Value of this deal?

Question

Here are the facts on this potential purchase: (2) adjacent properties, (2) deeds, owner wants to sell them together.

First Property: (3) units
Gross Rents $1625 per month
Water/Sewer: $600 per year (approx.)
Insurance: $2800 per year (quote/ insurance company, non-owner occupied, seems high)
Taxes: $145 per month ($1740 per year)
Maintenance: $150 month (approx.)
Financing: 80/20/5, 1st @6.87%, 2nd @7.87%, 5% down-payment
PMI: 1.05 % loan amount
Vacancy/Rent Loss: 10% of gross (???)

Second Property: (2) Units
Gross Rents: $1150 per month
Water/Sewer: $600 per year (approx.)
Insurance: $800 per year (quote/ insurance company, seems low)
Taxes: $145 per month ($1740 per year)
Maintenance: $150 month (approx.)
Financing: 100% of purchase price @7.87%
PMI: 1.05 % of loan amount
Vacancy/Rent Loss: 10% of gross (???)

Tenants in area tend to be some-what unreliable. Turn-over high. Decent location, could be worse. Property is fair to poor condition.

Whats it  worth?

Michael Rossi · Answer

I wouldn't even CONSIDER deal number 1 unless the purchase price was at or below $81,250.  I wouldn't even CONSIDER deal number 2 unless the purchase price was at or below $57,500.

Of course, you'd still have to perform a cash flow analysis using real world numbers (with all of the expenses, not just the ones you included).  Also, I wouldn't do a deal with less than 30% equity at closing.  Finally, you didn't include a number for repairs needed.  Are both buildings in perfect condition?

Good Luck,

Mike

Jimmy NA · Answer

MikeOH said: " evictions, legal costs, damage, lawsuits, and many more of the expenses, but they do exist; do occur with regularity; and they are significant "

MIKEOH,
I appreciate you becasue you're not afraid to tell people the uncomfortable, cold, hard truths.  But....How do I assign a $ figure for these things when I make an offer? If I want to net $100 per unit per month, shouldn't I really shoot for $125 b/c of these other expenses? Or should I look at these expenses all long term as losses for the income I make over 5, 10 yrs...What I am saying is, I know specific expenses for insurance, taxes, trash removal they have definate, concrete numbers but how do I put a number on these expenses listed above?

Michael Rossi · Answer

ctrentalguy,

Simply subtract your mortgage payment from 1/2 of the gross rents.  That will give you an accurate view of your cash flow.

Mike

MATT WARDEN · Answer

You can't put a dollar amount on these, really. The trick is to go off of historical expense ratios rather than try to estimate each expense (if you did the latter you would either be wrong or need to be so conservative in estimates that it would be impossible to make the numbers work).

The general number is 40-50% of gross rents will come in and go right out in expenses. Again, this is a long run average.

So, if you are renting out at $800/month, on average $400/month will go to all of your expenses (minus debt service). Thus, to cashflow $100/month your debt service cannot be more than $300/month.

Michael Rossi · Answer

ctrentalguy,

You can't possibly know an exact dollar figure for evictions, legal costs, damage, lawsuits, and many more of the expenses, but they do exist; do occur with regularity; and they are significant.  If you don't include them in your cash flow analysis, who is going to pay for them?  Are they magically off budget?  Failing to account for these expenses is the exact reason that newbies fail.  However, you can choose to include all the expenses or you can ignore them and HOPE for the best.  I haven't found HOPING to be very effective in business.

I never buy a rental unless it has at least 30% equity AND has a positive cash flow of al least $100 per month using all the real world expenses.  If you're simply buying the property as a flip, that's a different story.  However, multi-units are harder to sell than SFHs, especially if they won't cash flow.  Experienced investors wouldn't buy it if there's no cash flow, so you'll have to find a newbie to buy it.

Mike

MATT WARDEN · Answer

Buy Mike's book. The answer to your question is there.

If your searching skills are good, you can perhaps find the answer in this forum, as MikeOH has provided it many times, and it has been corroborated many times (even by once-nonbelievers).

Jimmy NA · Answer

Come on Mike,
Several of these things you mentioned can have a dollar amount assigned to them and they can be factored into a purchase. But,  how can you possibly predict the future and then work that into the purchase price?  Without a crystal ball how could I possible know "evictions, legal costs and damage...lawsuits."  It I tried to put a dollar value on these potential problems I would have to get the property for free.  Even me the newbie, knows there is some uncertainty you must accept to be in the business, right, Mike?

Jimmy NA · Answer

What if there is 30% equity BUT after careful consideration of ALL expenses it losses money each month? That is what is so enticing to me. I can get the (2) buildings together for X but there are worth 25-30% more if I sell them separately.  
So, I guess I am gambling on turning them over and not the income they produce (or fail to produce).

Michael Rossi · Answer

mwarden,

In other words, I won't pay more than 70% of the market value (less repairs) for a property, thereby giving me 30% equity at closing.

ctrentalguy,

You missed a BUNCH of expenses, such as advertising, management, entity maintenance, legal fees, office supplies, utilities paid by owner (even if tenants pay utilities), evictions, court costs, damage done by tenants (beyond the security deposit), lawsuits, capital expenses, etc, etc, etc.

Mike

Jimmy NA · Answer

What am I missing for expenses?