Too good to be true?

20 Replies

Let me start by saying I am new to real estate investing. I have been educating myself as much as possible with podcasts, videos, blogs.. basically everything I can get my hands on. I've been analyzing deals as much as possible, looking for my first investment property. I came across a property that has the potential for insane cash flow (I mean upwards of 40% ROI), but that is working under the assumption that all 4 units would be rented out; the two units not occupied will also need some rehab. I know vacancy must be taken into consideration and I plan on taking A higher % out than normal for it. The property is in a nice(er) part of a town but I am concerned about getting the units filled. Currently two units are filled with each paying 600 a month, and I could get this property for around $50k. Am I just having new investor butterflies? It would still cash flow with only 50% vacancy. I would hate to ignore the potential for such a huge ROI because I was overly concerned the other two units wouldn't be filled. What is your normal vacancy rate? Have you ever passed on a good deal because you feared prolonged vacancy?

It sounds like your main issue will be rehab not vacancy.  But having a $50k 4 unit property in what can be considered a nice part of town seems off to me.  What state is this in?

Originally posted by @Aaron Klatt :

It sounds like your main issue will be rehab not vacancy.  But having a $50k 4 unit property in what can be considered a nice part of town seems off to me.  What state is this in?

  

Central PA. That price is consistent with homes being sold within 2 miles of the property. 

I’m so happy you posted this! I’m ready to buy my first property as well. I am also finding properties with huge roi’s and saying is it too good to be true? In my case I think it is. I was listening to some podcasts on here and one successful investor listed his criteria. One of his criteria was he wouldn’t buy anything older than 1980. Mine was built in 1910. I would highly recommend listening to the podcasts on here

Hi @Adam Burns ,

Welcome to BP!

If the numbers make sense and you're comfortable with the area, then based upon what you've mentioned here I suggest you take the deal.

If you're buying for cashflow, then the $1200 a month coming in that should be WAY MORE than enough to cover your debt services (if there is any) and expenses.  I suggest rehabbing the 2 vacant units and get them rented.  I know completely how you feel.  My first rentals were 2 duplexes that closed on the same day.  All I had to go off of were numbers that worked and a vision.  Best investment I've made yet and making more.

I spent just over $60k for my duplex in GA.  So yeah... $50k on a quad that's already rented... yeah... you'll be good.

Originally posted by @Aaron Hunt :

Central PA has nice parts?

It sure does. Plenty of beautiful country, great state parks, low cost of living, hard working people who look after each other.. I love it.

Originally posted by @Kim Heinrich :

I’m so happy you posted this! I’m ready to buy my first property as well. I am also finding properties with huge roi’s and saying is it too good to be true? In my case I think it is. I was listening to some podcasts on here and one successful investor listed his criteria. One of his criteria was he wouldn’t buy anything older than 1980. Mine was built in 1910. I would highly recommend listening to the podcasts on here

While certain criteria will work for some whole not so much for others, I can tell you from first hand experience that’s not bad advice! I bought my primary resisdence with the ‘leasing with the option to but’ method, and although at the end of the day I got a fantastic deal, the home was built around 1900 and it caused me countless sleepless night so haha. I like to think of it as it haven me an education! The podcasts and webiars on BP are nothing short of incredible.

Originally posted by @Adam Burns :
Originally posted by @Aaron Hunt:

Central PA has nice parts?

It sure does. Plenty of beautiful country, great state parks, low cost of living, hard working people who look after each other.. I love it.

Was just messin around. Good luck! 

Even if the ROI isn't as crazy, you're still so far ahead it seems like it would be worth moving forward.

@Adam Burns high vacancy is usually a sign of bad or lazy management. It could be tired landlords. It sounds like the units need some rehab work. Assuming you put some money into updating the units, they should rent. Assuming all four units are similar, it seems you should be able to get $600 or more for the vacant units. 

The numbers work with even 50% vacancy, so it seems like a good starter property. It is easy to fall into the trap of seeing a good deal and wondering what you are missing. You are right to be cautious as a new investor. Make sure you have the property inspected. 

Super high ROI's usually come from pretty gnarly areas - like D- and F... 40% ROI on a rental has always been too good to be true for me - and I've played in some of the hoodest of hoods. Do your research on this one - could be great, but also could be a huge turd.

That kind of return raises some red flags for me. It doesn't mean the deal is bad. It just means you need to proceed cautiously and run your due diligence.

1. How strong is the rental market in that area?

2. Why are two units vacant?

3. What's the overall condition of the property and then the individual units?

4. Are there identifiable issues that will cost you money up front or in the near future (roof, heater, windows, etc?)

5. If it makes such good money, why is the seller getting rid of it?

6. If it's such a good deal, why hasn't anyone else bought it?

Just a few thoughts off the top of my head.

Does the 40% ROI include the cost to renovate the 2 properties? I dont think it's too good to be true but you have to wonder what the motivation is to sell if it has such good upside?

Do you think a bank would give a loan for this kind of property?

@Adam Burns Basing this off of what you said in the original post. Sounds like you're nervous for no reason. If it's in a good part of town as you say, and rehabbed (once you rehab it) filling it should not be a problem.

We must know if this is gross ROI. I've had several single family come in at 30% gross. They end up in 19% net range. I grab them as quick as possible. In my experience multi fam has had higher turnover and vacancy rate. Time will tell what your true roi on this one will be.

If you are willing to accept section 8 you shouldn’t have any problems getting tenants.

It'a not too good if the numbers are real.  Filling newly rehabbed units can be relatively easy if they are rented at or even slightly below market value.

I can only see the renovation costs as an issue. But if you would be already cash flowing with only 2 units rented, then you have a good deal on your hands. Even if it takes you 5 years to renovate you're still on top!

@Adam Burns ,

This is a great post! I grew up in Hershey, Pennsylvania (in central PA) and am now in the Philadelphia market. I've looked at a lot of investments in Harrisburg, Lancaster, Lebanon and surrounding areas, but have never pulled the trigger. However, I know a lot of people that have had excellent success in the middle part of the state.

To ease your mind, the following are some items to consider when looking at any investment (especially those that appear to be too good to be true):

  • Vacancy - you mentioned that you were prepared to over-estimate the vacancy rate for the property. It's important to put a number on that and to understand what it means. If a unit is vacant 1 month out of 12, the vacancy rate is 8-1/3%. Most standardized cash flow calculators default to a 5% vacancy rate. But I've seen plenty of new landlords decide to turnover a property themselves. Nights and weekends stretch the turnover from 1 week to 2 months. Then it takes another month to lease. In this type of situation, you're looking at a 25% vacancy rate for the unit. Be realistic with yourself and make sure you're not using "pie in the sky" numbers.
  • Rental Demand - This property has 4 units and it sounds like 2 of them are vacant. Based on your post, I'm guessing that they are vacant because the place needs work. Have you inquired with the seller about why they haven't prepared them for lease? Sometimes there will be a demand for a certain type of unit in one area, but not for another type. In my market, I do not invest in 2 bedroom single family houses. The demand for them is low. Check Craigslist to see if there are similar units (1 bedroom, 2 bedroom, etc.) for rent near you. Talk to property managers and get their feedback about the demand for different types of units. In some situations you may have great difficulty filling up the property, even if you've got the nicest property in town.
  • Renovations - Many new investors want to complete the least amount of work on a property to get a tenant into their apartment. I've done this myself. But I've found paint and carpet rehabs to be very short sighted. Today I make sure that I repair/replace anything in my properties that has a shelf life of less than 10 years. I prefer to have all of my apartments and houses vacant at the time of acquisition so that I can make the repairs quickly (and to choose the tenants - see below) without having to work around residents. If I have to assume the tenant, I will plan the repairs as the tenants turnover. But the bottom line is that you need to be realistic about what its going to cost you up front to put the property into a condition that will require no major repairs for a decade.
  • Tenants - I believe that most people are generally good. They pay their bills. They go to work. They take care of their family. But the number 1 factor in whether a tenant pays rent or not often boils down to whether or not they can afford the property. This factor impacts a potential investment in 2 ways. First, you have to ask yourself (research it if necessary) whether or not they people that want to live in the neighborhood can actually afford to live there. Do they work? Are there plenty of employment opportunities? Etc. Second, are the tenants living in the property you're considering good tenants? Do they pay their rent every month? How do they maintain their units? Do they interact well with the other occupants in the building? Get a tenant ledger for each unit. Look for proof of payments. Talk to the tenants about their feelings about living in the unit. If you're uncomfortable with the answers you are getting, make the sale contingent upon vacant units. Then you can pick the tenants you want, not who you are stuck with.
  • Expenses - Expenses are often the area where most people miss the mark. As a general rule, you should budget 30-35% of the gross rents (minus vacancy) to be allotted toward property expenses. This fluctuates slightly from location to location, but it's a good, quick analysis that you can do to see whether a property merits further analysis. Make sure that you include all of the expenses when making cash flow calculations. This will include some basic items like property taxes, school taxes, landlord insurance, rental license fees, management and maintenance. Expenses can also include additional costs like utilities (by the way, who pays for electric, heat and water in the 4 unit you asked about?), condo association fees, homeowner association fees and other. Lastly, you'll want to include an annual expense for capital expenditures. This will be a war chest that will grow over time. It's built to account for the cost of replacing larger items as they age (i.e. A flat roof has a life of 15 years and costs $3500. Capex budget for the roof is $233.33 per year).
  • Financing - An often overlooked component to a property evaluation is the financing. Consider the difference in cash flow on a $100,000 loan financed over 30 years at 4.5% versus 6%. At 4.5% the annual principal and interest payments come to $6,080.22. At 6% the same loan will cost $7,194.61 per year. That's a difference of $1,106.39 each year ($33,191.70 over the course of the loan!). And since you're purchasing a building larger than 3 units, you'll probably need to explore commercial loans. They're typically amortized over 20 years and will either reset (interest rate) or balloon at least once during the loan. Know your long-term financing options before you buy. It will have a big impact on your cash flow and profits.

Real estate investing has a lot of variables to consider with every investment, but it really isn't rocket science. Ask the right questions. Search for the right answers. Listen to your gut. If something looks too good to be true, it might be or it might not. Once you have all the data, make the decision that makes sense.

Good luck!

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