I MUST BE CRAZY

9 Replies

Ok folks I am looking for input.  Am I cutting it too close because it is a creative financing deal?  Here is the situation.

    I met a fellow awhile back when I was in city hall who was registering a fourplex he and his siblings had inherited from their folks.  I offered what advice I could and told him to feel free to call if he had any questions.  Well he did call awhile back with questions and I answered what I could and told him there was not enough information on other questions.  His folks had owned the property for forty plus years, but the kids had not been it for decades.  I looked the property up, good neighborhood, looked nice, great landscaping.  In talking I was surprised to hear they were losing money.  When I asked about equity he said the property was free and clear.

Here are the expenses and income.

Rent

$450, 450, 450, and $250 for the resident manager.

My opinion is fair market rental value is $600 to $675 per unit.  Three units are 3 bedroom, one is 2 bedroom because they took a wall out to make a bigger living room.  All units are 1 and 1/2 bath.  The onsite manager shows and leases apartments, collects and mails rent, and makes sure yard is cared for.  He also does light repair and maintenance, and is a retired plumber.  The place has 4 separate boiler systems for heat.  Has onsite water well for watering yard.  No updates in building since 1971 when it was built.  Still has original carpeting, sinks, etc.  Very well cared for, and tenants are all retired folks on a limited income.  There is a waiting list to rent at $450 per month.

Expenses

Owner pays water/sewer/garbage pickup, $200 month average.

Lawn mowing $35 per week, plus greentree sprays and fertilizes 4 times a year for $100 each treatment.  So maybe $800 per year, or $70 per month.

During winter snow removal is $75 per snow.  Lets guess high at $90 per month.

Maintenance will be $200 per month

I will put Cap Ex at $100 per month

Vacancy $150 per month.

Taxes $150 per month

Insurance $150 per month

Total $1110 per month

Selling price $200,000

Owner carries $40K on a second mortgage at 5% interest.  Interest only payments of $170 per month, with a 5 year balloon.

Mortgage $160K at 4.5% interest on a 15 year amortization is $1225 per month

Total cost $2335 per month.

I am pretty sure I can get $600 per month or $2400 per month income, possibly $650.  I have to pay the $170 per month out of my own pocket.  At the end of 5 years I will owe just over $119K and can refinance for another 15 years and get $40K out to pay off the note held by sellers.

    OK so why buy a 4 plex that you lose $170 a month on?

One in 5 years the negative cash flow stops, and in 15 more years the property is free and clear with very little of my money in it.

Two If I did a conventional 30 year loan, my monthly mortgage payment would be $810 per month.  That would mean a net of a little over $100 per door.  I use a 15 year amortization because it pays down quickly enough to pay off the 5 year balloon payment.

Three If I had $40K to put down the property would be breaking even even on a 15 year mortgage and making $100 per door on a 30 year note, I am in effect borrowing the money for a down payment.

Four I estimate the property to be worth about $220K, so I will gain a little equity.

Drawbacks, I will be on a negative flow for about 8 months as I gradually raise rents.  I do not have the heart to jump to rent $150 per month on retired folks, even though they really should be in a 1 bedroom apartment, not a 3 bedroom.  The local economy is in a slowdown from the oil price drop.  There were a fair number of oil field service jobs lost.

Plus for $170 per month for 5 years and 20 years of managing, I get a $220K property.  The property does not really need anything major right now, I would probably put $500 in GFI outlets, fire extinguishers, a few other low dollar repairs. 

This deal would be OK with a 30 year loan, I just want to pay down faster and am using a 15 year amortization.

No money down deals are hard to find.  I have no house payment, or car payment, or credit card payment.  Margins are slim around here, and this is as nice a property as you see here.  Give me your thoughts!

Hardly a distress situation or super-bargain, but could be workable.

The seller financing only accounts for $40K of the deal? 

Personally, I'd reduce the acquisition price by the 10% estimated closing costs that would have be paid if a brokered deal, or reflect that in more favorable terms.

You could play with a different payment structure. Could reduce principal of note(s) by improvements or tie payments to building performance. Or, walk not to another property that you plan to sell so the 4plex doesn't have the debt burden.

Given that it's essentially a seniors-only building, you have to factor the type of future tenant that might replace those that depart (walking or feet first).

In all, I'd tell sellers that I need more margin to make it worth my effort. 

@Jerry W. the first question that popped in my head was the fair market value. You told us what you think it's worth but have you confirmed that through comparable sales. A quick phone call to an active Realtor should confirm this and you might find you are getting a great deal or that you are buying a pig. Overall, you should budget about 40% of the gross towards expenses. Some of your numbers appear a little high but maybe that's just the going rate where you live.

Why don't you acquire it and manage it and get a partner to pay for a percentage of equity ownership down the road like a limited partnership, start a Corporation and have an equity contribution of the five years negative cash flow so that you don't have to put that up

And have a buyout clause of your partner, for instance give 20% rate of return on the equity participation, an option to bu him out

I hate negative cash flow's and I like to use partners

Thanks @Brian Gibbons , @Rick H. , and @Bruce M. for the input.  Let me explain more about the deal.  I recently put in a bid on a similar 4 plex in my town, which is a little over 30 miles from where this 4 plex is located.  I offered $220K with a similar financing.  It had 4 garages, but they were out back.  The local 4plex was very nicely done with Berber carpet, washers and dryers in each unit, and they were rented at $850 per unit and were full.  The local place was 15 years newer, but the garages were located a fair bit behind the property instead of being attached.  I do not know the rates 30 miles from here compared to my town.  I am positive I could get $800 per month on the units if they were local, so I am trying to be very conservative on all my figures and plan for the worst case scenario.  I have not seen a fourplex with an attached garage in my area, I cannot believe they would be a lot different but I am checking them out.  I probably need to do some upgrades before I push up rents a lot.  Anyway, Despite being excited, I am beat.  Bed time here.

Is your time free?  Why would you want to work for free just to *maybe* own that place in 20-30yrs when the mortgages are paid off?  I have some 4plexes for sale that are far better deals, granted they aren't owner financing but they are much cheaper!

I don't know if this is the only four-plex for sale in Wyoming, but this doesn't sound like an attractive deal to me at all.  Stuff needs to cashflow on day 1 especially given the lack of appreciation that is still present in the market.  You describe a slowing economy, yet you expect the value of your building to rise.  You are paying an interest only loan to the sellers.  You say everything is as is from 1971 yet state your Capital Expenses will be $100 a month(?).

Personally, I would walk away...

  

Their isn't enough money to be made here to really get interesting. 

It sounds like the property needs major capital improvements to get the rents to market, nothing lasts forever if everything is circa 1971 updates are going to have to happen at some point.

@Jerry W. I've been thinking about this deal. You really need to tie down the rents better. If it's 800 per month then that changes things a great deal.

I'm not a big fan of feeding real estate. Those alligators can eat your lunch and then some.

A couple of thoughts. There are a few expenses that I wouldn't do. Fertilize the lawn at a rental? No way. Lawn care and snow removal; it seems like the configuration would be a side by side. If that is the case each tenant does their own just like with a SFH. If they are 2 stacked on top of two. One set of tenants get the front to maintain and one set gets the back as far as the yard. The ground floor tenants get the sidewalk to shovel. Start charging them for water and sewer and garbage as well. I add it to the rent. Since they are separately metered, advertise as utilities not included and add the cost to the rent. Now you are at least break even and then after five years you are making money.

I don't think the 30 year route is an option. Conventional financing would not allow the current owners to carry back a second. Now since you are doing a refi in 5 years why not do a longer term amortization (25 years) with a 5 year balloon. This helps your short term cashflow. Also with better management, you would have increased value and the bank would lend you the full amount to takeout the second. If you want to feed it then pay it down over the five years but it does not lock you in to making the payment.

Finally, you get what you negotiate for. If your goal is nice properties that just cover the mortgage and you are donating management and upkeep you will end up with a stable full of those properties. If your goal is properties that make you money each month you will end up with a stable of properties putting cash in your pocket each month. Believe me, it's easier to find the first group.

When I started out my goal was to have the property cover the mortgage. I donated (I called it investing) the rest. 10 years later appreciation and rent growth bailed me out. Had I been more choosy then, I would be much better off now and I'm not complaining about where I am now.

@Bill S. , very solid and helpful information.  Thank you for the pointers.  I know you should not fall in love with a property but this one is nice.  The more I check out the local market the more excited I get.  I would be more confident if I had not just had 2 houses and an apartment open up costing me $2K a month until I get them rented out.  I have had lots of interest but none that I want to rent to.

  Your suggestions shave off almost $400 per month in costs.  That really gives me more options.

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