Is the price unreasonable or am I unreasonable?

Multi-Family and Apartment Investing
7yFollow

Is the price unreasonable or am I unreasonable?

Greg Callan
Member since 2018 · 20 posts · 3 votes

Hello all,

I am very new to investment real estate. I am evaluating some of my first potential buys, but I could use some guidance to determine when a property is not a good deal because of the parameters of the property or when it is not a good deal because I am expecting to have my cake and eat it too. 

Here are some details. The property sale price is $450,000. I was originally told that each unit was renting at $750. While researching it, the rent for the units have increased to $850. I currently have an apartment that is much nicer in a better part of town for $1050, so I feel like $850 is probably stretching this property. Two of the four units are being completely renovated due to a water heater blow out. The concept pictures of the renovated apartments do look VERY nice. In fact, nicer inside than my $1050 a month apartment, but still quite a bit smaller and in a part of town that is not as nice. Thus, my assumption is that $850 a month might be pushing it and it is possible I may see the rental price roll back to $750 especially if there is a downturn in the housing economy. Regardless, I will go with the optimistic $850 for the initial discussion.

Thus, total incoming rent = $3400 ($850*4)

Net operating income per month =$ 3400 / 2 = $1700 (Using the 50% rule here. My own estimations of the expenses came out to 42%. Please let me know your opinion of the 50% rule. The management company indicated that 35% was a good rule of thumb for expenses but that seems way too low after reading many posts about the 50% rule.

Financing - a 10% downpayment on an FHA loan, with 4.75% interest, and $268 of PMI each month for 132 payments. The monthly principal and interest payment is $2149.00.

$1700 NOI/month - $2149mortgage = -$449 (negative cashflow after I pay my mortgage)

-$449 - 268PMI = -$717 (negative cashflow with PMI)

From this perspective, the real-estate doesn't look like a good investment, although property depreciation and tax losses would offset some of these losses in the first few years. So where do I go from here? Is the seller's price unreasonable or am I unreasonable to expect a property to cashflow with a 10% downpayment?

1Reply
49 views

Most Popular Reply

Russell BrazilBusiness Member
Moderator
Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
7y

Well question 1 here is you said FHA loan. That indicates that you are looking at a 1-4 unit property that you plan to owner occupy.

So therefore things such as the expected rents and expected expenses will have zero to do with valuing the property. 1-4 unit properties are primarily values based on comparable sales.

Now id this is a 5+ unit, then you are looking at the wrong type of financing entirely.

Also, if you are using a low down payment, expecting cash flow isnt really something someone should expect.  When an investor buys a property, the assumption is its going to be at minimum 20% down, and typically more.

[email protected]301-893-4635Podcast Guest on Show #192
District Invest Group545 Reviews
WebsiteView Page
7Reply
See this reply in the discussion

36 Replies

Jump to latestLatest
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y

    Well question 1 here is you said FHA loan. That indicates that you are looking at a 1-4 unit property that you plan to owner occupy.

    So therefore things such as the expected rents and expected expenses will have zero to do with valuing the property. 1-4 unit properties are primarily values based on comparable sales.

    Now id this is a 5+ unit, then you are looking at the wrong type of financing entirely.

    Also, if you are using a low down payment, expecting cash flow isnt really something someone should expect.  When an investor buys a property, the assumption is its going to be at minimum 20% down, and typically more.

    [email protected]301-893-4635Podcast Guest on Show #192
    District Invest Group545 Reviews
    WebsiteView Page
    7Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    7y

    50% rule I think is a great napkin rule and if you do better great but if it does not work at 50% then you need to look at other factors IE will it appreciate to an extent that a little negative is OK.

    most on BP cringe when anyone talks about negative cash flow. and in markets that simply don't move or the rentals are all priced based on income.. IE the 1% rules seems to be popular place to price things.  then why buy them if they don't throw off some net spendable.

    Podcast Guest on Show #222
    JLH Capital Partners51 Review
    WebsiteView Page
    1Reply
  • Bjorn AhlbladPro Member
    Investor · Shelton, WA · Member since 2017 · 6k+ posts · 6k+ votes
    7y

    @Greg Callan Welcome to BP and congrats on digging into a deal! The market is still very high in most areas and finding CF is not easy. I use the 50% rule as a guide; but it is very dependable and surprisingly accurate. What you are expressing IMO is the market, and how hard it is to CF with a 10% down. Personally I see no point in doing deals that don't come out positive-and not just marginal either. I am in it for the income and don't trust appreciation unless it is forced. That property is not making any money at 450k and the seller might take offense at 325k! ;<)

    1Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    Hi Russell, Thanks for your feedback. Yes, the property is a 4plex. I would plan to live in one of the units as a means of saving money. The math gets pretty complicated to explain in paragraph form when I start talking about saved rent or saved vs a mortgage on another home, so I went simple here to assess if the base unit is a good plan if I should decide to move out before the 30 years are up. 

    There are some factors that do not get addressed here then. For example, the tax savings on a four plex that is only renting 3 units would be higher than average because it would look like I am taking large losses from the unit, when the losses are offset by savings from rent in another location. 

    Thanks for your feedback that most are expecting a 20% downpayment when evaluating the property. Could I get multiple opinions on that?? If so, the payment would be about 1877 a month for principal and interest which still puts me at a negative cashflow of $177 each month before tax advantages like depreciation. 

    0Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    Jay. Thanks for your feedback. I tend to agree that they should bring in some net. There is also an assumption that the cashflow should grow over time as the rent inflation and expense inflation diverge, but housing values are high right now so I don't know that is a good bet to hedge right now. 

    0Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    Thanks Bjorn. I agree with your sentiment that the property isn't doing well for me at $450k, but when I use a calculator to examine what the price would need to be to make it cashflow, it doesn't seem fair to ask that price of the seller. Moreover, I wouldn't get that price, other less lucrative properties are selling within two days in the market here. It is possible, however, those buyers have a different end-game / strategy / downpayment / etc... than myself.

    0Reply
  • Russell BrazilBusiness Member
    Moderator
    Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes
    7y
    Originally posted by @Greg Callan:

    If so, the payment would be about 1877 a month for principal and interest which still puts me at a negative cashflow of $177 each month before tax advantages like depreciation. 

     I cant speak to this property or the market you are in, but $3400 in rent on a $450k property in my market would be a home run.  My properties tend to be in the $400-$450k range, and rent for $2600-$3000 a month, and I make good cash flow on them. Mine however are single units, and they are all A/B class with high income tenants.  I imagine at $850 a unit, that yours are not high income tenants, nor A/B class.  So it isnt merely about the rents and the price, who lives there plays a large part in your overall costs.

    [email protected]301-893-4635Podcast Guest on Show #192
    District Invest Group545 Reviews
    WebsiteView Page
    4Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    Hi Russell. Could you tell me a bit more? Making sure that I make an educated decision (whether that is to hold em or fold em) is the reason I am here. Initially, my estimations of this property seemed like an opportunity that couldn't be missed, but as I have researched them further, the benefit has slowly dwindled. Could you explain a bit of some of the factors that would change this from a loss to the home run? or why $3400 on a 450K property would be a home run? Have I missed some variables that are important? I'm not sure I am familiar with the concept of A/B class so I am a bit ignorant there. Thanks in advance

    0Reply
  • Chris Grenzig
    Property Manager · Orlando, FL · Member since 2016 · 479 posts · 277 votes
    7y

    @Greg Callan $850 avg rent for 4 occupied units is $40,800 per year. 50% leaves $20,400 in NOI. On your purchase price you're buying this property at a 4.5% cap rate. This seems very overpriced imo, however, if you want large tax losses to offset any other gains from other stuff then it could be a great deal if you think their could be appreciation.

    It's all about your internal and external goals and what you want to achieve, but on a purely numbers basis I would pass. Also, I think no offer is insulting, but thats just me.

    1Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    @Chris Grenzig Thanks for your reply. That was my understanding as well. Thank you for refocusing me on Cap rate given that it does not account for the financing which is on me. I've read that what is considered an appealing cap rate may change from one location to another and that in some places (e.g., large metropolitan areas) lower cap rates may be considered appropriate. 

    How do I research what a reasonable cap rate is in my area? Given that this would be one way to estimate a fair offer (e.g., "at 5% cap rate, the property value is $408,000").

    0Reply
  • Chris Grenzig
    Property Manager · Orlando, FL · Member since 2016 · 479 posts · 277 votes
    7y

    @Greg Callan I wouldn't get to caught up on cap rates for 1-4 units, it's just a bad sign for me when you're proforma cap rate is 4.5% and you're borrowing money from the bank at 4.75%. Now if you think expenses will be 35-40% that cap rate changes so it's tough for me to say exactly, but for me I would want a proforma cap rate north of a 7% on a 4.75% debt rate, but its different for everyone.

    You're best bet is commercial brokers in the area for cap rate reserch, but they're going to be talking cap rates on probably 10+ units if not 30/50+ units. A lot of times they don't sell unit lower properties, so I would avoid the big shops and see if you can find a local brokerage on loopnet and call and have a conversation with someone there. I would also ask if they have any recent reports on the markets and submarkets from axiometrics, yardi matrix, costar, etc. 

    1Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    @Chris Grenzig - Thanks for your advice. I will look into the things you have suggested here. 

    1Reply
  • Thomas S.
    Member since 2016 · 13k+ posts · 12k+ votes
    7y

    Your rent is too low for a property valued at $450K as your own numbers already show.

    Keep in mind that your cash DP is actually buying cash flow at a vey high rate. To calculate the cash flow the property will actually produce use a hypothetical 100% financing to calculate your monthly debt repayment. This will account for the portion of your income generated by your own cash.

    You number will be worse than you have already come up with because this property is a very poor income investment property. Better pray for above average appreciation to make up for your ongoing losses until  you sell. 

    1Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    Thanks for the feedback @Thomas S. I believe that if the property will remain an option for me, the price will have to reduce. Rent will not probably be able to increase because I think we are nearing the top end here. Again, I have a larger (3 bedroom apartment) in a nicer part of town, with more amenities (e.g., fitness center, pool, hot tub) for $1050. I doubt many people would pay more than $850 for the property I am looking at.

    While I am looking at estimating expenses. I could use some feedback if the 50% rule fits me well. For example,

    I am in Utah where the property tax rate is low (.76%). Two of the units will be completely renovated and the other two were renovated two years ago. Roof and furnaces are relatively new. I'll have to dig to get specifics, if I decide this property still has a chance. Utilities are paid for by the tenants. I would be contracting a management company (10%) and paying someone to take care of outdoor duties ($100 per month). I have yet to get an insurance quote because that seems impossible until the renovations are complete. When I used the 1% rule for maintenance ($4500 per year) plus the above expenditures), I came out with a NOI of $22,200 after expenses. So NOT drastically different from the 20400 with the 50% rule. Also, could someone help clarify for me. The 1% rule does or does not include the Cap Ex improvements? 

    0Reply
  • Angelo Wong
    Investor · Milpitas, CA · Member since 2015 · 71 posts · 72 votes
    7y

    @Greg Callan

    Would not do it.

    If it's your first deal, there are probably a lot of other variables that's missing and your ability to comp is probably going to be way too optimistic.

    If you knew the market and have done a few deals there and know that you'd get some sort of appreciation or that $850 comp would actually work out or that you can somehow get it to $1050...then it might be OK.

    But I'd underwrite it at $750 and 60-70% expenses.

    A 900 - 2149 - 268 would be a more conservative estimate.

    Depends on your risk profile and how confident you're gonna be able to be right on the dot with your first go at underwriting a deal. And also if all things go terribly (like the above scenario of -1517 cash flow), if you'd be able to hang on to that until it appreciates or until you can figure out a way to bump the cash flow. And if you cannot and you're stuck with a -1517 cash flow deal, would you be able to sell it at a loss and be OK with it?

    0Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    @Angelo Wong I am leaning heavily toward that opinion at this point. I just wanted other opinions and to get feedback as I explored this first potential buy. I may speak further with the seller and see if we can find a deal that works for both of us. Unfortunately, I am not optimistic. Selling the property at a major loss is not an option I want to consider at this point in time. I am financially stable and do not want to rock that boat too much by taking reckless risks.

    0Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    As food for thought or maybe just good conversation. I created this spreadsheet. It compares living in one of the four units of this investment property, to paying rent at my current apartment, and purchasing a home in the area. As you can see, it would save me money compared to the other options, but it would be on a thin margin and potentially negative cashflow if I decided to move out. I used my best guess estimates for expenses here which come out to 42% of rental income. This is after tax. (EDIT - please ignore some of the colors, they do not mean what they may appear. Red text is not necessarily negative). 

    0Reply
  • Sam B.
    Investor · Indianapolis, IN · Member since 2015 · 270 posts · 217 votes
    7y

    So you have two options: Put down $45,000 for the privilege of spending $1,567 a month (base case scenario at $850 rent per unit), living in a worse part of town, and taking on a part time job as a landlord, or stay in your current rental for $1,050 a month.

    So, the question is, why are you even considering this?

    2Reply
  • Craig Sloan
    Member since 2018 · 200 posts · 123 votes
    7y

    Move on.  You can and should find a better deal.  A quick and simple evaluation tool is this.  Ask yourself; "If I could do this deal 10 times would I?"  If you did 10 deals like this you would be way in the hole my friend.  Keep looking.  You'll find the right one!

    0Reply
  • Todd Dexheimer
    Rental Property Investor · St. Paul, MN · Member since 2016 · 3k+ posts · 3k+ votes
    7y

    Just a quick glance, showing rent of $3400 and a sale price of $450,000 says the property is way over priced. Then when you show the math at a negative cash flow, it is way over priced. Even if you live there, it still doesn't work. What happens when you decide to move out? If rents are still at $850/mo, then you will be losing money every month. It's won't take long to bleed out on this property. 

    0Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    @Sam B. Thanks for your feedback. To answer your question. I am not really considering this property anymore, not unless the price were to reduce drastically. I was more so asking for advice as to whether I was evaluating the property accurately because I was coming to the same conclusion that it would be such a great deal anymore. When first presented with the sellers' estimates of expenses, it was a much different story. I am a newbie so they might have thought they would slip one past me.

    @Craig Sloan I like the 10 times rule. This one isn't going work for me unless the price drops drastically. 

    0Reply
  • Greg Callan
    OP
    Member since 2018 · 20 posts · 3 votes
    7y

    @Todd Dexheimer - Thanks I agree with your assessment. While using tax benefits of the loss, yes, I would still save some money compared to renting / buying, but that seems like a dangerous wager to me given that the depreciation taxes will be recouped by the feds if I decide to sell and THAT could end up costing me way more than I ever actually made on the property.

    0Reply
  • Sam B.
    Investor · Indianapolis, IN · Member since 2015 · 270 posts · 217 votes
    7y
    Originally posted by @Greg Callan:

    @Sam B. Thanks for your feedback. To answer your question. I am not really considering this property anymore, not unless the price were to reduce drastically. I was more so asking for advice as to whether I was evaluating the property accurately because I was coming to the same conclusion that it would be such a great deal anymore. When first presented with the sellers' estimates of expenses, it was a much different story. I am a newbie so they might have thought they would slip one past me.

    @Craig Sloan I like the 10 times rule. This one isn't going work for me unless the price drops drastically. 

    I would say your numbers look reasonably accurate. Sellers' pro-formas are almost always laughably wrong.

    0Reply
  • Maurice D.
    Coppell, TX · Member since 2015 · 485 posts · 310 votes
    7y

    working backwards from 1% the property should be in the 340K range to be in the ballpark.  450k is overpriced.

    Keep looking, and doing the math on every deal you see to get used to the numbers.

    also, do the numbers both ways  4 x 850 (to see future investment cash flow when you move out), and 3 x 850 to understand how much out-of-pocket will your contribution to the mortage be (if any).

    don't forget to factor in property management cost, even if you plan to manage it.  pay yourself and buy it so it can be run by a property management firm down the road and still be profitable.

    0Reply
  • Todd Dexheimer
    Rental Property Investor · St. Paul, MN · Member since 2016 · 3k+ posts · 3k+ votes
    7y
    Originally posted by @Greg Callan:

    @Todd Dexheimer - Thanks I agree with your assessment. While using tax benefits of the loss, yes, I would still save some money compared to renting / buying, but that seems like a dangerous wager to me given that the depreciation taxes will be recouped by the feds if I decide to sell and THAT could end up costing me way more than I ever actually made on the property.

     You could also give me $700/month and use that as a tax write off. I don't like the tax savings as an investment strategy. Sure it should be in your bag of tricks, but not as the only trick. 

    1Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free