Is this a good property investment?

Question

Hello everyone

I have found my first investment property that I am considering. It is in a good neighborhood with good schools. This is the initial info I have.

3 suiter-total rents 2500 a month, total gross income 30,000 a month.

seller is asking 189,000.  The realtors info provided to me was "annual expenses on the property are 6870 dollars which includes grass cutting, snow removal, gas, water, electric, trash removal, septic maintenence, applicance updates, lighting, painting, repairs, etc. "

When I put this property into the napkin figures It comes out:

Purchase 189,000, Cash to close 42,800, Monthly rents 2500, property tax 300, insurance, 100, Mortgage 800, vacancy 10% =250, repairs  5% = 125

Total 1575 dollars

But when I add in snow removal, electric etc. as additional expenses cited by the realtor of 6870 per year divided by 12:

1575 + 572 = 2147 dollars leaving 353 dollars after all expenses are paid  assuming I am being given correct expenses.

Is this a good deal? I tried to figure this step by step on the napkin from the article Rental property numbers so easy you can calculate them on a napkin, and came out in the red. Perhaps I am doing something wrong. The figures on the napkin don't include additional things like snow removal, electric, trash, etc. as the realtor listed among expenses. Anybody willing to discuss this or let me know if this is a good or bad deal?

Bill Jacobsen · Answer

As Joel mentioned you could have expenses of 60% of rents.  Based on the asking price that calculates to a CAP RATE of 6.3%.  Your total return is the cap rate + appreciation (if any) if buying for cash.

If using borrowed money I want my cap rate to be 3 percentage points or more above my cost of money.  In this case I would borrow at no more than 3.3%.

Good luck.

Bill

Joel Owens · Answer

"total gross income 30,000 a month."

You mean a year.

Out of 30,000 gross expected income they are saying annual cost for everything is 6,870 or 23%. Another 10% for vacancy is 33% total.

I say that is pure baloney.

If landlord pays utility (water etc.) you go by 60% total annual costs. Make sure before you even do that step that the rents the seller is claiming are not inflated. For example to get a tenant in they could say first months free or half off and the effective rent is much lower than what is quoted.

So let's say a 10 cap using 60% costs and there is no immediate deferred capex on the property and the rent has been verified middle of the market at 30,000 annually.

30,000 X .40 (60% costs property management, operating expenses, vacancy) = 12,000 NOI   At a 10 cap the sales price is 120,000

Glenn Gray · Answer

Hi Anna,

The repair/maintenance monthly average depends greatly upon the construction and condition. If there is a significant amount of deferred maintenance (roof, utilities, windows, carpet, appliances, plumbing, fixtures, etc), then the repair maintenance budget can sky rocket. Look closely at the condition, and be REALISTIC with what needs attention and what may potentially break. Inspection reports will detail all of this but will cost several $100 for multi-unit, if you rely upon inspector evaluation and you're not able to scope these on your own.

Also, the $572/mo expense for the summarized items may or may not be accurate. Reviewing the sellers books (expense report with invoices) should prove them out. If the seller states they aren't available, it's a warning sign. It indicates the seller is not organized and doesn't keep good records, or is a poor manager. The figure might be "made up" in that case.

All in all, the bottom line shows an annual ROI (return on investment) of approxmiately 10%:

Annual Profit: $4200 ($350 x 12)

Cost to close: $42,800

ROI - $4200 / $42,8000 = 9.8%

That's not all that attractive for what I would consider fairly risky - multi-tenant is higher risk than single fam, in my opinion. I suggest looking for 15% ROI in first year, or higher.

Good Luck,

Glenn