Buy and hold deal not looking like it will meet estimates. Now what?

23 Replies

bought a SFH, with the intention of fixing it and renting. We are well into the renovation and things are not really looking very rosy. In hindsight, we allowed ourselves to put too much scope into the renovation, and cost overruns have caused our planned investment amount to balloon to 340k. At the same time, we had been basing our expected rental rate off a similar but smaller house on the same block which was leased 2 years ago for 2400/month, but they just put it back on the market for only 2150, which concerns me about the possibility of us getting 2500-2600/month, which is what I'd estimated.

The numbers I'm using are:

Invested: 340k

(financed with our personal home equity loans @4% +/- but those are adjustable rates)

Expected ARV anywhere from 350-400k.

It's really hard to guess at this because this house has no basement and almost all the other houses in the area do. Personally I'd never buy one without a basement, so it's hard for me to look at it and compare it with all comps with basements. One smaller house without a basement recently sold for 330k. Our house will be maybe 25% bigger and more updated.

Property Taxes: $6000

Insurance: $1000

Maintenance: $3000?

Monthly Rent: 2200-2500

So based on these numbers, we would be cashflow positive by a couple thousand.

I'm hoping that maintenance for the first several years will be less than 3000/year as much will be new (appliances, bathrooms, plumbing, furnace, AC, water heater,roof).

Another mitigating factor is that I think this area is set to appreciate in value quite well. There is a lot of home improvement activity in this area. There are quite a few instances of homes getting additions and smaller houses being torn down to build new going on in the vicinity of this house.

We could just sell the house but I figure we'd end up paying something like 20k in closing costs, so if we sold we could end up with 10-30k in profit. Much lower than we expected when we started this project, and a pretty small return for such a large effort. But hopefully still a profit.

We are not full time investors, so by having this money tied up in a less-than-great deal isn't really preventing us from buying other properties or the like

So, if you were me what would you recommend? Cut bait and sell, or hold onto it at a slim cash flow rate and hopefully enjoy some appreciation in home values?

@Chris M.  the good news is i'd be shocked if you spent 3k on maintenance a year on any single family house, let alone a fully rehabbed one.

Depending on what your local market is indicating, you may want to let this first deal go, or keep it and face some possible uncertainty. You can use the experience to do your next deal that much better. I would have a sit down with your broker and really sort this out.

Good luck!

My concern would be the variable rate loans.  How often do they adjust and what are they tied to, Libor, 11 district cost of funds etc?  Many helocs change monthly.  Is there a maximum the rate can go up in a year, month?  A jump in interest rates could wipe out your small positive very quickly.

I'm not going to advise one or the other. Just remind you of the investment analysis principle, "sunk cost".

If you wouldn't buy the home for $350-$400K, then you should sell it. 

Of course, that's only one of many investment principles you should use in your analysis.

You should decide before getting too much farther into project. The improvements you make to the home to rent it will differ from those you'd make if you're going to sell it, right?

At least in my part of the country the repairs would be different.

Maybe you could give more details about your numbers. Did you borrow a total of $340K at 4% to buy and complete the rehab? If so, your monthly payment would be approx $1650. Add taxes and insurance @ $7k/yr and that's an additional $590/mo, for a total PITI of $2240. If your rent for $2300/mo, you are going to run negative as that doesn't account for ANY repairs, maintenance or vacancies.

You may be in an appreciation game where you get it rented and sell a year or two from now.  That being said, lots of people did that in 2007 (in hot markets) and it didn't work out so well.  

Post a few more details so we can brainstorm on actual debt service vs. rent

@Chris M.

I will sell, 10k profit is much better than losing sleeps every night.

You actually earn more than just the 10K IMO. The experience you gained will serve you well for all your future projects.

It's a crappy cash flow as most houses are in that price range. Try to sell it if you can just break even, if you think you can get appreciation in a year maybe wait and then sell.

Slim to negative cash flow, high likelihood that rates will increase (, all while hoping and praying for appreciation?  Sounds like a recipe for lost sleep.  I say dump this marginal deal and find a great deal.

Just wanted to add to your calculations, you have a newly renovated home to sell right now that you're saying you could make a little money on in addition to the lessons learned.  Once you rent it, you'll have a home that's been rented a few years, so instead of buyers hearing "newly renovated", they'll hear "2-year-old appliances, roof, etc." with the normal wear and tear that comes from that, and you'll have the potential for renter damaging the place as well (although I'm sure you'll be screening well, so not likely a factor).  

@James Wise would that include repairs as well? Stuff like replacing the roof (although, I'll probably be dead before this will need replacing).

@Martin Scherer they are tied to prime, adjust monthly and have no cap on how much they adjust each month as far as I can read. I could look for a more conventional mortgage but I would assume that would make the numbers even less favorable, unless I were to hold it for a long time and interest rates & rental prices were to climb.

If interest rates were to change I could always sell, but that would put me at the mercy of whatever the current market is at that time, which, if rates are jumping, might not be a good time to sell.

I made a pretty simple but effective spreadsheet when I first started analyzing deals. I enter just a few fields of info and it calculates all the critical numbers for me and also forces me to think about everything involved in a deal from maintenance, to cash flow to cash on cash return all the way through the rehab cost. 

From my calculations, if you are financing $255k of this property, you are cash flowing negative $239 if we use the most conservative rent estimate. Yes you can make any property cash flow if you put enough cash down but that's not really the point.

So from my perspective with limited information, it might be worth just selling this as a NEWLY REHABBED PROPERTY as @Lynn M.   says - she makes an excellent point. You will get top dollar during the summer months selling a new house. If you make any money, that's a win in my opinion. You get back all your working capital and you can move on to the next deal and not have to hope and pray that the market doesnt shift and you are left with a partially lived in home that's not worth what you put into it. Markets are hot right now and you can take advantage of that. 

@Bill Coleman

While I'm starting to think that you are right that selling would be the preferred strategy, can you elaborate on the 255k financing being cash flow negative? What numbers are you using? 30 yr mortgage for 255k @ 4% is 1217 /month or 14604/yr, + 6000 taxes + 1000 ins + 3000 maintenance = 24604 or 2050 / month, which is less than the low end of the expected rent. Do you have other things included like some vacancy or higher maintenance costs or am I missing something?

@Account Closed we borrowed the full 340k against our own home equity, so right now we are paying between 3-4% on that money, but as I have said those HELOCs are adjustable. I could possibly get a traditional mortgage on the place but I'm guessing the rate would be closer to 5 and there would be closing costs to push the numbers further in the wrong direction.

If we sold right now we'd be within the 1 year window so we'd pay short term capital gains, but if we are only making 20k the difference in tax amounts wouldn't be as great as if we are selling at a 100k profit.

Another option would be to try to rent it for 2500 and see if we get any interest. If not we could fall back on selling.

The house won't be completed until September or maybe even October. I'm a little concerned that we would be selling a family house in a great family neighborhood outside of the summer months. I'd rather sell when families are moving most during the summer months.

Thanks for the additional info.  It sounds like a terrible rental deal.  With 100% debt service on $340K, taxes and insurance you are not going to break even each month.  I don't understand where you got "cash flow positive by a couple of thousand"?  My calculations don't include any repairs or maintenance or vacancies or the cost of finding a tenant.  

And you're not even done yet. A lot can happen to a budget between now and September/October, especially with an open HELOC. Sometimes not having access to easy money forces you to focus and do better math.

I'd stop what you are doing, and get a few agents to look at the house asap.  Ask them the minimum you need to to do to get it sold for the best value this summer.  This really is a good time to be selling rehabs in good markets. Then I'd spend the next weeks making sure I could get it on the market  before August 1.  But that's me.  I would not be interested in scrambling for a tenant that will pay $2500/mo in October on a $350K+ property.   

The reason deals like this ultimately do not make sense is that rent increases do not go up parallel with cost of house. Aka i get around 900 per on a house i paid anywhere from 15-50 on. You are hopefully going to get 2400 on 340. 900 at 30 avg (est) = takes me 2.5 of these at 75k to equal what you get at 340. I get your rent at under 25 percent of what you spent. Further, if one of my 2.5 go vacant, i still have 1.5 paying rent. You have zero with a vacancy. Too much risk.

Lots of way better ways to use that money for landlord purposes. Sell it.

You should run your numbers more conservatively and decide if you can sell for an amount that would be better than holding an alligator.  If you can gain anything positive, it would likely be a better move.

Agree with K marie  I would sell this one.. Unless you see upside short term say 400 to 500k in 3 years.. then a small negative for that gain is acceptable just like CA. investors.

Although you take on risk of a Minnie bubble and values drop...

30k net gain on a 350k project is not the end of the world.. Most builders that build new construction net 10 to 15% ( of course they are building multiple units a year)  And many rehabbers don't do a heck of a lot better given the competiton. So your not in that bad of shape is you can NET 30k  including ALL in costs. ( which most investors have a hard time calculating) as K marie points out many times.

@Account Closed the cashflow was based on debt service of 340k @ 4% = 13,600 + 6000 taxes + 1000 insurance + 3000 estimated maintenance = 23600 and the low side of rent would be only 2200/month => 26400 which would be a couple thousand more than expenses. But I agree that margins are too thin.

Originally posted by @Chris M.:

@K. Marie Poe the cashflow was based on debt service of 340k @ 4% = 13,600 + 6000 taxes + 1000 insurance + 3000 estimated maintenance = 23600 and the low side of rent would be only 2200/month => 26400 which would be a couple thousand more than expenses. But I agree that margins are too thin.

 So your loan is interest only?  That'll catch up with you on rental hold.  :)

My husband and I have done well operating on thin margin with great houses in good areas on a 30 year loan. We rent the house out are self allowing us control and keeping cost downs If you do decide to keep the house I personally am a strong advocate to lock in a low interest rate. 

When will the house be ready? I would start marketing it now so you can see what the number will be!

@Chris M.  ,

Here is my question to you:

If you were to have the after-tax net proceeds from the sale of this house in your hands today (after all commissions and other costs), would you put that exact same money down today to purchase the property again, for the exact same funds you could get out of it?

If the answer is yes, because of the limited net proceeds after commissions, and appreciation upside I would buy it again, then keep it. If the answer is no, I would not want my net proceeds to be reinvested in this same deal - and would rather invest those funds elsewhere, then sell.

@Chris M.   Chris, I am happy to share my spreadsheet with you. Just email me. Email is in my signature.

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