New investors in a tight market

7 Replies

Hello all,

Currently our market inventory is low and sometimes overpriced in the 2-10 unit (value add and under market rents excluded) and new investors often do not have a ton of cash to invest.  I want to show examples of how new investors can enter the market and learn while making money in a relatively safe transaction.  

Everyone looks at the townhome market with a skeptical eye. The first thing everyone points out is HOA dues. One thing about the HOA dues is that they pay for things like snowplowing (since we are in Minnesota), grass cutting, insurance, and such. Townhomes offer a low entry cost, low maintenance, low risk, are easy to sell, and require little experience to manage.

So lets take a look at what the numbers are, here are two actual properties we sold in the Twin Cities area (Eagan) in the last two months.

Sale price $103,500 2Br 1Ba

HOA $165/month professional management company

Taxes $585/year $48.75/month

Insurance Farmers $150-$230/year HOA coverage walls in.

Loan $393.31 30-year 4.5% 25% down

investor self manages (other wise 10% of rent includes filling unit) tenant pays water and utilities

Expenses $626.06

Rent $1100/month renter pays water, heat and electric.  Rented 4 days after purchase agreement signed.

Profit $473.94/month  

Sale price $110,000 2Br 1Ba

HOA 165/month professional management company

Taxes $621/year $51.81/month

Insurance Farmers $150-$230/year HOA coverage walls in.

Loan $418.02 30-year 4.5% 25% down

Investor self manages (other wise 10% of rent includes filling unit) tenant pays water and utilities

Expenses $653.83

Rent $1150/month renter pays water, heat and electric. Rented on 1st of month after closing on the 15th

Profit $496.17/month 

What I like about these types of deals is that newer investors can get into them easily, it is a good start to learn to manage with little responsibility, they make money, investor doesn't need to worry about snowplowing, or grass, and they are only worried about appliances HVAC and rent.    The new investor can buy multiples in the same development and sell them easily if need be or if they are looking for a larger property.  This isn't for all investors as many with hit their loan limits with too many units, but that is when they can sell them individually or as a portfolio.

There are many different ways of making money in the Minneapolis market I hope new investors will consider townhomes rather than D properties that are much too complicated for new investors.

Amber Gonion, Contractor in MN (#Boiler Special Engineer sp711180) and MN (#40480519)

@Amber Gonion You make a good case for Townhomes.  I admit I have been one of those people who you mentioned that have been anti-town homes.  I think like all investments the bad deals can make the whole segment look bad.  It looks like you have figured out what works.

Tim Swierczek, Lender in WI (#103522) and MN (#103522)
(651) 772-9000

I haven't really looked at town homes much but your example seems to work ok. I would factor in repairs/cap ex, city fees and misc for a rental license, but that example would still be positive.

Before people look into buying a town home for a rental, they should make sure to read the HOA rules though. I know someone who has a rental town home and his HOA has a $250 move in/out fee for renters to discourage it.

Personally, I don't think I would purchase a 2BR/1BA for an investment unless it is a slam dunk. You are competing with apartments at that size and there are many alternatives. I usually try to stick to 3BR or something I could convert to that if possible.

Missing in your numbers is maintenance and replacement reserve. The good thing is those can both be less, but an investor should still use $100/month on reserves and $50 for maintenance (I would personally use $250 total for maintenance and reserves). Also, look out for city licensing fees, admin, accounting, etc. 

With that said I do think you assessment on Town homes is correct. You can get in at a lower price and cash flow well. I think that market is going to pick up a lot in the next several years, so your chance for appreciation is good as well. I really like the 2 or 3 bedroom's that have no stairs. Great choice for the older generation. 

@Amber Gonion - Interesting stuff about townhomes. I've never looked closely at anything with HOA fees, but those seem pretty solid, even though maintenance and capex reserves were not included. Like @Todd Dexheimer said, those are probably going to be lower in these townhomes since HOA's often include exterior maintenance.

Amber - my biggest reservation to buying the properties with HOA's would be the potential for jumps in the association fees effectively drying up future cashflow. They just seem like another variable out of my control. What are your thoughts on this potential issue? Have you experienced much change in HOA fees with fluctuations in the market?

I agree $50/month should cover maintenance/replacement of HVAC, water heater and appliances on a 15 year schedule. And $100/month for upgrades/reserves is plenty for these type of units. The 110k unit actually had a brand HVAC and water heater. Compared to SFH and duplexes for new investors it is just a pretty low risk easy to self-manage option since they are dealing with he renter and interior only.

Units that can be converted to 3br/4br units are even better. These are just two examples of the latest units we sold. Another nice thing is that new investors can find some of these units in nice areas like Hugo that don’t have any rental license requirements, and will have relatively good tenants to start with until they get their feet wet and get more experience with tenants.

I always worry about new investors dealing with $700/month tenants that know the system better than they do.

Amber Gonion, Contractor in MN (#Boiler Special Engineer sp711180) and MN (#40480519)

@Amber Gonion

Another poster made a good comment that some things should be considered, such as expenses for vacancy and for repairs. Still, other issues can come up with townhomes. One is that the municipality will require a rental license. And, does the HOA permit rentals? The liability for the HOA could cause problems.

But there are two other factors that really stand out.  One, the resale of the unit is limited.  If you need to sell this unit, it's not as easy, since the market for Townhomes is smaller than the market for SFDU.  There is also a smaller appreciation play, especially for a 2 bedroom townhome.  And the other factor, is the investor put down $25 grand for a $400.00 cashflow.  Don't discount the cost of cash in this transaction (something we all are tempted to do).  

Good points, we have targeted communities without rental license requirements (like our own community of Hugo) or Eagan (registration only, no fees) and of course we check the HOA rental restrictions before even sending properties for client review.

We find that the townhomes we are looking at are very easy to sell. They are the least expensive housing available ($150k and lower). So typically they are sold very quickly (more expensive TH certainly can be more difficult). 

We only recommend professionally managed units, since they tend to appreciate in value better. Appreciation is a concern, but it is location dependent, there are areas where homes have lost value while TH have appreciated, this is obviously not the rule though. I would much rather have a 150k TH in Hugo or Eagan than a 150k SFH in Frogtown, N mpls or the East side for resale.

Townhomes are not always the best investment out there, but my point is that they are a great starter for a new investor without experience.  It gives them a chance to deal with small problems in higher class neighborhoods and make some profit before dealing with tough neighborhoods, roof and siding issues, etc.  Once they understand and get a system up an running so that they can handle more complex issues.  

We recommend SFH to other investors that have more experience with homes and maintenance. Tougher neighborhoods for those with more experience dealing with renters.

Each investor has different skills that enable them to be successful in different areas.  Some come with skills others learn them on the way.

Amber Gonion, Contractor in MN (#Boiler Special Engineer sp711180) and MN (#40480519)

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