# First Timer Struggling with the Math

12 Replies

Hi, I am a first time buyer looking to break into the rental market.  I have been looking at multi families for about 6 months now and the one building I want to make a move on has so many variables that I am having a hard time with the math.  The building has 10 1br/2br units and 3 store fronts. It is a great location in a small town that really appears to be on the rise.  The price is \$320,000 (the owner won't negotiate) but the building needs extensive work.  2 of the apartments are partially gutted and need renovation. All the store fronts are empty and need to be completely renovated (plumbing, electric, heating, renovation).  The building needs roof work and extensive work on the outdoor staircase which is the second means of egress.  The building has many open violations, mostly due to the abandoned store fronts and to water leaking into tenants apartments from the roof.  I have received estimates of \$250,000 to cover most of the repairs.  This however does not cover future renovations to the other 8 apartments and one day to redo the whole roof.  I have an investor/friend that would pay cash for the building and then we would take out a construction loan for the \$250,000 for the immediate repairs. Our mortgage payment for the loan would be \$1,400 a month.  The building currently brings in \$4,875 a month. The current rents are low for the area because the building is such a mess. I understand that the first couple of years would be tough but once I start to add in the apartments that get renovated and then store fronts my monthly income jumps to \$8,875.

So when I do the math with this number \$8,875 monthly income with a 5% vacancy rate and 30% operation expenses + my mortgage (\$1,400) for the construction loan my cash flow total is \$4,502 a month which I split with my investor.  Again I have not calculated for the undervalued rents but I want to be conservative but the hope is that number would eventually be \$10,000 a month or more.

So finally for my question. When so much work is needed how does one look at the math? In my area (even with all the renovation costs) this seems like this is the best deal I can find.  In my eyes all the renovation costs will be paid from the proceeds of the building so it only becomes a factor when I want to sell?

And my second question (i know a lot of this depends on me) but is this just too big of a project for a first timer to handle?

Thanks for any input.  I know this is a long post.

Hi Oliver. Are you doing all these renovations on your own?

I am hiring contractors.

Hi Oliver,

Sounds like quite a project. One number I'm not seeing in your calculation is your estimated after repair value (ARV). If the property costs \$320k + \$250k to renovate = \$570k total invested. Now after the \$250k of repairs, is the property going to be worth considerably more than \$570K? If not, then I wouldn't consider this a good deal, at least from an equity standpoint. You would still have the cash flow from the rents, but you've basically bought the property at full retail value.

If this is the only property you can find right now, and it's not a good deal, I wouldn't pick up a bad deal just to get a deal. The wisest of investors know when to walk away, and that's a tough thing to do.

I haven't done an investment property deal yet, but when I do in a couple of months I plan on my first one to be a relatively small deal. Being the first one, it is likely that I'll make some mistakes that I can learn from, but they will be mistakes with only 2 or 3 zeroes after them, not 5 zeroes.

Good luck!

And your partner isn't expecting any payments on the money that he purchased the place with ? just splitting the potential profit and then waiting until you may sell the property ? is your name going to be on the title of the property ?

Lots of stuff missing in this.  Big one to be doing without good cash reserves, but the numbers look pretty good.

First off, what are your taxes on this thing?  That's always a concern up north.  I barely factor them in in Atlanta and have a house in Cleveland that I paid \$105k for and found out when I refi'd it the taxes were \$8k/yr.  I was like "huh?"  The taxes were as much as a mortgage would be on that much money, crazy.

So you've really got two things to look at here.  First is how much equity to you create by doing that much work.  Basically, what can you buy it for, how much does it cost to fix, what can you sell it for?

Then, you have a cash flow model that says OK how much will I have in this thing and how much will it kick off in income?  That's when you need to compare income to expenses and money cost and figure out the cap rate, etc.

In between the two you've gotta figure out what your costs are to get from one to the other, they are two very different analyses.  The roof is not a future expense, it needs to be in your rehab.  You're just asking for trouble letting that one slide.

10 1 beds you should be able to do for \$10k-15k each assuming they're fairly small and you can get some bulk pricing and such.  Then the roof and violations.  \$250k is probably right in that market, but thats a guess, I've never tried to fix anything in Mass, I just know that it costs more than the markets I'm in.

\$100k in income on a \$600k investment works all day long, your long term prospects are great.  Just gotta make sure you can get it full and have the cash to get there.  You'll lose some tenants when you start construction.  People don't like change, even if its better for them.  Just gotta factor in some extra lost rent when planning cash.  Also, my experience with 1 bedrooms is the tenants suck, you want to screen them well.

Good luck, sounds like a winner to me.

Thanks for the replies.

@Tom V

When calculating my numbers I was never concerned so much with AVR because my thought was that if I was able to significantly raise the income of the building enough to support the money spent on the renovations that it did not matter.  My thought was the value of the building was mostly tied to the income.  I was not overly concerned with appreciation.

@Patrick Liska

Yes, my partner is just splitting profits and would be paid back the investment when the property is sold. We would create an LLC together.

@Darrell Shepherd

Thanks for the info.  I have included my taxes, insurance, water, sewer, trash and plowing in the 30% expenses.  Once I get the income up to \$100,000 per year that will be \$30,000 set aside for those costs.  Taxes are \$6,500 and insurance is \$8,000.  That leaves a lot extra to cover the other expenses along with a 5% vacancy rate.  The construction loan will pay for the repairs and I was planning on putting the first 2 years of cash flow (Approx \$40,000) for a reserve.  There are a fair amount of nearby grad students to rent the 1 BRs to which is about 4 of the units.  The rest are two bedrooms.

Thanks for the info.

I want to throw caution to the wind...  Is your partner very experienced with real estate / investment property? What about your experience? It seems to be little, no offense. You have a mixed bag of things going on here with a mixed use building; commercial and residential.   I like the mixed use type of property.  Have you done a major renovation project before?  This can be a real headache.  I see this from clients who don't understand the construction process.

You may be biting off more than you can chew, and not having the experience may be the deal breaker not the cost of the project. I would run the numbers at worst case for at least 3 yrs to see if you can make it. I would want to know what the ARV after buying it at \$320k + \$250k + Apt reno = what??? Say apartment reno for 10 units at \$20k = \$200k, is the ARV better than \$770k? I would take over a plan B or C exit strategy with your partner as well. I hear many people on BP take about having several exit strategies. I would write out the plans and then pull them out of the drawer if needed.

For the construction part of this I would carry a high contingency of 25% for any of the unknowns, which you will find.  I would throw 18 months of construction time to the project.  I could see some marketing lag time to find tenants.

I can see the potential good deal here if the numbers and experience work out.  Good luck and post some follow ups!

@Jim Adrian   Thanks for the advice. I have managed some personal home renovation projects but nothing of this scale.  To be honest after receiving responses from this site and others I kind of agree that this is a project is a bit over my head.  Not impossible but would be difficult.  Also considering I still have my own business to still manage along with young kids at home I decided to walk away from the deal. However after walking away the seller now he has come back to me with a significant price drop of \$60,000 which is making me reconsider.

My question for you is when you talk of an exit strategy do you mean for the project as a whole or for the partnership?  Without sounding to naive what are options for exit strategies besides to sell or leverage more capital?  My thoughts were to try and slow down the spending on the project.  I would address all the main issues that need to be done but maybe not do full renovations on the apartments and just do minor updates.  I thought this would allow for some minor rent increases when apartments turn over but would allow to still have capital and some reserve funds.

In your first post you said the seller wouldn't negotiate on price, but now that you're walking away they drop the asking price by \$60K? To me, that looks like a big red flag that says that you made the right decision by walking away.

You are quite right: the value of this kind of property comes from its ability to produce income. Those are the numbers and calculations you need to learn about.

Find someone in the property's area who can bring you up to speed on analysis and valuation of commercial property. Then, you'll be in a much better negotiating position because you'll be able to show the seller what the building should be worth based on its income in its current condition - that is, the basis of your offer price.

The seller needn't be concerned with the ARV, but it will be important to you when seeking partners and investors.

David J Dachtera

Originally posted by @Oliver Miller :

@Jim Adrian  Thanks for the advice. I have managed some personal home renovation projects but nothing of this scale.  To be honest after receiving responses from this site and others I kind of agree that this is a project is a bit over my head.  Not impossible but would be difficult.  Also considering I still have my own business to still manage along with young kids at home I decided to walk away from the deal. However after walking away the seller now he has come back to me with a significant price drop of \$60,000 which is making me reconsider.

My question for you is when you talk of an exit strategy do you mean for the project as a whole or for the partnership?  Without sounding to naive what are options for exit strategies besides to sell or leverage more capital?  My thoughts were to try and slow down the spending on the project.  I would address all the main issues that need to be done but maybe not do full renovations on the apartments and just do minor updates.  I thought this would allow for some minor rent increases when apartments turn over but would allow to still have capital and some reserve funds.