Willingly Buying Lots of Negative Cash Flow?????

Question

I put in a LOI on a property that was turned down today.  It's a multiunit property that had an asking price of almost 400k, based on my analysis the most I could offer was around 140k.  So, I offered a bit less than that and it was turned down.  The broker told me that I'm looking at the property as numbers on a piece of paper and that others buyers are willing to pay 300k for this property.  He claimed he could sell the property tomorrow for 300k, but the owners wouldn't go for it.  So, out of curiousity, I ran the numbers for a 300k purchase price at 7% for 20 years.  The PITI payment is roughly $6,660 dollars, when the GROSS RENTS are only $4,370 per month!  So, this is a long winded post to ask WHY would anyone pay 300k for this property???  The broker was trying to tell me it's because I don't know the area, etc., but regardless of area, why buy a property that in best case scenario is going to lose $2,300 a month?

Jon Holdman · Answer

Yep, I get the same result.  The challenge is extracting $1100 in cash flow out of $2185 NOI. Your average rent is about $400. With rents that low, even 2% (i.e, $20K/unit) is not enough to get $100 in cash flow.

Jon Holdman · Answer

I think there's an error in the original calculations.  $300K at 7% for 20 years gives me a $2326 P&I payment.  Are taxes and insurance really $4300 a month?

If I just apply my simple analysis, and go for break even, I get:

Rent: $4370
NOI: $2185 (50% rule)
Max loan/price: $281,827

At 30 years, $328K is break even.

If taxes and insurance really are $4300, its not a deal at any price.

Owen Dashner · Answer

To play devil's advocate here, if a buyer paid $300K cash for the property, they would get around 8.7% cash on cash return, assuming 50% expenses and $4370/mo. rent...  That could be one reason people would buy at that price- it's tough to get 8.7% anywhere right now.

I mean, who doesn't have $300K cash laying around, right?  ;-)

Brian G. · Answer

Jon, here is my analysis:

Rent: $4370 
NOI: $2185 (50% rule) 
Cash flow: $1100 ($100 per unit)
Max PITI: $1085
Max loan/price: $140,000 @ 7% for 20 years

Let me know if you think the loan % or length should be adjusted or if you see other errors.  I'm still learning.

Brian

Brian G. · Answer

Jenny, yea if they want that price, they can bury someone else.

rich, good idea, set myself a reminder to check back in 6 months.

Christian, I'm sure the broker wants as big a commission he can get.  I don't know if he knows the rental business, my guess is no.  Do you find it worthwhile to give the tutorials?   :lol:

Brian

Christian Malesic · Answer

This may be less about the owner and more about the agent...

How does the agent get paid - commission.

If price goes up, commission goes up.  In the example we are discussing, from less than $140k to $300k offer price, commission more than doubles.

As to the "you don't know this area" comment from the agent - I respond, "I know rentals, and would be happy to sit down and educate you on them."  It is a kill 'em with kindness approach that makes me feel all warm and fuzzy inside.

Rich Weese · Answer

Here are a couple other thoughts.
1. Maybe the broker is the one that doesn't undersyand investments
2. Did you arbitrarily select a 20 year amort? there are 30 yr loans also.
3. Is the rent roll for current units rented or based on 100% occupancy? I had a realtor show me a building that was collecting LESS than 50% of rent roll and he DIDN"T know it.
4. Are rents maxed out?

There are also other conditions that might still be helpful that he didn't tell you or wasn't aware of.

Rich Schroeder · Answer

just a suggestion...wait 6 months and then go back to the broker. Ask him if the area is soo good, why hasn't the building sold yet?  Then make another low ball offer and see what happens.

Michael Rossi · Answer

As I've said many times before, the VAST MAJORITY OF NEWBIES IN THIS BUSINESS FAIL IN A RELATIVELY SHORT PERIOD OF TIME!!!  If he can sell the property to a failure for $300K, that's in his best interest.  The newbie is paying that much because he/she is ignorant.  Simple as that!

Mike