Advice on MPP for Rental / Flip in 2 years

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Advice on MPP for Rental / Flip in 2 years

Rowdy B.Pro Member
Developer · Flagstaff, AZ · Member since 2014 · 30 posts · 1 vote

Hi all -

I'd like some advice on the max purchase price (MPP) of my first investment property. Using the 70% method, I'm coming up with a MPP of $57,500, using another method previously posted on BP ( ), I'm coming up with $75,000.

If anyone has the time to wade through all the details below and provide some advice, I'd certainly appreciate it.

Thanks!

Rowdy

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Primary Goal: generating a 20% profit through reselling

Secondary Goal: achieving more than 10% annual return on total investment in rent.

Due to the requirements of the retirement fund I am using to purchase it, I can only purchase property using cash (cannot take out a loan), and have to hold it for at least two years so as not to be identified as "carrying on a business". I am in Australia at the moment, and all the information I can get is from the selling agent, my buyers agent, and a very reliable and helpful relative who visits properties and sends me photos. I've been looking for almost a year, and this is the best deal I've found so far.

Here's what I'm looking at:

  • 4 bed 2 bath
  • split level home (basement+ground level)
  • carport (no garage)
  • 1800 sq ft home
  • 6000 sq ft fully fenced lot
  • Selling agent's resale estimate: $135,000 - $140,000
  • Buyers agent resale estimate: $130,000
  • Zestimate: $125,000
  • Selling agent's estimate of repairs $10,000 - $20,000
  • Buyers agent's estimate of repairs $20,000
  • Selling agent's Prop. mgr estimated rent $1000 - $1100/month
  • Buyers agent estimated rent $1200 - $1400/month
  • Zestimate rent: $900
  • My guesstimate of other costs (closing + unknown): $10,000

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Here are the figures I plan to use:

  • Sale price: $125,000
  • Total costs: $30,000 = $20,000(repairs) + $10,000(other)
  • Rent: $900/month

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Max Purchase Price (MPP) using 70% rule: $57,500

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MPP = Sales Price * 0.7 - Total Costs

MPP = ($125000*.7) - $30,000 = $87,500-$30,000 = $57,500

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Max Purchase Price using: Sales Price - Other Costs - Profit - Repair Costs: $75,000

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Desired Profit: $20,000

MPP = $125,000 - $10,000 - $20,000 - $20,000 = $75000

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Rent Yield (MPP $57,500): 12.3%

Rent Yield = Annual Rent / (MPP $57,500 + Other Costs + Repair Costs)

Rent Yield = ($900*12) / ($57,500 + $10,000 + $20,000) = 12.3%

Rent Yield (MPP $75,000): 10.2%

Rent Yield = ($900*12) / ($75,000 + $10,000 + $20,000) = 10.2%

===========================================

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More details (from my relative):

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Repairs needed:

  • New shingles for roof. Current shingles do not meet standards needed to qualify for insurance.

  • Doors and door frames

  • Some windows

  • Ceiling in basement

  • Kitchen and bathroom floors (new tiles or laminate)

  • LOTS of paint, indoor and outdoor

  • All new kitchen appliances

  • Some drywall repairs but nothing extensive

  • Bathroom tile, shower, faucets, vanity

  • All new light fixtures

  • Some vent repairs and new vent covers.

  • Possibly some new carpeting.

Pros:

  • Hardwood floors upstairs are in good condition

  • Fairly new water heater and furnace

  • Nice sized fenced in back yard

  • Car port

  • 2 full bathrooms

  • Good sized master bedroom and bathroom downstairs

  • Lots of storage, closets and cabinets in kitchen are in good shape.

  • In a decent neighborhood on the outskirts of town.

  • Structurally sound

  • Basement is mostly finished

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  • Erik HitzelbergerPro Member
    Investor · Louisville, KY · Member since 2011 · 331 posts · 278 votes
    12y

    @Rowdy B. - Here are some quick thoughts...

    1) I despise the 70% rule. As an investor, it is my responsibility to know the costs associated with the transaction and not to rely on 'rules of thumb.' The 70% rule indiscriminately groups costs that have wide ranges and produces a MAO with NO indication of PROFIT. Why anyone would enter a deal without understanding what they are going to make is beyond my comprehension. All of that being said, the formula is MAO = 70%ARV - Repairs (not total costs). Thus, the MAO would be $67,500 which is much closer to the $75K calculation.

    I'll step off the soap box now...

    2) Your agent represents you and should be the person you rely on for accurate market knowledge including comps, rental rates, etc. If your agent isn't capable to do this, find one who is. Do not consider anything the seller's agent has to say of any value. He / She has a fiduciary duty to get the best terms possible for the seller. Personally, I consider most everything on Zillow to be equally worthless.

    On to the rehab...

    3) In my area, $20,000 seems reasonable for the repairs you list based on the level of finish that a $125,000 prop requires. The only 3 things that concern me a little are 1) why does the basement ceiling need to be replaced? Water? Is the leak fixed? and 2) If you are painting the exterior, does this mean the house is wood siding? Is this common for the area? 3) If the shingles are that bad, is the roof leaking?

    If you are comfortable with the answers, then I think you are in good shape. getting a few quotes would be great if you have the time.

    4) As I mentioned, you should calculate your MAO using MAO = ARV - Profit - Closing and Carrying Costs - Repairs. Since you are paying cash, you wipe out all of the bank fees, a portion of the legal fees, and the interest payments. Depending on your agent, the biggest expense in this category is likely to be the commission when you sell. Regardless, $10k seems like it would cover anticipated costs excluding carrying costs while rented (see below). If you were just flipping it, I'd say your $75K number is right on if not a little conservative due to your agent saying ARV = $130.

    5) The tricky part of this deal is the 2 year holding period. I'll argue you aren't buying a rehab prop you have to hold for 2 years, you are buying a rental you want to sell in 2 years. Thus, there are many other factors to consider. For instance, do you delay some of the updates until you are ready to sell so that the items are new for the buyers not for the tenants? Do you anticipate the market to be steady? Appreciate? Depreciate? I wouldn't count on appreciation, but it's better if your agent thinks values will go up rather than down.

    6) Given the 2-year restriction and your stated goal of selling the property, I'd strongly consider finding a tenant-buyer who wants to do a lease with an option to buy. You might miss out on a little appreciation, but the tenant(s) will be more likely to keep the property in good shape as they know it will one day be theirs.

    7) Your rental analysis doesn't include vacancy, repairs, management fees, insurance, or taxes. The monthly yield will likely be more in the $450-600 range. Thus, your 2-year profit would be about $32k. That's better than 15% annually!

    Overall, it sounds like a good deal. Paying cash gives you plenty of exit strategies and the opportunity to adjust your plan over time. I hope this helps a little. Good luck!

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  • Rowdy B.Pro Member
    OP
    Developer · Flagstaff, AZ · Member since 2014 · 30 posts · 1 vote
    12y

    Hi Erik -

    Thanks very much for the quick and detailed reply!

    1) why does the basement ceiling need to be replaced? Water? Is the leak fixed?

    A very good question, and one which I am in the process of finding out

    2) If you are painting the exterior, does this mean the house is wood siding? Is this common for the area?

    Yes, and yes

    3) If the shingles are that bad, is the roof leaking?

    The roof isn't leaking, but the shingles are the "T lock" style, which I understand make it either very hard or impossible to insure, so I'm planning on getting them replaced.

    Do you delay some of the updates until you are ready to sell so that the items are new for the buyers not for the tenants?

    The home is between downright ugly and uninhabitable at the moment, so for as much as I'd prefer to wait on the rehab, will be doing most of it before getting tenants.

    Do you anticipate the market to be steady? Appreciate? Depreciate?

    My crystal ball and all of the agents in the area say the market will remain steady. I'm not factoring in any growth or loss. I'm mostly interested in profit through buying right and rehabbing.

    I'd strongly consider finding a tenant-buyer who wants to do a lease with an option to buy.

    Thank you very much for the idea - I hadn't considered that option!

    Your rental analysis doesn't include vacancy, repairs, management fees, insurance, or taxes. The monthly yield will likely be more in the $450-600 range. Thus, your 2-year profit would be about $32k. That's better than 15% annually!

    Yes, you're correct - I only have been looking at the gross rent compared to the total purchase costs. I do appreciate knowing that monthly net rent will be about half or a bit more than the gross rent.

    I hope this helps a little.

    Thank you, Erik - it has helped me immensely!

    Rowdy

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