Buying a SFR. Rent or flip?

Question

Hey BP Gurus:

First off, I've enjoyed BP immensely.

I have a deal that I'd appreciate some feedback on.

I have a SFR in my neighborhood where the sellers have accepted a purchase contract. The deal points are as follows:

Neighborhood: stable and desirable, good school districts, close to amenities, in Scottsdale, AZ.  HOA is very well respected and has done a fabulous job since inception. 
Asking price: $325,000
Offer: $310,000 Offer accepted
$80k down
Finance: +/- $230,000 @ 4.0% for 30 years.  Pmt. approx. $1,072/ mo.  0 pts. On loan.
Current market rent/ mo. Approximately $1,700-$1,800/ mo.

Inspection: house is in rent ready condition. Simple and clean.  Roof is old, yet well maintained; a/c is 30 years old.
Sq. ft.: 1,560 
Price/ ft. $198.71
Recent comparables: $198.00 and $248/ft.

HOA annual fee: $198.00
Taxes: $2,000/yr.
Property manager:  Me (I'm a CPM, SCSM, with 26 years experience.  The house is 4 doors down from me.). And, I may fire myself at any time.

Cash on cash: probably in the 4.2-4.5% range.  (Need to get a handle on operating costs)

Here's the fun part: the house lends itself to additions that will add 400 s.f. of desirable space, including storage and family room.  I have access to complete plans for an identical remodel.  I figure I can build the additions for $50.00/ft, or $20,000.  Added value of the 400 s.f. Would be $80,000.  I don't need insight into the construction costs models, as special circumstances make me comfortable with the costs I've assumed.

Appreciation, conservatively, has been very good of late, with Phoenix supposedly leading the nation in increased valuations.  Investment in Metro Phoenix has been very strong, as has the rental market.

What would you do?  Run away? Rent, then flip? Flip after remodel? Go into a different line of work?

Paul Falbo · Answer

@Levigale:  Thanks for your perspective and input.  I'm having a problem pulling the trigger on this one.

The two comps provided are approximately two weeks and three days old, respectively.  The first is the exact floor plan of the one I have under contract.  The second has one more bedroom and has been renovated within the last 3 years.  Objectively, the "exact" comp does not have the curb appeal, has not been updated, and is on the Main Street into the neighborhood.

In addition, I found out today that there is a serious backup offer on the table.  Demand in the neighborhood is very strong.

My inspection showed a need for a new tile roof ( approximately 9k) and an old AC unit (4k).  I have both a trusted roofer and AC man ready to install.

I've asked for a 7.5 K reduction in price.  Will hear back in a few days.

I agree that the leasing return is marginal.  I have the cash for the roof/ac and am leaning toward a one or two hear hold with the additional improvements being done within the first year.

Since the home is very close to mine, I can monitor/manage/renovate with relative ease.

"Deals in the neighborhood are getting harder to find; and, I can't shake the feeling that this would be a good longer term investment with a sale in 2 to 3 years......

Paul

Levi Gale · Answer

Well using the 50% rule your cap rate would be about 3.5%. But since you can easily manage it yourself I would expect the rate to increase to about 4.3%. I get that by reducing 50% to 38%, just assuming that managing fees would be around 12%. I think you should be concerned about the age of the roof and A/C though. Sounds like a nightmare waiting to happen in the first couple years of ownership. If your reserves aren't well built you could easily become a motivated seller when those items fail.

As far as flipping goes you would really need to post true comps to figure that out.

Paul Falbo · Answer

Thanks Eric.  I appreciate the perspective.

I used to fish lake Conroe.  One of my favorite lakes in Texas.

Your introduction of the 2% and 50% rules caused me to search the BP site for an explanation, as I had not utilized this technique.  The best rent I could hope for would be $1,800/mo.  With a cash on cash of >4%, it's better than a CD or savings account.

Appreciation in Metro Phoenix has been leading the nation, but the loss of value was substantial 3 or 4 years ago (30-35% loss in value in the neighborhood)

I was leaning toward the flip strategy after expansion and upgrades. Just don't know if I have the energy.

Thanks again.

Eric Thomson · Answer

Hi Paul,

I'm no guru, but I like numbers, so here's what I've got:

The 2% rule would suggest that for that purchase price you would want rents of around $6,000 per month. The 50% rule would mean of your potential $1,800/month rent, $900 would be available to service your loan, so you would come away with an estimated -$172/month.

If you're confident in the numbers to flip the property and make at least the $60,000 from the 400 sq ft conversion I would suggest going that route. Your lender may not be happy about it if you are going conventional (especially with 0 points).