Should I walk away?

61 Replies

Hello BP members,

I need your help analyzing this deal.  I have a feeling what you'll tell me but I just need to hear it so I can walk away from it.   It will be my first deal.  I've been looking into MF 2-4 units but no luck here in Central California.  Units with cash flow are in areas that I don't want to deal with.  Units that are in good areas are asking for outrageous prices that just don't make sense to invest in.  So I looked into SF home and hope that appreciation in good areas will outweigh the negative cash flow. Here's the house I'm looking at:

SFR 4/2 1800 sq ft, built 1994, tile roof. HVAC hasn't been changed.

Pros: excellent neighborhood, very low crime, very good schools (8-9 range), walking distance to elementary school, near hospital with new cancer center opening early 2018, new medical school to be built in 2019

Cons: negative cash flow

Asking price: $285k (down from 305K initially, seller has new home built end of 8/31 so they want to sell it quick)

Finance: 25% down, 4% interest, 30-yr, loan amount 214k, closing $8.5k, rehab $3k

Rent: $1,750 

Operating expenses: 50.6% total + 8% vacancy

NOI: $795

Cash flow: -$225

Cap rate: 3.3% 

If purchase price was $280k and I manage the property, then cash flow will be negative $47 with cap rate 4.1%.  My wife and I work full-time and we live off of one salary and save the other.  Even if we don't have renters, we can take a hit.  I'm not sure if that would change anything.   This house can be sold for $300 if they seller wasn't in a rush.  So that's 10-15K in equity right off the bat for me.  It is an upcoming area that I truly believe it will appreciate to the $320-350k in 3-4 yrs.  My house is near by and it has appreciated by $60k in two years.  We bought it new for $330 in 2015.  Now similar homes are going for $390-400k. 

Thank you for your time. 

HN

if you can afford the upkeep and wait out the appreciation it looks like a low risk deal  The fact that you know your area very well is a big plus besides rents are always going up Good luck

If you are comfortable as a speculator as opposed to a investor for income then the opinions of others should be irrelevant.

Speculating on appreciation is the underlying motivation for real estate purchases in CA so you are the norm if you buy. Although it is high risk most in CA are convinced there will never be a peek to your market. The theory is that everything only has one direction....up. The theory of gravity is not a accepted science.

IF they are right then go ahead. If they are wrong you will be in good company.

Thanks @Thomas S.  You're right.  Ideally you want to invest in property that appreciate and provide positive cash flow.  California is a very big state.  The mean home in Central Valley California is $300,000 vs $880,000 in San Jose, CA.  They are two different markets.  

How long are you ok with losing 225 a month for?

What will you do if the house doesn't appreciate like you want it to? What if the market takes a down spiral and rents and appreciation both go down? What happens if one of you loses their job?

I get that California is tough, and plenty of smarter people than I have speculated in the California market and won, so I won't comment on your strategy. But you and yours need to sit down and talk through some worst case scenarios before you pull the trigger.

Originally posted by @Travis Dawson :

How long are you ok with losing 225 a month for?  

What will you do if the house doesn't appreciate like you want it to? What if the market takes a down spiral and rents and appreciation both go down? What happens if one of you loses their job?

I get that California is tough, and plenty of smarter people than I have speculated in the California market and won, so I won't comment on your strategy. But you and yours need to sit down and talk through some worst case scenarios before you pull the trigger.

Thanks @Travis Dawson. I'm planning to manage it myself so cash flow is actually negative ~$50. I'm planning to hold it for 20-30 years so I think it's safe bet that it will appreciate. Either of our salary can pay for both mortgages (my house and this one) and all living expenses. If we both lose our jobs, then I guess we can borrow from our IRA (or family) to pay for a short period of time until we find jobs. We work in health care industry so it should not be a problem finding jobs.

I'd want a bit more of an initial equity cushion than $10-15K ... I understand that this would be in addition to the 25% you put down, but I'm talking about equity in the deal that you don't put down. If you decided you wanted or needed to sell short term, that 10-15k would get eaten up and then some in transaction fees. You ideally want something that you could sell for a profit (with transaction fees included) at anytime if you need or choose to, starting the day after you close escrow, even if your intention is to hold. You may need to go for something that needs more than $3k in reno where you can force appreciation a bit more to get it, or try to negotiate them down in price more ... I think if you could find that then it would cash flow too (or at least be cash flow neutral) ... I know, easier said than done in today's market. You are right to not want to compromise on quality IMO, though.

In the beginning of the thread it sounds like you almost want to be told to pass, or walk away. 

However, the numbers and responses you've given make it sound like you would like to be told to pull the trigger. What I'm hearing are solid - highly responsible financial habits, very familiar with the local market and aware of the possible downsides. 

Have it inspected, and pull the trigger man... If you find it's not for you, sell it. Even if you take a loss, at least you know. 

Are there any local meet ups/ investors who could ease your mind about the purchase?

You got this,

GN

Originally posted by @David Faulkner :

I'd want a bit more of an initial equity cushion than $10-15K ... I understand that this would be in addition to the 25% you put down, but I'm talking about equity in the deal that you don't put down. If you decided you wanted or needed to sell short term, that 10-15k would get eaten up and then some in transaction fees. You ideally want something that you could sell for a profit (with transaction fees included) at anytime if you need or choose to, starting the day after you close escrow, even if your intention is to hold. You may need to go for something that needs more than $3k in reno where you can force appreciation a bit more to get it, or try to negotiate them down in price more ... I think if you could find that then it would cash flow too (or at least be cash flow neutral) ... I know, easier said than done in today's market. You are right to not want to compromise on quality IMO, though.

@David Faulkner.  Good suggestion.  I'll look into homes that can be force appreciated a bit more.

Originally posted by @Hau N. :
Originally posted by @David Faulkner:

I'd want a bit more of an initial equity cushion than $10-15K ... I understand that this would be in addition to the 25% you put down, but I'm talking about equity in the deal that you don't put down. If you decided you wanted or needed to sell short term, that 10-15k would get eaten up and then some in transaction fees. You ideally want something that you could sell for a profit (with transaction fees included) at anytime if you need or choose to, starting the day after you close escrow, even if your intention is to hold. You may need to go for something that needs more than $3k in reno where you can force appreciation a bit more to get it, or try to negotiate them down in price more ... I think if you could find that then it would cash flow too (or at least be cash flow neutral) ... I know, easier said than done in today's market. You are right to not want to compromise on quality IMO, though.

@David Faulkner.  Good suggestion.  I'll look into homes that can be force appreciated a bit more.

No harm in trying for this one at a lower negotiated price as mentioned, so long as you are willing to walk if you can't get it at that price ... assuming it is a listed property, you may consider going in through the listing agent, to either give him the incentive to double end the deal if he makes it happen for you, or to try to get him to lower his commission on your side and the price by the same amount to net the seller the same and still give the listing agent a bit more commish. 

Originally posted by @Graham Nash :

In the beginning of the thread it sounds like you almost want to be told to pass, or walk away. 

However, the numbers and responses you've given make it sound like you would like to be told to pull the trigger. What I'm hearing are solid - highly responsible financial habits, very familiar with the local market and aware of the possible downsides. 

Have it inspected, and pull the trigger man... If you find it's not for you, sell it. Even if you take a loss, at least you know. 

Are there any local meet ups/ investors who could ease your mind about the purchase?

You got this,

GN

Thanks @Graham Nash.  There are few groups in town, but I haven't checked it out yet.  I'm planning to in the near future to network. 

Originally posted by @David Faulkner :
Originally posted by @Hau Nguyen:
Originally posted by @David Faulkner:

I'd want a bit more of an initial equity cushion than $10-15K ... I understand that this would be in addition to the 25% you put down, but I'm talking about equity in the deal that you don't put down. If you decided you wanted or needed to sell short term, that 10-15k would get eaten up and then some in transaction fees. You ideally want something that you could sell for a profit (with transaction fees included) at anytime if you need or choose to, starting the day after you close escrow, even if your intention is to hold. You may need to go for something that needs more than $3k in reno where you can force appreciation a bit more to get it, or try to negotiate them down in price more ... I think if you could find that then it would cash flow too (or at least be cash flow neutral) ... I know, easier said than done in today's market. You are right to not want to compromise on quality IMO, though.

@David Faulkner.  Good suggestion.  I'll look into homes that can be force appreciated a bit more.

No harm in trying for this one at a lower negotiated price as mentioned, so long as you are willing to walk if you can't get it at that price ... assuming it is a listed property, you may consider going in through the listing agent, to either give him the incentive to double end the deal if he makes it happen for you, or to try to get him to lower his commission on your side and the price by the same amount to net the seller the same and still give the listing agent a bit more commish. 

I've thought about that as one of the podcaster did it (going to the listing agent).  I didn't think of asking the agent to lower his commission to give it back to the seller also.  Thanks.

Hau,

Sounds like you could do this deal and it probably will not hurt you, in fact it might be good for you to finally get your first deal under your belt.  Since it's close to home, an area you know well, and your planning on managing the property yourself where you will learn so many valuable lessons, a cost of -$225 per month it could be a very good starting property.

However, don't ignore the effects of -$225 per month on your Investor attitude.  If you can't realistically predict that you can raise rents over the next 2-3 years to cover all costs and show a profit then you should try and restructure the deal so that you can.  And if that isn't possible you should pass. 

I have an SF rental within 1 mile of my residence that I manage myself, it carried a -$250 cash flow for over 2 years before I was able to make some positive changes and now it's only -$100 and it still bothers me every month.  The income isn't the problem, I earn sufficient to cover the entire mortgage on any given month but losing even $100 per month on a property starts to negatively impact my mindset ... from time to time. 

Even a $50 per month positive cash flow from your investment activity will help you create and keep the right mindset which is important to help you gain momentum as an RE Investor.

To your Success!

I don't get why you would buy it? Why not invest in the stock market for 20-30 years where you can get 5-8% after fees? For higher return use your money as a lender. Be a private equity investor in other syndications, businesses or crowdfunding. Your investment is $82,750, plus $6000/year until rent gets to the break even point, so likely over $100,000.  I don't get it, but I'm not from California. 

I primarily look at cap rates when evaluating property so my answer will be biased. 3.3% is quite low. Seems like the rental demand is not there in your area. Maybe look into some underlying factors there? I dont touch anything below 8%. As others have said, it could take a mental toll after time that you'll be managing a property with negative cash flow. Also, many ETFs will give you 8% adjusted for inflation. I admire your analysis and considerations, but would walk away. You will know when you find the property and you'll be excited to make an offer. If you're hesitant now, whats going to happen in 6 months when you have a large maintenance or repair cost? Either way, good luck.

If you are looking for purely equity, you should be able to weather it. If you have, as you seem to say, a large income, perhaps you really don't care if there is no income from the property and you build equity and hope for appreciation. I would, however, suggest you put in the 10% property management fee into your numbers. It would be really bad if you find that you are not good at or don't enjoy managing yourself, and now are paying 175/month to a manager.  Perhaps you find that you really do like it, you want to purchase more, but you'll find it hard to expand with a negative cash-flow property (and to convince any family members to go along with you). I'd keep looking. 

Originally posted by @Hau N. :
Originally posted by @David Faulkner:
Originally posted by @Hau Nguyen:
Originally posted by @David Faulkner:

I'd want a bit more of an initial equity cushion than $10-15K ... I understand that this would be in addition to the 25% you put down, but I'm talking about equity in the deal that you don't put down. If you decided you wanted or needed to sell short term, that 10-15k would get eaten up and then some in transaction fees. You ideally want something that you could sell for a profit (with transaction fees included) at anytime if you need or choose to, starting the day after you close escrow, even if your intention is to hold. You may need to go for something that needs more than $3k in reno where you can force appreciation a bit more to get it, or try to negotiate them down in price more ... I think if you could find that then it would cash flow too (or at least be cash flow neutral) ... I know, easier said than done in today's market. You are right to not want to compromise on quality IMO, though.

@David Faulkner.  Good suggestion.  I'll look into homes that can be force appreciated a bit more.

No harm in trying for this one at a lower negotiated price as mentioned, so long as you are willing to walk if you can't get it at that price ... assuming it is a listed property, you may consider going in through the listing agent, to either give him the incentive to double end the deal if he makes it happen for you, or to try to get him to lower his commission on your side and the price by the same amount to net the seller the same and still give the listing agent a bit more commish. 

I've thought about that as one of the podcaster did it (going to the listing agent).  I didn't think of asking the agent to lower his commission to give it back to the seller also.  Thanks.

As I think about this further, it may be best to just put the offer in through the listing agent and don't ask them to lower their commission. That is a conversation between the seller (who pays the commission on both sides) and the listing agent, not between you and the listing agent ... the listing agent may reach the same conclusion on their own that it makes more sense to lower the commish a bit to net more total from both sides, or they may be able to pull it off to get paid in full on both sides, and however the agent works it out is really of no concern to you, so long as you get your price ... if they come back and reject the offer, then you may offer that up as an alternative to get the deal done if you like, since at that point it may be dead anyway if that doesn't happen.

I think if you can handle the negative cash flow for a little it will out weigh the appreciate that you will receive. It is obvious you know the area and the area is up and coming. There is def a market coming and your about to Capitalize on the appreciate.

Good luck !

What source is this deal? Off-market or MLS?

How many units have you actually walked through in the past 6 months?

If the answer is: MLS and less than 20, than it would seem to me that you're choosing to settle for the sake of "getting started." I just could never recommend losing money in hopes of someday maybe making money. Invest for cashflow, appreciation is icing on the cake. Take massive action and find a better deal.

There's also a reason other investors haven't scooped this one up yet. I'm curious what other investors are doing in your area to be successful?

It looks like a nice house from the pictures (at least I think I found the house you're talking about) in a great neighborhood. It's been on the market for a while so I'm guessing you can get it for a little bit lower and maybe break even on the cashflow? In addition to maybe replacing the HVAC, it looks like there's carpet in the bathroom? Not a big deal, just something I noticed, should be cheap to replace with tiles. Otherwise, it looks like it's pretty much rent ready. Maybe a bit of landscaping in the backyard. The other thing I noticed is that there are new constructions nearby starting around 280k but the houses seem a lot smaller. Good luck!

Originally posted by @Wren Martin :

Hau,

Sounds like you could do this deal and it probably will not hurt you, in fact it might be good for you to finally get your first deal under your belt.  Since it's close to home, an area you know well, and your planning on managing the property yourself where you will learn so many valuable lessons, a cost of -$225 per month it could be a very good starting property.

However, don't ignore the effects of -$225 per month on your Investor attitude.  If you can't realistically predict that you can raise rents over the next 2-3 years to cover all costs and show a profit then you should try and restructure the deal so that you can.  And if that isn't possible you should pass. 

I have an SF rental within 1 mile of my residence that I manage myself, it carried a -$250 cash flow for over 2 years before I was able to make some positive changes and now it's only -$100 and it still bothers me every month.  The income isn't the problem, I earn sufficient to cover the entire mortgage on any given month but losing even $100 per month on a property starts to negatively impact my mindset ... from time to time. 

Even a $50 per month positive cash flow from your investment activity will help you create and keep the right mindset which is important to help you gain momentum as an RE Investor.

To your Success!

Thanks @Wren Martin. I think in a few years after the medical school is built and the Cancer Center (I didn't mention but the VA clinic is going to open a clinic around this area also), rent is going to increase. An average medical class has about 150 students. There are four classes so that 600 medical students looking for a place in this area. Nothing is a 100% but my guess is rent is going to be in the low 200s for a 4 bedroom eventually.

Thank you for the subtle point of investing mentality.  That's helpful.