Good cash flow, but after repairs, upside down.

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Good cash flow, but after repairs, upside down.

Sarah McCluskey
Rental Property Investor · Member since 2019 · 55 posts · 44 votes

Currently under contract for a 3 bed upper/lower duplex. It was a FSBO listed around market rate, but I know if it went on MLS it would've gone for more. 3 bed duplexes are hard to find in my area to purchase and to rent, so demand is there.

During inspection the crack we were a little worried about in the foundation turned out to be a much bigger problem than anticipated. Entire basement leaks. Estimate to rebuild bowed wall, install interior drain tiles and sump pump, is $20k. It will also need a new driveway which is currently sloping towards the house, which is the reason for the bowed wall. 1950s home with original windows, but they work. Air conditioning units 30 years old, will need to be replaced soon. Roof will need to be replaced in the next couple years. Bathrooms are in rough condition, was planning on giving them a facelift.

All in, I’m estimating $30k right away, and probably another $20k in the coming years.

Here are the numbers.

- purchase price $151k

- rent: $2200 total

- property taxes $4500

- insurance $800

- initial repairs $30k

- additional repairs $20k

- will be hiring property management company for 10% of rents

- setting aside 10% for repairs

- setting aside 20% for capex (future roof)

- cash flow $530/month

- cash on cash return with initial $30k in renovations is 9%

To me, the numbers work from a cash flow perspective. Where I’m getting caught up is that the property will not be worth the $200k I will have put into it total. I’m planning on buying and holding, not selling, but I still don’t know if it’s a bad move.

This would be our first rental property. But I don’t know if I should back out because of the unexpected $20k that came up from the inspection....

Thoughts? Is it a bad deal to put in more to the property than it’ll be worth, even though the cash flow is good?

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Jay HinrichsBusiness Member
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
5y
sounds like a money pit.. if its not worth 200k once you dump 50k into it  why do it.. ?

just B/C of the greater fool theory is no reason to reach for a deal.. cash flow is only one component of IRR
if value is less than what you have into it.. you have zero exit strategy when you tire of being a landlord.
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  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    I should add that If we want to move forward we would counter the seller at $20k lower...because of the inspection / basement issue. However, this seller is extremely difficult to negotiate with, he sold one next door with the same issues last year for a few thousand dollars less (didn’t have AC). So I’m pretty confident he will not come down on the price. And quite honestly, if we don’t take it, it won’t be hard for him to find someone else who will deal with the basement issues at this price.

    0Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    5y
    sounds like a money pit.. if its not worth 200k once you dump 50k into it  why do it.. ?

    just B/C of the greater fool theory is no reason to reach for a deal.. cash flow is only one component of IRR
    if value is less than what you have into it.. you have zero exit strategy when you tire of being a landlord.
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    19Reply
  • Kenneth GarrettPro Member
    Investor · Florida Panhandle/Illinois · Member since 2016 · 4k+ posts · 3k+ votes
    5y

    @Sarah McCluskey

    A sellers asking price is irrelevant. The only thing that matters is whether the numbers work. If this were a BRRRR and the ARV was 200K that would be a big no and move on. If the ARV is at $250K and cash flows to meet your criteria then I would move ahead. Your going to be in at 90% LTV or more. In my view point, I would not do this deal unless the seller is negotiable.

    8Reply
  • Alexander Szikla
    Real Estate Agent · New York City · Member since 2020 · 819 posts · 641 votes
    5y

    It sounds like a good deal, not a great deal. 

    You will likely get it stabilized above an 8% cap rate but as per your note, you may get lots of equity stuck since it won't refi incredibly well. 

    I'd recommend not hiring a property manager as that is significant yield you are giving up and you want to at least learn about the properties "issues" in the first year. Also, most issues will come up then and you want to handle them cost effectively (a PM typically won't). 

    4Reply
  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    @Jay Hinrichs thank you for your comment. You validated my concerns. I have some other investor friends who have told me that if it cash flows well, and I buy and hold, not to worry. But I agree with your point.

    0Reply
  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    @Kenneth Garrett great point. Thanks for your comment. We will likely counter much lower, and he will not accept. But I’m 100% okay walking away.

    1Reply
  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    @Alexander Szikla thanks for your comment. I’m a full time working mom of 3 little kids. While I’d love to self manage. The property is 40 minutes from me and I just don’t have the time. However, I know this property manager very well, and a few of her clients, and they’ve actually experienced cheaper costs through the PM than when they would hire contractors themselves. I know it’s an added cost, but in my situation it’s a necessary one to be able to invest :-)

    0Reply
  • Steve K.
    Realtor · Boulder, CO · Member since 2016 · 3k+ posts · 5k+ votes
    5y

    @Sarah McCluskey sounds like even just the things you know about now could end up costing well over $50k, and you still need to budget for the things you don't yet know about. Oftentimes FSBO sellers are completely unrealistic with their asking price based on the property condition, and this seems like it could be one of those cases. I'd write the inspection objection asking for a considerable discount (at least $50k, ideally more). I wouldn't be so sure this property would be worth any more on the MLS, as retail buyers tend to shy away from properties with tons of deferred maintenance, outdated bathrooms, original 1950's windows, old roof, old AC, foundation issues, etc. Most buyers are looking for move-in ready. I'd negotiate hard for the right price on this one, and be ready to walk if the seller is unreasonable as there are likely some additional issues hiding in the walls that you haven't uncovered yet. Like Jay said, from what you've told us this sounds like a money pit. I'd probably ask for the discount, explain the reasons why/share the inspection report, and if the seller declines say "thanks but no thanks" politely then circle back in a month or two if they haven't found a "greater fool", and make an even lower offer then.

    1Reply
  • Jonathan R McLaughlin
    Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes
    5y

    @Sarah McCluskey To answer your primary question about it being worth going upside down for cash flow I would say almost certainly not. You are fighting to get back even and the cash flow isn't going to do it for a long time, even if it cash flows as you hope. 

    Honestly this sounds like a nightmare and I think your future capex numbers are way low. Do you have your own crew or great relationships established? If not you are at a lot of people's mercy. 

    1Reply
  • Timothy VanWingerden
    Real Estate Broker · Lexington, KY · Member since 2017 · 131 posts · 129 votes
    5y

    If it’s not worth the money you put into it after you finish repairs you are not in a good spot. Also, if possible you always want to finance your initial repairs. This keeps the cash-on-cash strong and allows you not to rely on cash flow for big ticket items.

    0Reply
  • Natalie Schanne
    Real Estate Agent · Princeton, NJ · Member since 2016 · 1k+ posts · 1k+ votes
    5y

    @Sarah McCluskey - If the homeowner will not negotiate down $20k, I think you are likely to get a better deal on another property, ideally one that has been homeowner occupied so some of this work has been already done. 100% of the homes where the inspector said I had 5 years on the roof, I replaced it for $7-10k within the first 12 months. Also Sounds like the landlord has been doing the minimum band aid stuff. Also, consider your total rents. Are you more likely to get higher rents if you got a similar price 3-4 unit instead with more 1/1 or 2/1 units than 3/1 units? If you’re house hacking and need more space, I sold a duplex where the first floor unit had two beds and one bath on the first floor and a non legal bedroom in the basement with a half bath. If you’re owner occupying, maybe get something like that where you’ve got the space but the other units rent for more. In my market, 1 bed is like $900, 2 beds are like $1000-1100 and 3 beds are like $1300. So if the same price house fits 4 1/1 you get much more rent than 2 3/1’s. In my market I’m paying $400/window for a professional install, $5000-6500 for an AC ($7000-8500 for both), $6-10k for a roof, in addition to 3-6k for a full bathroom refresh. Repainting everything 4-5k plus paint. Everything adds up quickly. Make sure you have the cash reserves to handle it. Did you already ask if the seller would do a carry back like his price but lower $$ down and $$$ over time?

    5Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    5y
    Originally posted by @Sarah McCluskey:

    @Jay Hinrichs thank you for your comment. You validated my concerns. I have some other investor friends who have told me that if it cash flows well, and I buy and hold, not to worry. But I agree with your point.

    I understand that position..  but there is more to it than just cash flow..  or tying up that kind of money and credit when there are other opportunities out there MOST LIKELY .. If you feel rents can rise methodically or substantially ( which increases value) over say the next 5 years then I get that thought process.. 

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    2Reply
  • Dennis Wayne
    Member since 2020 · 339 posts · 356 votes
    5y

    Your deal is not a deal ... keep looking

    3Reply
  • Ola Dantis
    Multifamily Syndicator · Houston, TX · Member since 2016 · 1k+ posts · 2k+ votes
    5y

    @Sarah McCluskey For your property you should definitely pass on this deal. 

    The issues are the issues this Seller wants you to know, as you might be not pleasantly surprised post-purchase to discover other "new" issues pop up. 

    Plus, the budget of $30k might easily go up to $50k or more because with foundation, drain lines, and driveways to rebuild, you can't tell what you will find until after construction starts, by that time you are already knee-deep and can't come out. 

    Don't even step into this mess as a first deal.   

    6Reply
  • Spence Kal
    Rental Property Investor · OH (ohio) · Member since 2018 · 166 posts · 113 votes
    5y

    Yikes! I wouldn’t buy a house at the “top” of the market that wouldn’t sell for what repairs cost. What happens if you end up in a financial crisis and have to sell because of something unexpected? What if you find a better deal 5 years from now and want to unload the maintenance headache? Personally I wouldn’t, as exciting as finding and buying a property is, I like to think I’m running this business for another investor, and have to keep things tight to not let them down or lose my job. That way it feels more like a calculated business decision instead of me just really wanting a property.

    1Reply
  • Robert Herrera
    Investor · Denver, CO · Member since 2015 · 492 posts · 267 votes
    5y

    @Sarah McCluskey

    Remember, there are always other deals to look at. If it doesn’t fit your criteria, move on and don’t force the deal

    2Reply
  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    @Spence Kal I like that perspective! Thanks!

    0Reply
  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    @Robert Herrera great point. Thanks!

    1Reply
  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    @Ola Dantis great point. Thanks!

    0Reply
  • James Horner
    Rental Property Investor · Flagstaff Arizona · Member since 2020 · 14 posts · 17 votes
    5y

    @Sarah McCluskey

    Hey! Looking at your deal my fear would be your initial repair costs becoming more than you the property is worth and eating up your cash flow. As a contractor when I hear foundation work needed that’s pretty major. Id say get multiple quotes. Foundation work and driveway work can end up costing way more and unless done right sometimes the contractors don’t actually fix the job. There are a lot of contractors that say they know how to work with concrete then two years later you have a major crack in the new wall and you see the same water coming in. I’d say keep looking at houses and running the numbers and if he dropped the price enough to make it worth it than great! If not there are always other deals.

    0Reply
  • Matt J.
    Rental Property Investor · Hugo, MN · Member since 2014 · 283 posts · 257 votes
    5y

    Many people have already said this, but keep searching for a different deal. Way too many things could go wrong with this one and there's not enough equity to make it worth your while. I also was wondering where you came up with setting aside 20% for Capex and 10% for maintenance every month. Setting aside that much makes it seem like it would be pretty hard to find many places that would cashflow at all.

    0Reply
  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    @James Horner thanks for your comment! We are countering back $40k less. I’m confident he won’t accept, and I’m ok with that!

    2Reply
  • Sarah McCluskey
    OP
    Rental Property Investor · Member since 2019 · 55 posts · 44 votes
    5y

    @Matt Jennissen normally I calculate 10% for repairs and 10% for cash flow. Because this home has some deferred maintenance issues, that’s why I’m setting aside 20% for capex. Even with that it cash flows over $500.

    0Reply
  • Jim K.
    Handyman · Pittsburgh, PA · Member since 2018 · 5k+ posts · 13k+ votes
    5y

    @Sarah McCluskey

    Hmm.

    1. This is two 3-bedroom, 1-bath apartments stacked over each other, over a full basement?

    2. How old is the building?

    3. Where is the building? (City, State)

    4. Occupied already?

    5. When you say the bathrooms need a facelift, how much of a facelift are we talking about? In the picture below, the toilet is hiding behind the shower wetwall.

    0Reply
  • Matt J.
    Rental Property Investor · Hugo, MN · Member since 2014 · 283 posts · 257 votes
    5y
    Originally posted by @Sarah McCluskey:

    @Matt Jennissen normally I calculate 10% for repairs and 10% for cash flow. Because this home has some deferred maintenance issues, that’s why I’m setting aside 20% for capex. Even with that it cash flows over $500.

    Got it, that makes sense. Even with that level of cashflow, I really don't think it's the best idea to put more into a property than what it will appraise for. As others have said, that leaves you with no exit strategy should something go terribly wrong. It's been my experience that there will always be at least 1 or 2 things that come up you didn't expect going into it, Murphy's law.  

    0Reply
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