What would you offer?

Question

Hi everyone, I have another thread going with more detail (probably too much detail) but I have the pressing question of “What should I offer?” that I wanted to ask outside of that thread.

So here are some copy/paste excerpts from that thread on income and expenses to see if I can come up with a good offer.

Also, here is the link to that thread if you want more information. http://www.biggerpockets.com/forums/88/topics/118247-6-plex---issues-concerns-repairs-etc

Owner owns free and clear, willing do owner financing due in 6 years. asking price $259k, he said he's already received an offer for $245k and that's as low as he'd go. He wants $30k down and 5.75% on the amount he finances. tax assessed value of property is around $210k according to a property program I have access to at work.

Rental income currently at $2700 per month (I would like to renovate and raise to $3200/month)
Taxes are $2990 a year 
Electric for outside lights are $70 per month 
W/S/G - $405 per month 
Insurance - $110 per month 
7% ish vacancy - $189 per month
10% maintenance - $270 per month
Estimated Mtg payment $1254 per month

If I were to pay full asking price of $250k,that would put the current cap rate around 7.08%. Even if he dropped it $50k down to $200k, that would still only take the cap rate to 8.86%. I wonder what would be a reasonable offer in this case?
 
Here are updated figures after upping vacancy and maintenance costs as it stands with asking price of $250k, current expenses, and current income: 
Expenses - $(1224)/month 
NOI - $17,712/year 
Cap rate 7.08%

What I would like to do is buy it for $200k, put $30k in repairs, and raise rents from $450 average to $550 average which would make the numbers as follows.
 
Expenses - $(1290)/month 
NOI - $23,520/year 
which would put me at around a 10.23% cap rate...

He also gave his approval for me to take a contractor of my choice in to estimate costs in both time and money to bring the place up to par. But before I even go that far I want to make sure this is worth pursuing.

Thank you,

Shane H. · Answer

Thank you all for your input, I really do appreciate it.

@Mehran Kamari

I am more worried about getting a non profitable unit for my first investment than getting a declined offer. You guys have been invaluable in assessing the situation, and if after reviewing the numbers, I cannot feasibly do anything higher than say $170k PP then so be it, he can decline it. But if I offer $245k just so he’ll say yes and then find out I’m losing money every year, then that would be far worse.

I didn’t include a PM fee as if I do this, I truly have to every extra dollar and put it into the savings to refinance out of owner financing in 5 years.

That is a good point about the 8.3% though.

No one can be sure of anything, but I know my area fairly well, and $550 is very feasible as long as the place is not a dump.
Thanks for the numbers too, it’s really helpful to look at it from a clear perspective.

@Dev Horn

Haha Dev, I hear you there!

You are right about the non motivated seller. He told me that outright, and even if he didn’t have a $245k offer, he still owns it outright, it’s making him money, and he still has 3-6 years left on the depreciation schedule.

@Aaron Montague

Did you really mean 109k or was that a typo? If not, how could I feasibly expect someone to come down by over half of what they are asking? Also, I do not have any cash in the game, between the investor lending me $40k and owner financing the rest. So would you still expect 15%?

Trash, sewer, and water are the $470 with I assume water being the majority of that.

I didn’t include the management fee as that would all be going towards the upcoming down payment savings due in 5 years.

You guys are great, I really appreciate you taking the time out of your day to help me and provide your feedback.

Aaron Montague · Answer

I would offer 109k to get to my required returns; 100/door/month and 15% Cash on Cash.  I assume this is a 6 unit place, correct?

If you can get the rents up to $550/unit, the price tag goes up to $195k.

I assumed 30k in renovations in the mortgage for both.

Here are the expenses as I see them:

Mortgage Rate 4.75%

Length of Mortgage in years 30

Monthly Mortgage payment $543.82 (109k)

Monthly Mortgage payment $880.28 (195k)

Taxes $249.17

Sewer and Water $200.00 ( I made this up, but you entire utility bills comes to $470/month)

Trash $- (I did not see a cost here.  Did you invlucde this in your maintenance section? Maintenance is under Cap Ex and Ops in my spreadsheet)

Heat/Utilities $270.00 ( I made this up, but you entire utility bills comes to $470/month)

HOA $-

Cap Ex and Ops $270.00

Insurance $110.00

Mgmt Fee $330.00 (You didn't have this in the number.  Were you thinking of self managing the property?)

Vacancy $231.00

Total Expenses $2,203.98 (109k)

Total Expenses $2,423.08 (195k)

Mehran K. · Answer

If he's already received an offer for lower than $245k, and you believe that, anything lower than that will result in a declined offer!

I haven't ran all the numbers on my own, but I don't see a 10% PM fee included in the expenses. I would count that even if I was going to manage the property myself.

I like to use 8.3% vacancy as a minimum (1 month) in my calculations.

Are you sure the market can support rents raised that much, even with improvements? Just throwing that out there. Don't base your offer on what you can raise the rents to, you're purchasing the investment for how it performs now.

I'll use the 60% Rule (adjusted 50% rule for the fact that you're paying Water etc). I'll use $250k PP and the terms you listed. You mentioned the loan would be due in 6 years, but I don't see what length of amortization he'll be using. I'm going to assume 30 years since you're estimating the mortgage payment to be $1254.

$2700 x 40% = $1080 NOI

$1080 (NOI) - $1284 (Debt Service on $220k @ 5.75% 30 year Am.) = Negative Cash Flow.

Even at $200k PP, with a $170k Loan, your Debt service would be $1008/mo

Dev Horn · Answer

Wow. This makes my head hurt - great analysis Mehran K.

Looks like the numbers tell the story.  I think the biggest red flag is that alleged offer of $245K.  You don't have a motivated seller on the hook here, you have an opportunistic seller.  Best of luck on this!

Aaron Montague · Answer

Originally posted by @Shane Hughes:

I would offer 109k.  That gets me to my numbers.  You have to pay the investor back, right?  The killer here is the set of utilities that you have to pay.  They don't change based on how much you spend on the place, so they just sit there and eat your revenue.  Against your original numbers I have to drop the purchase price 60% just to get enough out of the mortgage to hit my investment criteria.

I would never expect the seller to come down to 109k.  Your original question was "What would you offer?"  That is the number I need to make it worth my time and money.

What would you offer?

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