Trying to arrange my first deal..here is the proposal!

6 Replies

Okay, so I found this vacant property that I really want to purchase as my first investment property. I contacted the owner of the place to talk to her about selling - she said she wasn't interested, and planned on renting it out in a few months for the upcoming school year. This was 10 months ago, and the place is still vacant.

The problem is, the owner is an old Italian woman and has no clue what kind of shape this place is in....she thinks its a palace. I walked through it and it needed a lot of work...I'm estimating about 12,000-15,000 (and that's doing the work by myself/with my dad). I want to call her and propose the following deal...but I would like to know what you guys think about this, and listen to your suggestions/opinions. Thanks a lot!

Lease Option Offer Information

I would like to lease to own this property via the following lease option agreement.

I sign a 36 month lease with the owner for $1500/month plus $8000 cash up front ($3000 for first and last months rent + $5000 fee/deposit).

This is conditional upon;

• Permission from owner to renovate and improve property
• Permission from owner to sublet/sublease the property

Other Conditions/Specifics

I have the option to purchase the property at any time after the first 12 months of our agreement and before the end of the 36th month. During this time period, no other buyers have the right to purchase this property.

Purchase Price = *$180,000

Over the course of the lease, 50% of my monthly rent payments will count as a credit towards the final purchase price. For example, if in the 30th month I decide to exercise my option to purchase the property, the purchase price would be $180,000 less 50% of the previous 29 monthly payments at $1500 (29 payments x $1500 x .50 = $21,750). $180,000 - $21,750 = the new purchase price of $158,250.

The owner pays property taxes throughout the term of the lease
The tenant pays utility costs throughout the term of the lease
Maintenance and repair costs will be equally shared between owner and lessee (me)

*According to the city’s website, the owner was paying property taxes based on an assessed value of $213,000. The interior of the property is in terrible condition and would not have been considered in this calculation. The last time I saw the place it was vacant with no locks on the doors.

Financing

I plan on borrowing $30,000 from my Uncle. $8,000 will be given to the current owner right away, and approximately $15,000 will be used to renovate, update etc ($7000 left). The remaining money will then be invested in coin operated laundry machines which will be placed in the basement of the property. The $4000-$5000 that is left over will be saved for emergency expenses.

Projected Income

IN 2, 3bdrm apartments = 6 tenants @ $500/month = $36,000/year
OUT $1500/month paid to current owner = $18,000/yr

BALANCE =$18,000/year
OUT (to me in form of monthly cash flows) = $5,400/year
$450 x 12 = $5400

BALANCE >$12,600/year<

This amount will be used to pay off initial $30,000 loan. Over the course of three years this totals $37,800 ($12,600 x 3), providing a 26% return on investment.

Brandon,

Here is the way I see this deal:

Gross Rents: $3,000 per month
Operating Expenses: $1,500 per month
NOI: $1,500 per month

Mortgage/Debt payments: $1,680 (including repayment of $30K loan)

Monthly LOSS: $180

This does not sound like a good deal to me.

Mike

Mike,

Thanks for getting back to me. I appreciate your response, however, I am wondering where you got those figures from? If you have time, could you please break down how you came to a $180 loss/month.

With my calculations, I accounted for monthly cash flow of approx. $450, including debt service reduction of $1050/month...that is how I broke down the $1500 NOI. What am I missing? Thanks!

Brandon,

You missed ALL of the operating expenses such as taxes, insurance, vacancies, management, maintenance, legal fees, evictions, damage done by the tenants (in excess of the deposit), utilities (during vacancies/rehabs), advertising, capital expenses, court costs, etc, etc, etc. I could go on and on, but I think you've got the idea.

Mike

You missed ALL of the operating expenses such as taxes, insurance, vacancies, management, maintenance, legal fees, evictions, damage done by the tenants (in excess of the deposit), utilities (during vacancies/rehabs), advertising, capital expenses, court costs, etc, etc, etc. I could go on and on, but I think you've got the idea.

Under a lease agreement would I not be exempt from taxes, insurance, management (I would do myself), maintenance (I don't own the property) etc...?

Also, I personally know the 6 people who would be moving in and I am not worried about damage etc, although I still left approx. $5000 in the first year for those fees, plus I could reinvest the monthly cash flows.

Even if with all the factors you mentioned, I'm curious as to what ratios/calculations you used to come up with -$180/month! Thanks a lot!

Brandon,

Throughout the United States, operating expenses run 45% to 50% of gross rents. That data is widely available through many sources. I always use 50% when considering rental properties (to be conservative).

Depending on how the lease is worded, you might be able to get the owner to pay the taxes, insurance, and maintenance, but I doubt it. This is a commercial venture for you and the owner would probably insist on a triple net lease where you pay all taxes, insurance, and maintenance. Also, even if you do the management and maintenance, it is still an expense. If you think it won't cost you anything (time and money) to manage the building, you are mistaken. The only difference is that you will get paid for the management and maintenance instead of a third party. That does not change the fact that the management and maintenance are expenses and it does not alter your cash flow.

I personally know the 6 people who would be moving in and I am not worried about damage etc,

Uh-Oh! That breaks a personal rule that I have which is to never rent to anyone I know (especially friends and family). In my experience, renting to people you know is a terrible idea. IT's a great way to turn friends into enemies. Your friends will want to be a little late on the rent (but they'll promise to pay you later). Your friends will expect you to do them favors. Your friends will trash the place and you won't be able to understand why your friends are tearing up your property.

Good Luck,

Mike

Mike,

Thanks again for the response. You raise some valid points about renting to those you know, and I'll definitely reconsider that in the future.

With regards to the triple net lease where I would pay taxes, insurance and maintenance - I feel like this situation is different and there is a big opportunity for me here. For starters, this property has been sitting vacant for over 1 year now, with absoulutely zero income coming in. Over this time period she has still had to pay all of her taxes, insurance etc., so she's definitely losing a decent amount of money. On top of this, the last tenants completely trashed the place leaving her with a ton of repairs and maintenance to take care. Since she is older and cannot do the work herself, she would have to pay someone else which makes the cost of repairs even higher. Basically I feel it's her only option. No one else is knocking on the door looking to rent/buy from her - she has no leverage to negotiate.

Also, this property is in a very good location and will definitely get a ton of attention once it is cleaned up. On top of this, the university which it is very close to is looking to expand, and will want this piece of land in the next 10 years...

I have a feeling she would be very interested in my new deal. It provides her with $8,000 up front (proving my credibility) and guarantees her a positive monthly cash flow for the next 36 months. I found out through a real estate agent/friend, that she bought the property 8 years ago for less than half of what it's worth (or appraised at by the city) now ($100,000). Does this deal change at all in your mind now, or are there still some things I should work out? I know there are a lot of specifics which I still have to consider, but I feel as though the foundation of this deal would be solid enough for the both of us to still profit.