Analysis Help for a New Investor with a Unique Opportunity

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Analysis Help for a New Investor with a Unique Opportunity

Matthew BrillPro Member
Investor · Boca Raton, FL · Member since 2015 · 234 posts · 103 votes

Hello BP community,

I am new to buy and hold investing and have being doing as much reading and learning as possible while looking for deals to get started with. I came across an opportunity involving purchasing duplexes in a new construction project. I would be buying 4 units (2 duplexes) directly from the builder. I networked to meet the builder and his partner and they said they would help me out, saying they would take a smaller margin, help get 0 money down financing, set up property management (which there company does), set up an LLC, and even 1031 to something bigger when the time presented itself.

The proposal is they will sell me each unit for $137,750 which will appraise for $160,000 per unit. This built in equity will supposedly allow me 0 money down. The terms presented to the bank are a 5% loan rate on 5 year terms and a 25 year amortization schedule (I am also currently reaching out to other lenders and trying to improve on these terms). That put the monthly principal and interest cost at $805 per month per unit. They also estimate taxes at $150 a month per unit and insurance at $125 a month per unit for a PITI of $1080 per unit per month.

Their market analysis estimates potential rents of $1320 per month and they claim there is already a waiting list of 125 people.

Assuming all of the above to be accurate, I also calculated the following monthly expenses per unit based off what I have come across in my studying:

Vacancy (1 month per year): $110 (of note, this is part of a 55 years old and up community so possibly a higher likelihood of long term tenants)

Maintenance (5% of rent): $66

Property Management (10% of rent): $132

If I use these expenses at the end of each month I am looking at -$68 per unit per month ($1320 - $1080 - $110 - $66 - $132). I realize that I am also not accounting for capital expenditures. 

I know in general I don't want an asset that results in negative cash flow but I have two questions. 1) Am I possibly overestimating expenses since everything will be brand new? 2) Should I not necessarily be as concerned about the potential negative cash flow since I am getting $22,250 free in equity? I would plan to sell in 5 years, hopefully before any capital expenditures, which would net me $33,448 per unit (taking into account the negative $68 cash flow per month).

I know this was a lengthy post and I appreciate you all taking the time and sharing your thoughts.

Thanks,

Matt

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Joel Gabelman
Cleveland, OH · Member since 2012 · 28 posts · 22 votes
10y

I've spend almost 12 years in finance, more than 9 in commercial lending at the big boys: US Bank and JPMorgan Chase. There are A LOT of "bankers" who are clueless and hungry for deals (commission), but they have $0.00 credit authority to approve (usually). You should actually ASK how the credit approval works for this deal. Since is relatively small, MAYBE they (branch) can approve instead of submitting it to credit. Regardless of a big bank or small bank (I've worked at both), 90% of time, it's credit administration that has the ultimate say, not the sales guy (lender/RM, whatever). If this is a small community bank and starving for investor loans in CRE with 86% leverage, you've found a pot o'gold.

Based on your numbers, purchase price is $137,750 and expected value is $160,000.  This is an 86% LTC (Loan-To-Cost).  I don't know of a single bank doing 14% equity down.  On an investment property, we'd look for 25% down, sometimes 20%.  Additionally, like you touched upon, banks will look at the lesser of sales price or appraised value.  So in your scenario, if the builder is really going to give you a "steal" at $137,750, the loan will be based on this figure.  Finally, most all lenders for "A-money" (best pricing at the banks vs. private money), will require a personal guarantee, and tertiary repayment support.  Primary: tenants rent; Secondary: Collateral; Tertiary: personal cash flow.

Other questions/thoughts that jump out to me:

1) Why is the builder giving you such a great deal???  If YOU could get $!60k for a home, would you take $137,750???  For starters, this sounds TOO GOOD TO BE TRUE.

2) Research the builder - what else have they done?  Depending on where you live, they likely will need a C.O.O (Certificate of Occupancy).  I'd make sure to see this that the city says the places are good to go.

3) If comps support value, and all the above rings true, I'd STILL be cautious.  Maybe run it by a local guy for good measure.  

There are other concerns, but the biggest one is why is the builder giving you such good deal? I'd be VERY surprised if the Bank will finance based on appraised value vs purchase price too. I have a HUD home near me needing around $40k-50k of work. Purchase is $40k, and it should appraise based on comps for around $90-$100k. If your lender will go off APPRAISED value, I'd love to talk to them!

Best of luck - be careful.

-Joel

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  • David Dachtera
    Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes
    11y

    I would ask about doing six units and look into a commercial loan instead. That would be based on the properties' income rather than your credit, though you may be required to put up a personal guarantee.

    1Reply
  • Matthew BrillPro Member
    OP
    Investor · Boca Raton, FL · Member since 2015 · 234 posts · 103 votes
    11y

    Hey Dave, thanks for your reply.

    That had crossed my mind. With the commercial loan will the properties be grouped together so they couldn't be sold separately? Would it qualify despite there being negative monthly cash flow or would the terms change enough that there would be positive cash flow?

    0Reply
  • David Dachtera
    Rental Property Investor · Rockford, IL · Member since 2014 · 4k+ posts · 2k+ votes
    11y
    Originally posted by @Matthew Brill:

    Hey Dave, thanks for your reply.

    That had crossed my mind. With the commercial loan will the properties be grouped together so they couldn't be sold separately? Would it qualify despite there being negative monthly cash flow or would the terms change enough that there would be positive cash flow?

    Those answers are for you to determine.

    0Reply
  • John Arendsen
    Homeowner · VISTA, CA · Member since 2015 · 727 posts · 340 votes
    11y

    Not totally sure how commercial vs personal loans differ in the overall scheme of things but I would think that the commercial lender wouldn't mind a principle reduction of the over all debt service and allow you to spin off the units when the opportunity presents itself. 

    Also one thing I didn't see in your very well articulated presentation was any mention of appreciation. I'm assuming that these properties are in the path of progress and upward mobility hence you should factor in some appreciation as well. Just sayin............................

    0Reply
  • Doug N.
    Lynnwood, WA · Member since 2015 · 221 posts · 157 votes
    11y
    Originally posted by @Matthew Brill:

    (...) the builder and his partner and they said they would help me out

    (...) they [said they would] would take a smaller margin

    (... they said they would) help get 0 money down financing, 

    (... they said they would) set up property management 

    (... they said they would) set up an LLC

    (...) and even 1031 to (...)

    (...) which {they say] will appraise for (...) 

    (...[they say]) This built in equity [claimed by them] will supposedly allow me (...) 

    (...) They also estimate taxes at (...) 

    (...) and [they also estimate] insurance at (...)

    Their market analysis estimates potential rents of (...) 

    (...) they claim there is already a waiting list of (...)

    Hi @matthew brill - 

    Sometimes it helps to look at the simple essence of a potential deal, ignoring all of the numbers and terms in the first-pass analysis.

    In this way, some things become very clear. 

    My edit may look snarky and such, but it's how I look at things sometimes, especially when I am trying to get a basic read on a proposal. 

    There's a lot to work with here, and I can only advise that you follow your instincts. 

    Please let us know what happens, and best of luck!

    0Reply
  • Matthew BrillPro Member
    OP
    Investor · Boca Raton, FL · Member since 2015 · 234 posts · 103 votes
    11y
    Originally posted by @John Arendsen:

    Not totally sure how commercial vs personal loans differ in the overall scheme of things but I would think that the commercial lender wouldn't mind a principle reduction of the over all debt service and allow you to spin off the units when the opportunity presents itself. 

    Also one thing I didn't see in your very well articulated presentation was any mention of appreciation. I'm assuming that these properties are in the path of progress and upward mobility hence you should factor in some appreciation as well. Just sayin............................

     Thanks for replying John. I didn't want to assume appreciation just because I wanted to be conservative in estimating potential gains. As far as the loans go, I admittedly don't know enough about the structuring of commercial loans to be able to make a worthwhile evaluation compared to a residential loan. 

    0Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    11y

    @Matthew Brill didn't quite say it, but I will:- RUN AWAY!...

    2Reply
  • Matthew BrillPro Member
    OP
    Investor · Boca Raton, FL · Member since 2015 · 234 posts · 103 votes
    11y
    Originally posted by @Doug N.:
    Originally posted by @Matthew Brill:

    (...) the builder and his partner and they said they would help me out

    (...) they [said they would] would take a smaller margin

    (... they said they would) help get 0 money down financing, 

    (... they said they would) set up property management 

    (... they said they would) set up an LLC

    (...) and even 1031 to (...)

    (...) which {they say] will appraise for (...) 

    (...[they say]) This built in equity [claimed by them] will supposedly allow me (...) 

    (...) They also estimate taxes at (...) 

    (...) and [they also estimate] insurance at (...)

    Their market analysis estimates potential rents of (...) 

    (...) they claim there is already a waiting list of (...)

    Hi @matthew brill - 

    Sometimes it helps to look at the simple essence of a potential deal, ignoring all of the numbers and terms in the first-pass analysis.

    In this way, some things become very clear. 

    My edit may look snarky and such, but it's how I look at things sometimes, especially when I am trying to get a basic read on a proposal. 

    There's a lot to work with here, and I can only advise that you follow your instincts. 

    Please let us know what happens, and best of luck!

     Thanks Doug. I think I get what you are saying. There is a lot of inherent trust that would be assumed from my end and that is something I am dealing with. I feel like I have a good grasp who they are as businessmen and members of my community. I am at the point where I would move forward with them when it is time to put pen to paper but I am trying to decide if it is a worthwhile opportunity or not. Being this would be my first investment purchase, I am also wondering if the advice of @joshua dorkin and @Brandon Turner apply and I should jump in to get some experience. Thanks again for the input!

    0Reply
  • Matthew BrillPro Member
    OP
    Investor · Boca Raton, FL · Member since 2015 · 234 posts · 103 votes
    11y
    Originally posted by @Brent Coombs:

    @Matthew Brill, I am concerned that you are being groomed by these builders (similar to how gurus groom their seminar attendees).

    @Doug N. didn't quite say it, but I will:- RUN AWAY!...

     Thanks Brent. Any recommendations how I could further look into this to cover all my bases? 

    0Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    11y

    @Matthew Brill, I am mainly concerned about the ethereal 2020 guesstimate values that have been planted into your head, because they seem to be the ONLY reason you are considering this proposition.

    Getting back to earth, how much have similar sized (but older) duplexes recently sold for? What are their rents and waiting lists? (The sort of research that those Builders won't tell you about). All the best...

    1Reply
  • Cynthia Calhoun
    Full-Time Investor · Woodstock, GA · Member since 2015 · 105 posts · 47 votes
    10y

    Hi @Matt,

    Find a professional who's not vested in the outcome, and get their opinion!

    If not the above: @David Dachtera is right on the money, with the commercial loan scenario...I'd take that route for sure. If not, then I'm of the same opinion as @Brent Combs and @Doug M. Run!!! Plain and Simple (or at least bring in an unbiased party.

    It sounds very similar to a scenario I encountered a little over 3 years ago...I will spare you the sordid details; but I hear "all of the same optimistic quotes". I spent time with these people, and felt they had my best interest at heart. It was to be my 1st commercial project. I had read, researched, and learned all I needed to know about the project, on my own (or so I thought). The key players said all the right things, the numbers looked good, and I even had a "30-day money back guarantee" on my EMD! Well, 3 years later, I still get sick to my stomach when I think about how gullible I was...the broker was less than honest, the attorney was less than honest, and the seller was less than honest...and I was less than educated...so I lost a hefty sum of money!

    2Reply
  • Doug N.
    Lynnwood, WA · Member since 2015 · 221 posts · 157 votes
    10y

    @Matthew Brill bravely and selflessly writes:

    The key players said all the right things, the numbers looked good, and I even had a "30-day money back guarantee" on my EMD! Well, 3 years later, I still get sick to my stomach when I think about how gullible I was...the broker was less than honest, the attorney was less than honest, and the seller was less than honest...and I was less than educated...so I lost a hefty sum of money!

    This is exactly why I keep coming back to BP. I learn so much, and it doesn't cost me a cent. (Thank you, Cynthia - that's not easy to write!)

    Let us know what happens!

    2Reply
  • Cynthia Calhoun
    Full-Time Investor · Woodstock, GA · Member since 2015 · 105 posts · 47 votes
    10y

    @Doug M. Thanks...

    Yes, it was difficult to write. Hell, it's difficult to own...and I actually typed it, then erased it...but I realize acceptance and ownership of our less-than-perfect decisions is the 1st step. Being open about it is what keeps us humble. Humility is what assists us to consistently learn, grow, and ask for help. Being transparent (naked) about our mistakes is therapy. It's "the most free we will ever be". 

    3Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    10y
    Originally posted by @Matthew Brill:

    ...

    The proposal is they will sell me each unit for $137,750 which will appraise for $160,000 per unit. This built in equity will supposedly allow me 0 money down. The terms presented to the bank are a 5% loan rate on 5 year terms and a 25 year amortization schedule (I am also currently reaching out to other lenders and trying to improve on these terms). ...

    Something does not sound quite right here; I suggest you actually talk directly to lenders about this. For purchase money, lenders will value the property for a loan based on the lesser of purchase price and appraised value, so this nothing down idea will go away when the lender takes that approach. Once there is one hole in the scheme ...

    3Reply
  • Doug N.
    Lynnwood, WA · Member since 2015 · 221 posts · 157 votes
    10y
    Originally posted by @Cynthia Calhoun:

    @Doug M. Thanks...

    Being open about [mistakes] is what keeps us humble. Humility is what assists us to consistently learn, grow, and ask for help. Being transparent (naked) about our mistakes is therapy. It's "the most free we will ever be". 

     Cynthia - that is so right! And so difficult at first, but ultimately a great freedom, as you put it so well! You should post more - you're a good writer with some good experiences to transfer... Best of luck!

    0Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y

    @Steve Babiak, Aah, but THEY will "help get 0 money down financing", remember? (But I certainly worry about any Financial Institution that will fudge appraisals just so they can lend money at 1-2 points above conventional Rate to people who have no money. And I worry about who they are in league with to carry out deceptive appraisals).

    Someone in another thread brought up the "low document" loans that were foisted on unsuspecting home buyers back around 2005-7. Seemed too good to be true? Have we as borrowers and lenders learned ANYTHING since then?...

    0Reply
  • Matthew BrillPro Member
    OP
    Investor · Boca Raton, FL · Member since 2015 · 234 posts · 103 votes
    10y

    @Brent Coombs @Cynthia Calhoun @Doug N. @Steve Babiak

    Thank you all for taking your time and for your constructive criticisms.

    I met with the two investors and the banker. The banker is, in fact, a commercial banker and doesn't do any conventional mortgages. He did mention briefly taking the lesser of the appraisal value vs purchase price but then was willing to take it to his underwriter once the units are built and appraised. At the meeting, the investors were also approaching the banker regarding a construction loan for the same project. I received copies of all the documents the banker was given. After, I called a lender I already had an established a relationship with to get his take on the financing and I am waiting to hear back from him. In the mean time I am checking on rental comps and will talk to some people at my local REAI regarding some of the above topics.

    If everything magically turns out to be accurate, I am still curious as to if you think the likely negative monthly cash flow is worth the equity. The "deal" seems to go against what is in my mind as a buy and hold investment as there will not be passive income. Are the risks of losing money every month (again, assuming the numbers are accurate) worth the potential equity? If not, then trusting these people is a moot point.

    Thanks again, I really appreciate it. 

    0Reply
  • Doug N.
    Lynnwood, WA · Member since 2015 · 221 posts · 157 votes
    10y
    Originally posted by @Matthew Brill:

    @Brent Coombs @Cynthia Calhoun @Doug N. @Steve Babiak

    (...)

    The "deal" seems to go against what is in my mind as a buy and hold investment... 

    Matthew - 

    If this deal is going against your thinking, I have to ask the (obvious?) question:

    Why are you thinking about it?

    0Reply
  • Matthew BrillPro Member
    OP
    Investor · Boca Raton, FL · Member since 2015 · 234 posts · 103 votes
    10y
    Originally posted by @Doug N.:
    Originally posted by @Matthew Brill:

    @Brent Coombs @Cynthia Calhoun @Doug N. @Steve Babiak

    (...)

    The "deal" seems to go against what is in my mind as a buy and hold investment... 

    Matthew - 

    If this deal is going against your thinking, I have to ask the (obvious?) question:

    Why are you thinking about it?

     Point well taken. And that's why I brought the question to the forums. I don't fancy myself a wholesaler and, although it wouldn't be a wholesale deal, I would essentially be acquiring it at wholesale to sell at retail if it is not bringing passive income. I am trying to decipher if the monthly loss is worth the equity and resale gain. 

    0Reply
  • Doug N.
    Lynnwood, WA · Member since 2015 · 221 posts · 157 votes
    10y
    Originally posted by @Matthew Brill:

     Mathhew - That's a great way to deconstruct this!

    The monthly loss is engraved in stone. 

    The equity gain is speculative (and should not be in any serious analysis).

    The resale amount is unknown to anyone.

    Would you advise your sweet grandmother to invest her pension in this scenario?

    If not her, then why you?

    PS: Edit: I was thinking of appreciation, not equity, in stating it's speculative. My mistake. However, equity is also not a given, as a) you are flowing negatively each month, and b) your appraisal is not your own. 

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    10y

    Negative cash flow means you are subsidizing a tenant to live in a property - that is something the government already does enough of (think Section 8), so why should you want to do that?

    The only way that might make sense is if the property value goes up at a rate that equals or exceeds the absolute value of the negative cash flow (I.e. It breaks even overall) - but investing for appreciation is somewhat speculating. 

    0Reply
  • Joel Gabelman
    Cleveland, OH · Member since 2012 · 28 posts · 22 votes
    10y

    I've spend almost 12 years in finance, more than 9 in commercial lending at the big boys: US Bank and JPMorgan Chase. There are A LOT of "bankers" who are clueless and hungry for deals (commission), but they have $0.00 credit authority to approve (usually). You should actually ASK how the credit approval works for this deal. Since is relatively small, MAYBE they (branch) can approve instead of submitting it to credit. Regardless of a big bank or small bank (I've worked at both), 90% of time, it's credit administration that has the ultimate say, not the sales guy (lender/RM, whatever). If this is a small community bank and starving for investor loans in CRE with 86% leverage, you've found a pot o'gold.

    Based on your numbers, purchase price is $137,750 and expected value is $160,000.  This is an 86% LTC (Loan-To-Cost).  I don't know of a single bank doing 14% equity down.  On an investment property, we'd look for 25% down, sometimes 20%.  Additionally, like you touched upon, banks will look at the lesser of sales price or appraised value.  So in your scenario, if the builder is really going to give you a "steal" at $137,750, the loan will be based on this figure.  Finally, most all lenders for "A-money" (best pricing at the banks vs. private money), will require a personal guarantee, and tertiary repayment support.  Primary: tenants rent; Secondary: Collateral; Tertiary: personal cash flow.

    Other questions/thoughts that jump out to me:

    1) Why is the builder giving you such a great deal???  If YOU could get $!60k for a home, would you take $137,750???  For starters, this sounds TOO GOOD TO BE TRUE.

    2) Research the builder - what else have they done?  Depending on where you live, they likely will need a C.O.O (Certificate of Occupancy).  I'd make sure to see this that the city says the places are good to go.

    3) If comps support value, and all the above rings true, I'd STILL be cautious.  Maybe run it by a local guy for good measure.  

    There are other concerns, but the biggest one is why is the builder giving you such good deal? I'd be VERY surprised if the Bank will finance based on appraised value vs purchase price too. I have a HUD home near me needing around $40k-50k of work. Purchase is $40k, and it should appraise based on comps for around $90-$100k. If your lender will go off APPRAISED value, I'd love to talk to them!

    Best of luck - be careful.

    -Joel

    4Reply
  • Joel Rodriguez
    Computer Programmer & Real Estate Agent · Miami, FL · Member since 2015 · 63 posts · 17 votes
    10y

    Hey Matthew, I recommend as many other here, that you stick to the facts. Find you ways to verify all the information, I am pretty sure after a solid research it should vary a litter.

    Nevertheless, having said that, assuming the numbers are right I'll still be interested in the deal, but, I'll try by any means to make it cash flow positively. I am thinking in a couple of approaches: 

    - Negotiate the price, (Nothing to lose) 

    - As it is you first buy and hold deal I would consider self PM. (Labor the cash flow)

    - As the deal is not requiring any down payment, and it seems to be putting about 20K in your pocket right away, I would analyse the deal more optimistically, IF and only  IF you have some money to risk, (bet, support losses, education expenditure), what ever you want to call it.

    Take care!

    0Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    10y

    @Matthew Brill  I am late to this party ... however one of my little pet peeves is the marketing of instant or built in equity from sellers of properties... I find that this is just not the case.. the value is the value you pay not some phantom value that is derived by comps or even an appraisal.. if the true market value and the true open market would allow the builder to sell for 10 to 20% higher then that's what they would do  .  end of that discussion.

    So you need to figure out what your paying for them is a fair price in your mind..

    I am a builder and I sell for Market value.. if I have a home that is worth 400k I sell it for 400k not 375k and GIVE my buyer 25k of free equity...

    Doe that make sense. ?

    just look at the deal on the merits of what your paying for it. pre 08 it was common to use a HML to put you into title and then refi you out so you had no money in the deal.. I did literally thousands of those for my clients in CA. But this is not pre 08 anymore.

    Willing buyer willing seller = Market value  its RE 101

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    4Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y

    @Joel Rodriguez, if the "numbers were right", there is NO WAY that these builders would be settling for 86% of its REAL value, when 100% was ACTUALLY available. In short, the numbers are NOT right! 

    These builders are gambling that they can find someone to believe that their retail price is actually a wholesale price, but that is no reason to recommend that @Matthew Brill become a gambler too.

    Oh, I just saw the above post from Jay. Yes, what Jay said!

    1Reply
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