better. 

    I would disagree.  You should analyse the property as if all units are rented (with an appropriate vacancy allowance for the market) and ensure the business can provide a rate of return that meets your objectives.

    If the {M}IRR of the business is sufficient, then you look at the personal advantages of residing in the least profitable unit.

    0Reply
  • Austin Fruechting
    Investor · Kansas City, MO · Member since 2017 · 791 posts · 1k+ votes
    9y
    Originally posted by @Mark McNutt:

    @Austin Fruechting

    3 units and I would be living in one of them. Down the road i could probably rent it for 500$

    Unit 1 850

    Unit 2 650

    After the repairs (The kitchens need new appliances and cabinets and bathrooms need a little work) I would probably end up buying it for almost 15 or 20k more. (repairs are built into the mortgage). Should I be a lot more concerned about overpaying by about 20k? 

     Is your realtor saying it's only worth $110k even after you do the work? Or that it's worth $110k as it is now?  If it's worth $110k right now the work you are doing adds value to the property too so you wouldn't be overpaying by $20k. 

    0Reply
  • Mark McNutt
    OP
    Philadelphia, PA · Member since 2017 · 8 posts · 2 votes
    9y

    @Roy N.

    It looks like its been on the market since the end of March and there has been no price reductions. I already made a verbal offer with the seller and the lowest hes willing to go is 115. 

    I dont think there have been any prior offers and Im not sure if there is a lot of interest on it. 

    0Reply
  • Austin Fruechting
    Investor · Kansas City, MO · Member since 2017 · 791 posts · 1k+ votes
    9y
    Originally posted by @Roy N.:
    Originally posted by @Austin Fruechting:

    @Mark McNutt - how many units, what are the rents per unit? 

    Preliminary if your numbers are right and you can live for +$400 a month instead of -$700 a month I wouldn't worry about the extra $5k in purchase price.  Even if you paid an extra $5k in cash to get it, you only have to live there 5 months to get it back, but the majority of that will be financed anyways.  So if you can make a swing of over $1k in your monthly expenses the sooner the better. 

    I would disagree.  You should analyse the property as if all units are rented (with an appropriate vacancy allowance for the market) and ensure the business can provide a rate of return that meets your objectives.

    If the {M}IRR of the business is sufficient, then you look at the personal advantages of residing in the least profitable unit.

     I'm not disagreeing with what you are saying about analyzing.  That's why I asked about the # of units and rents.  

    But just going off his assumptions and if it were true he could have be +$400 cash flow (while living for free!) I wouldn't care about and extra $5k on purchase price. So I was extrapolating out analysis on if those assumptions were true, it was providing a great return. Because then he rents his out later and cash flows even more. But I'd be pretty happy with even just $400 cash flow on a $130k all in purchase, not even counting the additional unit to rent later.  

    EDIT TO ADD: I don't know the market and how that compares with that exact market.

    0Reply
  • Austin Fruechting
    Investor · Kansas City, MO · Member since 2017 · 791 posts · 1k+ votes
    9y
    Originally posted by @Mark McNutt:

    @Austin Fruechting

    3 units and I would be living in one of them. Down the road i could probably rent it for 500$

    Unit 1 850

    Unit 2 650

    After the repairs (The kitchens need new appliances and cabinets and bathrooms need a little work) I would probably end up buying it for almost 15 or 20k more. (repairs are built into the mortgage). Should I be a lot more concerned about overpaying by about 20k? 

     If you are getting $1400 in rent for the other units, and if it falls around 50% expenses you would have $700 left to pay the mortgage.  I assume you will be the property manager though and probably do some of the repairs yourself as well.  If so, maybe 40% to expenses and you have $900 left to pay the mortgage, which I assume is around $600.  So while you are living there I would guesstimate +$300 in cash flow and you have a $1k difference in monthly cash from where you are right now. 

    After you move out and hire a property manager you have $1900 in rent and 50% rule leaves $950 and you make $350 with someone else managing. 

    How does $1900 in rent for $135k (1.4% rent/purchase) compare to others you've looked at?

    0Reply
  • Mark McNutt
    OP
    Philadelphia, PA · Member since 2017 · 8 posts · 2 votes
    9y

    @Austin Fruechting 

    Honestly I'm not sure how it compares. I didn't do the math on the others because I haven't been able to get another one to the point where I would want to or can afford to buy. But I really appreciate you breaking that down for me. This is all still pretty new to me and I'm still learning how to judge a good investment and think like an investor but that alone i think answers my question and will help me judge similar questions in the future. Good sir you have taught a man to fish this day. 

     Thank you so much for taking the time to help me out! 

    1Reply
  • Roy N.Pro Member
    Rental Property Investor · Fredericton, New Brunswick · Member since 2013 · 7k+ posts · 4k+ votes
    9y

    @Austin Fruechting

    I get your angle on this.  The point I was trying to drive home is:

    "It's a business first ... and second ... and third ... "

    1.4% rent/purchase may be an acceptable metric - or it may be meaningless. What is the projected stream of free cash flow {based on actuals}? ... how does the CoC compare to your rent/purchase.

    The OP should get some actual data - it may be that operating expenses run 60-70% of revenue - and perform a discounted cash flow analysis before making a firm offer. {M}IRR may only be 2-3%

    I concede to your point that $5K is not likely going to have Mark circling the drain ... but, in my experience, most {residential} realtors have a built-in positive bias ... so, if his realtor thinks the property is only worth $110K, there is a strong possibility the business may only be worth $100K ... or even less.

    Math doesn't lie ... get the actual data (2 - 3 years worth) and run a full analysis.

    0Reply
  • Greg H.Pro Member
    Moderator
    Broker/Flipper · Austin, TX · Member since 2013 · 4k+ posts · 4k+ votes
    9y

    If the property was worth $110k, I would want to by it for $80k. I am an investor, not a retail buyer. I have never not would I ever buy a property that I couldn't turn around and sell it for the next week if I had to.  Maybe that is why I have been doing this for 28 years. 

    Additionally, you are mentioning doing a 203k which is one of the most difficult transactions to go through.  Count on repairs being much higher due to all code upgrades and such that will be required by the appraiser.  

    If I were your agent, I would advise you to take a minute and familiarize yourself with 203k(the chances are your agent has never been through one either) and make sure this is the deal for you. For those who think an agent/broker would never do that, this one would. A 4K commission doesn't change my life

    0Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    9y

    It will be very difficult for you to buy a property under market value with a FHA loan. Having said that, you also do not want to pay over market value. The good news there though is that in practice this is tough to do with a FHA loan ... as part of escrow, you will have an appraisal done on the property. So long as the appraiser is competent, then the appraisal condition should protect you from overpaying. If the appraisal does not come in at your offer price, then either the seller lowers the price to appraisal value or you walk ... and yes you absolutely should walk if this happens ... under no circumstances should you bring extra cash to the table to cover the difference between appraisal and offer price. So, there you go ... you can put in your offer ... if it appraises, then great, you have a property at market value ... if it does not appraise, then I already covered your options.

    1Reply
  • Greg H.Pro Member
    Moderator
    Broker/Flipper · Austin, TX · Member since 2013 · 4k+ posts · 4k+ votes
    9y
    Originally posted by @David Faulkner:

    It will be very difficult for you to buy a property under market value with a FHA loan.

    Not necessarily and would vary greatly by market. Offers on HUD homes are no preference whether FHA financing or cash. Off market properties or properties that have high number of days on the market would also be a possibility

    0Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    9y
    Originally posted by @Greg H.:
    Originally posted by @David Faulkner:

    It will be very difficult for you to buy a property under market value with a FHA loan.

    Not necessarily and would vary greatly by market. Offers on HUD homes are no preference whether FHA financing or cash. Off market properties or properties that have high number of days on the market would also be a possibility

    Difficult, yes. Impossible, no. And the more desirable the market, which are the ones folks should want to invest in, then the more competition there will be from all cash buyers and the like and the more difficult it will be. It would be darn difficult in places like Austin or SoCal. HUD homes may offer some loopholes as mentioned, but just because you can get an accepted offer doesn't mean you can close the darn thing. One fleck of chipping paint and the FHA inspector will be no-go, which it makes it hard to get a fixer in distress. Ok, so FHA fixer loans may get you around this, but those aren't exactly easy to close either ... so, yeah difficult but not impossible. I think it is important to level-set expectations since every other newbie I've met seems to think they can just waltz right into any market, without much work, and without two nickels to rub together, and pick up a fantastic below market deal ... so, I'm just trying to keep it real up in here.

    1Reply
  • Nick DiTommaso
    Macomb, MI · Member since 2017 · 10 posts · 2 votes
    9y

    I feel i am in the same position looking at a duplex, judging if its worth. I recently watched a bigger pockets Youtube video the other day, i forgot the title but its about the 4 square calculating a rental property. The major point I received from that video and from the looks of your position is that if it fits your needs and goals. Considering your position on short/long term goals its really up to you choice. I'm my current calculation for a duplex I can see a few hundred dollars coming in monthly but I know equity will grow. 

    I am not a veteran, but spend majority educating myself for my first purchase and one advice I have been obtaining from podcasts, audio books and friends is that is to just jump in a do it. You really wont know how if its worth it until you try, but being smart and calculating like you have is ideal. The first property is a experience for next set of properties, that is if your goal is to continue for multiple properties. 

    1Reply
  • Katherine S.
    Investor · Grosse Pointe Shores, MI · Member since 2017 · 160 posts · 74 votes
    9y

    I don't know if the numbers work for the rental, but one thing I can add is that a verbal offer is not the same thing as a written offer.  Meaning that one is theoretical and the other is real.

    I'd make a low ball offer, and keep making it periodically if he turns it down.  If he really wants out, at some point, he's going to face reality. 

    1Reply
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