Quick Opinion on an underperforming property?

19 Replies

Hoping to tap into some of the insight and wisdom of the community to find possible options for my underperforming property. 

Before Bigger Pockets, I bought/over paid for a condo in 2009 as a primary residence on an adjustable rate FHA loan in a North Carolina college town. Circumstances changed, I moved out of state and have been renting the place for the past 4 years. The issue I am running into is that after the 10% property manager fees (brought them on when I moved across the country), and the condo association dues (would not buy a condo again, these are killing me), cash flow is at a break even for the year . Any maintenance or turn over costs push me to a net loss for the year. The comps over the last 4 years have seen property in this particular community of 500 condos decrease by about 15% as newer, bigger construction goes up all around. I have not had an appraisal in 6 years but looking at the current comps I would say I only have about 15% equity in the property. The location is very good and the rental history has been solid, the community itself is just getting outdated and passed by newer, high dollar investments.

So what would you do?

1) Keep the property as is, not cash flowing but maintaining mortgage pay down and slowly building equity.  Its on an adjustable rate, which isnt ideal.

2) Cut ties, sell the property and invest in a better cash flowing opportunity.  I know a lot more know thanks to BP!

3) Aggressively pay the mortgage down and refi it on a fixed rate mortgage with the intention of holding it long term.  This would cash flow, but I still have the overhead of property management and condo dues.

4) Increase rents by updating the unit or furnishing it.  This community and market could support $150-200/month increases in rent with about 5k in updates, but then again Im renting to college students!  Furnished rentals are not commonplace currently and I worry about the necessary turn over costs and possible damage with this population.  

5) Forget long term leases and rent it through Air bnb.  This totally negates the idea of passive income but would increase cash flow for the time being.  There are lots of people in the area who would turn the place over for 15$/hr, 

6) Any other options that have worked for you??

Any experiences youve had or ideas would be awesome.  Love to hear if anyone out there has had success in a similar situation.

Thanks so much!  Alex

(919) 260-8811

@Alex Johnson I have a townhome in the same predicament. It is in a great area and never had a problem renting. So I paid it down and refinance. Now, I have positive cash flow but nothing to bragg about, but the property is appreciating. 

I suggest pay it down, refinance and keep it especially if you are in a nice area. The worst case is that you have someone pay your mortgage and in 30 yrs it will be paid off. 

My two cents...

In my experience as an investor and trader, I have found that unloading a non performing investment is very hard for most people to do. Just ask yourself whether you would buy this condo in the current market conditions that you described. If the answer is no than bite the bullet and take whatever equity you can salvage and reinvest it in a neighborhood like the one that you said was the cause of the decline in your property. It sounded to me like a better place to be. Just a thought.

Break-even with, what I would assume minimal yearly effort.  What is your incentive to get rid of it?  I am guessing 15% equity after sales fee isn't a sizable amount of money.  

Maybe call your lender and see if they would flip you to a fixed rate mortgage?  I doubt it, but one can try.  

I might also suggest that sitting in a highly leveraged positioned while only receiving a break-even cash flow leaves very little cushion if the neighborhood, or the tenant base or  maybe the HVAC goes south.

@Alex Johnson

Here is how I am doing math for my rental property.

Inflow of capital:

  1. 12 months of rent
  2. Yearly appreciation

Outflow of capital:

  1. Cost of capital
  2. Expenses
  3. Reserves for long-term, big ticket items.
  4. Vacancy - lost rent (1 month)

To simplify the matter, I take the properties current value and at 4% rate, I just calculate the cost of capital. Now you may have 85% mortgage that you are paying about 4% interest and the 15% equity, where you are losing 4% interest income as that money is not accessible to you. Call it opportunity cost. Either way, your cost of capital is x% on entire value of the property.

Expenses are what they are - Insurance, HOA, Repairs, Gardner, property mgt., etc.

You can choose to set aside certain $ every year as reserves for big ticket items (paint, carpet, etc.)

I factor in 1 month of vacancy as my cost. It is conservative, but one can allocate less/more.

Finally, I do not bring in principal paydown/equity into my calculation. The way I see equity is just a transfer of funds from your checking account to your own "property" account. It is still your money, just not accessible that easily. So, it is neither income nor loss.

When you do the Inflow minus Outflow, you should see positive number. I'd cut loose the property if outflow is higher. I'd choose conservative appreciation 1-2%, and if I get lucky with higher appreciation, great! From your post, I wasn't sure if your property values are declining year after year. So, that's something to consider.

I hope this helps.

I would check and see if you could refinance it and make it cash flow...If not I would cut ties and move on.  

One other possibility I just thought of was owner financing it to someone?

Thanks for all of your input on a question without necessarily a clear cut answer.  

Steve L, there isn't a huge incentive to sell it other than freeing up capital to move on to a deal with a bit more meat on the bone so to speak.  But yes, you're right, that 15% is not a huge number so the benefit is minimal. The break even I'm seeing now is completely hands off, so flipping the loan over to a fixed and continuing as is is not a bad position.

Kyle, Owner financing it to someone is something I haven't thought about....  Have you had success with that and what would a deal like that look like?

(919) 260-8811

@Alex Johnson I would see what your net proceeds would be if you sold....and calculate it based on both an after tax amount, and also with the possibility of a 1031 exchange.  Now take that net proceeds number and see if you can realistically take that amount and make a better return on it, without adding any other outside cash to it, or just a small amount.  If you can better deploy your capital then do.  If you can not....then just keep the condo.  Not every property we have has to cash flow.  There are other metrics to consider like the fact that someone else is paying down your debt for you.  Yes cash flow is ideal, but it is not the end all be all.

Also consider refinancing.  A bank may not even look at the true equity in the property.  If you use the same lender, ask about a stream lined refinance.  With that they will likely not even look at the true equity in the property, they will only look at the equity based on the original purchase price and loan amounts.  This will also have less fees involved, so you will stretch out to another 30 years at todays great interest rates and likely increase your cash flow.

Russell Brazil, Real Estate Agent in Maryland (#648402), Virginia (#0225219736), District of Columbia (#SP98375353), and Massachusetts (#9​0​5​2​3​4​6)
(301) 893-4635
Originally posted by @Dharmesh R. :

@Alex Johnson

Here is how I am doing math for my rental property.

Inflow of capital:

  1. 12 months of rent
  2. Yearly appreciation

Outflow of capital:

  1. Cost of capital
  2. Expenses
  3. Reserves for long-term, big ticket items.
  4. Vacancy - lost rent (1 month)

To simplify the matter, I take the properties current value and at 4% rate, I just calculate the cost of capital. Now you may have 85% mortgage that you are paying about 4% interest and the 15% equity, where you are losing 4% interest income as that money is not accessible to you. Call it opportunity cost. Either way, your cost of capital is x% on entire value of the property.

Expenses are what they are - Insurance, HOA, Repairs, Gardner, property mgt., etc.

You can choose to set aside certain $ every year as reserves for big ticket items (paint, carpet, etc.)

I factor in 1 month of vacancy as my cost. It is conservative, but one can allocate less/more.

Finally, I do not bring in principal paydown/equity into my calculation. The way I see equity is just a transfer of funds from your checking account to your own "property" account. It is still your money, just not accessible that easily. So, it is neither income nor loss.

When you do the Inflow minus Outflow, you should see positive number. I'd cut loose the property if outflow is higher. I'd choose conservative appreciation 1-2%, and if I get lucky with higher appreciation, great! From your post, I wasn't sure if your property values are declining year after year. So, that's something to consider.

I hope this helps.

Thank you Dharmesh, very helpful.  Working through the numbers as you've laid them out, and including the opportunity cost and month vacancy, there is outflow as I've experienced. The rental history has been 100% which has helped and the fact the unit is in a thriving college town helps as well. There is however very little wiggle room to keep the property positive in case of a large repair or prolonged vacancy.

(919) 260-8811
@Russell Brazil
 

Great info. If I were to streamline the loan, Would the bank look at that loan differently as I originally purchased it as a primary residence and now am treating it as an investment?

(919) 260-8811

@Alex Johnson Great question...and I am not really sure.  @Upen Patel is a mortgage broker...and he might be better able to answer that question than me.

Russell Brazil, Real Estate Agent in Maryland (#648402), Virginia (#0225219736), District of Columbia (#SP98375353), and Massachusetts (#9​0​5​2​3​4​6)
(301) 893-4635
Originally posted by @Alex Johnson :
@Russell Brazil
 

Great info. If I were to streamline the loan, Would the bank look at that loan differently as I originally purchased it as a primary residence and now am treating it as an investment?

If you are still holding the original FHA purchase loan, then you can do a FHA Streamline on the existing loan amount into a lower rate and lower MIP. Depending on the property, the automated underwriting system might even waive appraisal.

Upen Patel, Mortgage Banker

Federal NMLS# 1374243

Upen Patel, Lender in (#National Lender NMLS 1374243)
(571) 331-5161

@Upen Patel

And there is the beauty of this community, Thanks so much.  I'll see what my bank can do

(919) 260-8811

Good idea on the financing.

To this point:  Increase rents by updating the unit or furnishing it. This community and market could support $150-200/month increases in rent with about 5k in updates, but then again Im renting to college students!

What kind of updates would increase rent that much for college students?  We do furnished to college students but do 9 month lease, there is a separate summer market though. Furniture wears and some things like couches need to be replaced every few years. If furnished rentals are not commonplace currently are they in demand or not ?  What you do depends on the type of student you target, if it is a small unit where you are talking 2 people and you get grad students they may have their own stuff and favor a nicer look in  floors and kitchen where if its undergrads partially furnished might keep the moving wear and tear down and make it show better at turnover.

@Colleen F.

Curious about your 9 month leases?  Are you signing one set of students for fall and spring semesters then brining in new tenants for the summer semester?  Are you charging a premium for the short term leases or is that what youve found works best in your market?  Im not sure if furnishing is in demand, it may be more of a trial and error I'd be willing to give a try....

The unit Im speaking of hasn't been updated in a while, as in a few decades!  Some of the units around us have updated the kitchens, changed the flooring, etc. and are renting them for $100 or so more.  Running the numbers, it may make sense in the next years, especially if we can market to grad and med students who will stay for a few years.

Good questions to think about here, thanks for your input!

(919) 260-8811

@Alex Johnson Like others have suggested, a refi might put you in a better spot. Another thing to consider are those upgrades you mentioned. Here is my logic:

5k upgrades amortized over 5 years (I use 5 years because everything gets dated and wears in about that much time) 

You are looking at a monthly amortized cost of about $84. 

Consider it a trade off. You are trading $84 each month so that you can get $150 extra rent each month. (Not a huge boost in income) What you are also getting, however, are tenants who have a nicer place to live. They weigh this against living in a less expensive unit and the cost of moving. Which leads to less vacancy in most cases. 

Now, if it is a dog put it down. I've held onto a property too long in hopes that the market would return. In retrospect I would have been better off performing some upgrades and selling. (Even at a loss) 

Good luck with your venture!

-todd

One set of students for academic year and then since we are at the beach there is a summer market of weekly non-students rentals, much like your Airnb idea. Summer rents are higher.  A 9 month lease is typical for students in our area and rate is driven by number of bedrooms.  Grad students though want to have year round leases and have had a few apply at an apartment we have. They are better tenants with less partying.

For furnishings you can offer as an option and see if they bite but you have to be prepared with saying what you will furnish.  There are companies you can rent furniture from.  

If you do decide to update think hardening the unit.  We put recycled solid surface counters and upgraded from carpet to hardwood and rubber tile for the basement. Students like a good dishwasher and fridge not ss but functionally good. they aren't scrapping the plates.. good luck.

Hey Alex, I was reading your post here and do think you should refi out and change your PM.  We have some lenders we work with in the Charlotte area, if interested ping me.  Also, 10% property management is high, we pay 8% right now with MW Properties and once we hit the 6th property it drops to 6%.  They take care of everything for you!  I read a post last night about folks renting for 9 months and then 3 months, but then I also heard about renting for a year and then telling the person that you are ok with them subleasing it for the 3 months they are in college, if they get more then what they pay you then they get to keep it, but this way they can keep their stuff stored there over the summer months.  Are you near UNCC?  We have looked around the area to possibly get some student rentals but have not jumped on anything yet.  Later 

I'm actually up at UNC in Chapel Hill.  Always looking for good PM as well, thanks for the info.

(919) 260-8811

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