Buying house with a possible break even or negative CF

Buying & Selling Real Estate Discussion 95 Replies

Hello, I am looking at one of the last options in my price range of a duplex in Auburn, WA. List price is 235,000. But rents are only 1390 a month. We are shooting for offering 215 and counting on raising rents to at least 1490 (one renter is M2M, other is term so I can't until term is up.)

Expenses

Prop tax 3171 annual

Insurance 400

Maintenance 10%

Vacancy 5%

Loan payment 871/mo

I'm getting nervous because by some calculations I will have a small positive cash flow of 20 to 100 but if I add anything else like utilities cost or if repairs are more than 10%, I end up in the red monthly. 

This will be my first rental, but I will be doing the property managing too. Mainly because I could not afford a property manager with such a  razor thin profit margin but also because I stay home with my 1 year old and want to help with income in some way.

Our real estate agent has brought up the point that we will be gaining equity. Also that we may be priced out of the market soon. Which looks very possible.

Any advice appreciated. 

I'm trying to schedule with a financial advisor at my bank now

To clarify rents are 1390 total

695 per unit

If you are banking on appreciation.... and said appreciation doesn't happen you are going to be in for a bad time. I see you have 5% for vacancy... but what happens when you raise rents and the m2m tenant leaves it takes you a month to get new tenant in place. What happens when a repair is needed before the reserves are built up? 

I wouldn't do this, doesn't seem like a good deal to me. It seems like you are "only" buying because you "might" be priced out. If you did go through with this with such thin margins I'd hope you have healthy reserves in place.

Thank you for your input, I appreciate it.

Correction to my post, 10% vacancy is what I calculated. But the rents are on the lower end as they are now. So I imagined if the m2m tenant, tries to find a lower rent to move to in the area, they may just discover that even with raised rent, their current place is the lowest still. 

I'm not banking on appreciation as much as just getting an equity built up and hopefully a small monthly income.

My worry is, even if you estimate a small profit of 100 to 200, what if you end up underestimating repairs or other expenses even if you use the standard calculation? Or is that just part of the risk in this, that you can only estimate so much and sometimes expenses do outweigh the profit?

Thanks again! So new to this. Just trying to get some input from some more seasoned property investors.

Underestimating is just part of the risk in this business, but a good way to cut down on some possible repair expenses is to learn to fix most things yourself.  Youtube will be your best friend if that is what you decide to do, at that point all you would be paying for is materials as you are providing the labor.

Secondary question to this, washington state had the highest increase in home prices in the nation at 12% this last year till now. 

Being it's a first investment home, should we look in another state instead? Or would that also be risky because of our lack of knowledge in the field. 

We are starting to consider it since options here are very slim. Being on one income, we are hoping for one with current long term tenants. 

You can look out of state but a very important thing to consider is that WA has no state income tax where as most other states do.  That alone could shave 5-10% off of any income gains plus the 5-10% you would lose by going to a property manager.  It all depends on the deal not the state, if this isn't the right one another will come along that will be.  Even looking farther out, but within driving distance might be an option I.E. Spokane or Yakima.

@Jayme Jahns I ran your numbers are you're already in the red with that mortgage, those rents (even on the high side) and insurance. Where did you get the $400 number? In WA monthly would be more like $100-$200/monthly depending on the age of the home. I have a duplex in South Kind County and it cost me $250K and rents are $3200 and it still doesn't always cashflow due to repairs (it was built in 1930). I wouldn't buy this one, especially if you want some extra cash. It's 100% an appreciation play and not in an area of high appreciation (Auburn). I'd try looking at properties in Tacoma or other areas if you want cashflow. All of western WA is getting very hard to do for cash flow due to the run up in prices these last couple years.

@Jayme Jahns - My husband and I own a "break-even" property in Ballard, Seattle and don't regret it one bit.  That property has appreciated by $100k in the last 2 years!  This is a long-term play for us.  However, we both have high salary jobs and can easily navigate those months when we are slightly in the red.  As we "gradually" increase the rent on this particular tenant (we inherited a good tenant and that means something to us), we'll be consistently in the green in the near future. 

In sum, I'd only proceed with the "break-even" transaction you mention above if you have ample funds to weather the months when you'll be in the red (and do expect to be in the red with that marginal cashflow projection.) Repairs, property tax increases and other unforeseen expenses do happen (more often than we like in Wa)! 

Look at an amortization chart, you aren't making a dent in equity for a long time unless you force appreciation. I use a CPA and I'm from CA so I might be WAY OFF... but if you're making 100-200 mo in "profit" saving 10-15% of that isn't that great. It could be offset anyways by deprication (I think, I'm not a CPA).


Prop mgmt while you pay for it you have to at least consider the value. You might not pay for it if you do it your self, but your time is still worth something and it's only fair to calculate it going against a PM. 

Lastly, if you went OOS you would be likely be able to better cashflow/return which if it's a buy and hold might work better. You'd miss out on appreciation, but you weren't banking on that so it shouldn't be that big of a problem. People also always talk about what if you had to travel to visit your property OOS it'd eat of profit... except you're paying a PM so why you traveling often. Yes, you will need to travel in the start to find the property, but once it's under control of the PM... let the PM do their job.

Originally posted by @Ana Marie B. :

@Jayme Jahns - My husband and I own a "break-even" property in Ballard, Seattle and don't regret it one bit.  That property has appreciated by $100k in the last 2 years!  This is a long-term play for us.  However, we both have high salary jobs and can easily navigate those months when we are slightly in the red.  As we "gradually" increase the rent on this particular tenant (we inherited a good tenant and that means something to us), we'll be consistently in the green in the near future. 

In sum, I'd only proceed with the "break-even" transaction you mention above if you have ample funds to weather the months when you'll be in the red (and do expect to be in the red with that marginal cashflow projection.) Repairs, property tax increases and other unforeseen expenses do happen (more often than we like in Wa)! 

 Question for you, how does appreciation factor into your long term play? Are you going to leverage against it to acquire more property or 1031 into something else?

@Jayme Jahns Cashflow is not the only investment strategy. It is certainly not mine. In addition to appreciation potential, consider the renters building your equity every month. If you have a fall back plan in case it is vacant more than you expect or you can't rent it for what you think you can, you should be OK. My biggest concern would be the opportunity cost - could you put your money somewhere else and make more with less risk? Maybe...maybe not?

Medium logoJason Hirko MBA, Corridor Funding | [email protected] | (512) 560.7985 | http://www.corridorfunding.com

Hello @Jayme Jahns ! I concur with some of the other investors who have posted. This deal does not look too hot. I would probably pass. There are likely other opportunities that will offer better cash flow.

Medium nelson homes investments final resizedAaron Nelson, Nelson Homes & Investments | [email protected] | http://aaronnelson.kw.com/ | WA Agent # 127645

Oh wow, thank you for all the responses. I'm going to try to respond to them all. Might take me a bit with my 1 year old interuppting occasionally lol

Gustavo, thank you for running the numbers. I really appreciate getting your advice, being that you are from the area and have nearby rentals too. And the insurance, I just pulled off of a calculation my real estate agent showed me. But tbh I'm not really familiar with the difference in regular home insurance and umbrella insurance. From what I understand umbrella covers you from being sued (up to a specified amount like 1 m). But I wasnt sure if that also covers the basic disasters that normal home insurance does. Flood, fire, ECT.

I'm gonna call usaa to get a quote though.

Maybe I will try Tacoma. But we tried to avoid it because of the crime rate. I myself, don't feel comfortable in Tacoma by myself in some residential areas except maybe north tacoma which is high priced. Do you think we would do better in Tacoma? I suppose If the cash flow is good, we could just hire a property manager so I can try to avoid going there a lot. 

Matt from CA, 

Thanks for your advice, That is a good point that equity is a long term play that ties into appreciation. I've been trying to talk to a financial advisor but when I called the bank that use, they tried to force me to pursue the loan through them. So, it's safe to say I cannot trust the advice of my bank who would stand to make money either way if I use them for my loan. Should I talk to a CPA? Or is there any other professionals I might be able to meet with in person that won't have a vested interest in making money off of this deal either way? 

To answer your question about if I plan to use appreciation to acquire more property or 1031.. I would say, yes, ideally I would like to invest in more property down the road that could give us a higher cash flow. 

And 1031, I'm not sure what that stands for, if you mean just sell it to use the money as a DP on another investment, it's something I also considered. We do have a bit of debt I would like to pay off too. But maybe it makes more sense to pay the debt slowly and just invest in more rentals long term?

Aaron

Great points, thank you! I was thinking of trying to do repairs myself to save money.

And I had not considered state tax for OOS investments at all. That is a great point to consider coupled with the added property manager expense. 

Jason

Thank you! On investing somewhere else, I will have to do some research. But the money we have available to invest would just be our down payment from our heloc. If anyone has any specific recommendations, I'm open to listen. We were hoping for a bit of cash flow to help with me having had to quit my job to stay home with our little one. But if we can only get cash flow with high risk, maybe not worth it. 

Ana Marie

Thanks for your response, we are making it but probably couldn't weather too many months of negative cash flow. I mean, we could for a bit but I'm not sure if it would be worth it or worth more debt accruing. 

Aaron, 

Thanks for your input too. It's hard making this decision when getting advice only from the bank or agent who will make money on it either way. 

It's nice to hear from professionals in the business, especially that know the washington state market too. 

Thank you all, sorry if I missed a response. Would love to hear any additional points or advice. 

Is 235k market price for essentially a turnkey property, or is 235k 50k below market value and you can do some forced appreciation on it? Would I buy a property that would break even on cash flow but I had 50k in extra equity on the day I close escrow? Heck yes I would ... if things don't work out with it as a rental I sell for a profit. Would I buy something at full blown retail price to break even on cash flow every month, probably not. Cash flow is an important thing, but it is not the only thing ...

it's an older place, haven't gotten to see inside yet or do inspection. Zillow estimated 245,000 I think but probably not a reliable estimate since I'm looking at buying it now, knowing it's not a good investment even at it's list price of 235 being the rent would only being in 1390 total which is why I was gonna offer 215. 

So, I wouldn't think it would be an easy flip at this moment if renting didn't work out. Also considering we paid closing fees and have to pay the heloc from the DP.

@Jayme Jahns - So in paying the downpayment from your HELOC (I'm assuming the whole downpayment) you are effectively leveraging the entire purchase?

Medium transparent background hresJake Hottenrott CPA, Jacob R. Hottenrott, CPA, LLC | 618‑304‑1584 | http://jakehottenrott.com

the rent seems very low. have you checked if it is market rate?

We had our house paid off, took heloc on it to pay DP on investment house.

I did check rents in the area. It does look like it is very low and could stand to be raised a bit. But we are banking on raising at least 100 right at the start, not sure how much more we could while staying competitive. 

Seems like most deals on the West Coast have minimal cash flow.  If you can't find anything better (assuming you looked long and hard), the market could be factoring a shortage in housing opportunities and implied appreciation.  Up in Vancouver, you have lots of international investment into the city, which lowers returns.  A bit of a gamble.   Don't get into this unless you can afford to feed the loss.

By leveraging the entire purchase, you mean borrowing, then yes. Technically

We decided on paying off our home to save interest rather than keeping our mortgage and investing elsewhere. 

Then later, decided on pulling out money for an investment home.

Thanks Brian, that's pretty much exactly what the scenerio is in Washington. 

This market is not for the timid which is probably why it has me questioning pursuing this at all. 

But at the same time, we want to invest somewhere. Maybe the timing is just not right. And I definitely have a lot more to learn. I just didnt want to get into this with so little knowledge. Im sure there are plenty of people that dive in with ignorance and it turns out great but also I'm sure there are twice as many that it turns out a catastrophe for their finances and credit. 

Oh well, I'll see what happens. 

We truly appreciate all of your feedback. We are thinking we don't want this house now. At least at that price, if they end up dropping it much lower, like 200,000,to match the low rent, then maybe. In which case, positive cash flow would be much less concerning. 

Here is the best piece advice I can give you. The math either works or it doesn't. If you try to flub the numbers you are only hurting yourself. 

You ran the numbers with capex and maintence and were in the red. Full stop. 

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