Deal Too Good To Be True?

Question

I am an OOS investor and found a quadplex that I am interested in. I am getting mixed feedback on the area in KS - from the area is not where one would feel safe at night, to there is a lot of investment going on in KC, and it is becoming gentrified. I would just need to buy and hold.

The deal analysis is showing very little cash flow, but I think the property will make up in equity what it will lacks in CF. Also, as I am from a state where the taxes are really high, moving to KSMO will also indirectly help cash flow by reducing my taxes (I am look at FHA loan, with ~3% down).

An RE mentioned, that 5 blocks either way, old homes are being torn down with new homes being built for ~700K.

My thought process is that in the first 5 years I will break even, but then it would pick-up.

Any thoughts?

Chris Seveney · Answer

@Batool Hussain

I review every investment and compare it to, can I do better elsewhere, whether it be real estate, stocks, bonds etc

Five years just to break even personally to me does not feel like a great investment as I could do some hard money lending and nearly double it in 5 years. This is some of the things to consider, but you have the right mindset that real estate is not a get rich quick scheme

Justin Moy · Answer

I would not purchase a deal that projects to break even for 5 years and then hopefully make money.

You could invest in a syndication or fund 100% passively and receive a 6%+ preferred return that will accrue for 5 years and a 15 - 20% total return over a 5 year period so I don't see why you'd want to break even for 5 years.

KS does have lots of infrastructure being built and depending on the area it's likely it will appreciate over 5 years but I would not recommend waiting that long just to break even.

Alan Asriants · Answer

Yeah, 6 months of rental escrow does not seem to give me any green flags.

Section 8 is not a sure fire way of having "stability"

Section 8 might only cover 50 bucks of the rent, the rest is "not stable"

I would consider traveling to this area and seeing it for yourself. I could never invest in an area i have never seen with my own eyes.

Just because something looks good on paper doesn't mean it is actually a good investment

Eliott Elias · Answer

How is this too good to be true?

Tommy Nguyen · Answer

Hi @Batool Hussain,

Five years to break even is a difficult task. Yes, the appreciation is wonderful, but cash is king! Also, cash flow is a defensive mechanism when things go wrong (i.e., vacancy or HVAC replacement). Class C neighborhoods should provide more cash flow. Yes, I understand your local government is providing value to the neighborhood via infrastructure.

However, a five-block distance may be significant. Talk to your agent and ask for recent sales (comps) in your area. How long do these houses stay on the market? If houses tend to sell for less than average and stay on the market longer, you should look elsewhere.

Lastly, you have to keep in mind the quality of the tenants. Class C tenants usually require more attention.

All the best,

Tommy Nguyen

Deb S. · Answer

I would contact a realtor in the area or property management company and ask them about the neighborhood.  What's the crime rate like, school system, etc. Sometimes property is cheap because of the location (most investors will not buy it) but don't assume. Get some facts and decide with real information. If you do buy it and it turns out to be a not so good investment, you may also have a tough time selling at your asking price.  Do your homework before you put out any money.

Nick Benjamin · Answer

ZIP code? Some areas of KC are great and seem to good to be true but it might be for real!

Michael Gansberg · Answer

@Batool Hussain - a new investor's probability of success has an inverse correlation to the investor's distance from the investment property. Out of state usually means you can't easily pop in to check on your investment, and, as unlikely as it sounds, there are people out there who may even try to take advantage of you due to your inability to easily see what's going on.

Many investors don't invest in their backyards because they think the cash-on-cash return is too low, or they have some other complaint, so they fly their dollars across the country in search of higher yields, even though the investor has little experience in their OOS target market. "Cleveland(for instance) has such high yields, I should buy there," they reason. Investing remotely not only makes it harder to visit the property, but it also means you'll have less knowledge of your target area.

And your post conveys the hypothetical and largely illusory joys of Section 8 investing. Many investors think this way: "The government's paying, their credit is good! Free money forever." Remember that all Section 8 recipients have to re-certify(annually, I think, but I wouldn't really know since I haven't had a Sec 8 tenant in a very long time.) If they fail to re-certify, the checks stop, and the eviction starts. Also- Sec 8 recipients generally have problems holding full-time or part-time jobs(if they had no such problems, they wouldn't receive Sec 8, and once they're on Sec 8, why would they want to get off?) So these tenants of yours will be home during the day, with little but time on their hands. What could possibly go wrong?

Another word about Sec 8. There are annual inspections, and the inspectors don't feel like they're doing their jobs if they don't cite you for violations in need of correcting. Now after having Sec 8 tenants for years, I realized that I never passed a single inspection or re-inspection, and that all the stuff that was broken was not broken the year prior, but for some reason, I(the property owner) still had to fix it though I'd never set foot into the resident's apartment. Sometimes I was required to do substantial upgrades, only for the tenants to break a whole new round of stuff over the next year. Section 8 is a sucker's bet.

You note in your first paragraph, "I would just need to buy and hold." Your time is valuable- if you need to hold for 5 years, as you suspect, well then you'd better be finely compensated for your time(and trust me, there's time involved) and for locking up your capital. If the cash flow is negligible as you suggest- and if you're wrong about the appreciation- then after 5 years, you will be a seriously unhappy camper. You'll say, "Why didn't I just buy an index fund? Grr!"

Alex Olson · Answer

Reach out to a real estate agent that knows real estate investing really well (50% or more of their sales are investment property) to get their opinion.

Deal Too Good To Be True?

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