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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  • Joel Rodriguez
    Computer Programmer & Real Estate Agent · Miami, FL · Member since 2015 · 63 posts · 17 votes
    10y
    Originally posted by @Brent Coombs:

    @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!

     Ok, nothing to argue, your piece of advice is really good, for Brent and for me. It just feel like there is no way to find a good deal with low money down,  what would recommend for some like me, or Brent trying to start in the buy and hold business?

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

    Thanks for the great points @Steve Babiak @Joel Gabelman @Joel Rodriguez @Jay Hinrichs @Brent Coombs

    I definitely wouldn't agree to do anything until the appraisals are done, those being by the builders, bank, and one I pay for myself. 

    It's seems to be that the bank won't approve such a loan which makes my decision much easier.  I also thought it was all too good to be true when they suggested it to me initially. They claimed they'll still make 10% (I don't know how after seeing their build costs) and it will allow them to recoup some costs quickly without listing on the market. Also, although I do not have much of an income now, I will be finishing my medical residency in less than a year and my income will increase substantially. They claim this is a reason both they and the banker will want to start a relationship now.  They also have a property management company, who's services they would want me to use. 

    Although they are offering me these 4 units "below market value" there are a lot more in the complex that they are planning on selling at the proposed $160,000. I have come across some people in my local community that know one of these investors and claim his family is well respected from a business sense, although I know that doesn't necessarily mean anything about him personally. I also spoke to another RE investor removed from the situation from my market who thinks the $1320 rent is attainable. 

    Thanks again everyone. I really enjoy the dialogue and it is tremendously helpful.

    0Reply
  • Russ Draper
    Investor · Boston, MA · Member since 2015 · 398 posts · 147 votes
    10y

    Hi Matthew,

    I know I'm after the fact now, but I wanted to chip in the basic answer for anyone in the future that comes across this post:

    1) Don't buy a negative cashflow property, especially for your first investment!  Unless you really know what you are doing or like to gamble on appreciation (don't do this either).

    2) I don't know of any zero money down loans anymore, no matter where you look.  Especially for a new investor.

    3) Everyone lies.  The builder, banker, lawyer, etc.  Expect this, and don't trust what anyone is saying.  The deal is obviously too good to be true, offer what makes sense, not what they want to get!

    1Reply
  • Brent Coombs
    Investor · Cleveland, OH · Member since 2015 · 6k+ posts · 2k+ votes
    10y

    @Matthew Brill, it's not supposed to be easy to find positive cash flow with no/low money down. That's why BP exists; to help us through the maze of mine fields, not so that it is easy, but so that it is do-able - with belief and the right knowledge AND persistence. Cheers...

    0Reply
  • Aaron Mazzrillo
    Investor · Riverside, CA · Member since 2011 · 2k+ posts · 3k+ votes
    10y

    There is an old saying regarding playing poker; when you are not sure who the patsy is at the table, put down your cards, pick up your chips and leave. 

    I have a strong feeling you might want to think about that for a bit.

    1Reply
  • Logan Hicks
    Business Owner/Investor · Millersville, MD · Member since 2015 · 191 posts · 71 votes
    10y

    @Matt

    I want you to think about this long and hard.

    The word "Free".

    You are paying 137,000 for a property THEY SAY is worth 160k.

    One thing you arent even thinking about, HOA. How long do you think itll be before a bunch of side by side duplexes go HOA?

    On top of that, you are LITERALLY carrying the note for the builders. You are their Escape clause.

    They build it, expense it, drop it on trade lines, and they have an immediate buyer, who helps them cash out of the entire venture, paying them a substantial sum per unit, per sqft, and leave you carrying the note. 

    They say they are giving you equity, well thats great.

    Whos gonna pay the -66 dollar balance per unit, per month?

    Thats also assuming you get ideal market rent, and that another builder doesnt build right down the road from you, which happens ALL....THE....TIME.

    Your equity is only good if you can leverage it, and with 137k of 160k, you are at ~85.6%, or in essence, the Equity is worthless. 

    You can leverage it at all, and even if you did, its a net cash negative property set already.

    As for the 1031 Exchange, LOL @ That.

    What RE investor do you think is going to want, much less give you a good deal on an exchange for properties that are cash NEGATIVE?

    They arent doing you a favor, they are taking you for a ride down financial disaster Ln.

    Just an FYI, according to the NAHB, the cost of building the average home is roughly 200k. Thats roughly a 2200-2400 Sqft unit.

    Average duplex ranges from 800-1500 Sqft.

    How big is the space you are buying?

    What is the quality of construction?

    What is the quality of the unit itself? Marble tile? Granite or Quartz Countertops? Brand new appliances?

    Those are important details usually, but on this deal, irrelivant, because most places never qual for the full 150/sqft value in building material costs.

    Average is roughly 110-130 on the mid to high ends, so giving you bene of doubt, thats at best, roughly 143k @ the 130 mark for 1100 sqft realistically.

    What that translates to, is what they are really building it for, in almost all reality, is more likely around 110, or 121,000, and you are paying their mark up, getting a "discount" at 137k per unit, or paying roughly 16k per unit, for 6 units, wipe the slate for them, and allow them to walk.

    Thats also assuming high grade materials, and a high construction quality score, which most likely is around a 5-7 instead of a 9-10.

    TL;DR, 

    they arent your friends bro.

    The hookup would be around the 110-120k range per unit.

    0Reply
  • Justin R.
    Developer · San Diego, CA · Member since 2015 · 1k+ posts · 1k+ votes
    10y
    Matthew Briil Just a note that your $125 per unit per month insurance estimate is wayyyyy high. Different risk factors, yes, but my duplexes and triplexes are between $700-900 per year. That alone should make the properties cash flow neutral with your numbers.
    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    10y
    Originally posted by @Logan Hicks:

    ...

    As for the 1031 Exchange, LOL @ That.

    What RE investor do you think is going to want, much less give you a good deal on an exchange for properties that are cash NEGATIVE?

    ...

    Many good points in the post, but the point  quoted here assumes that in a 1031 exchange that the relinquished property is to be sold to an investor - that would not be required for a 1031 exchange. Owner wanting to do 1031 exchange could get the property (or one unit of the property) vacant and sell to an owner occupant. 

    I agree that you would not want these folks involved with any replacement property acquisition in a 1031 exchange ... for all the reasons already put forth in this thread. 

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

    @Matthew Brill discounting the price by the amount of commission they would pay makes sense. I can agree with that.. and if they get a quick sale and cut their holding costs and pass that on to you I can agree with that... so massage it a little.. it might be better than we are thinking.

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  • Corey Melkonian
    Real Estate Agent · Watertown, MA · Member since 2015 · 366 posts · 77 votes
    10y

    Great read guys, very informative.

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

    Thanks for the advice @Russ Draper

    @Aaron Mazzrillo

    0Reply
  • Logan Hicks
    Business Owner/Investor · Millersville, MD · Member since 2015 · 191 posts · 71 votes
    10y

    Also, for those of you who want to work with builders in the future, always require a COST PLUS contract.

    Make Time an irrelivant factor, and get at least 5 quotes on the time.

    State specifically the man hours will be based on the average of the 5 independant quotes, and add the materials cost to it, plus the margin, which 10-15% is a good margin for them because you are a built in buyer.

    Watch how fast they finish, and how much cheaper your average unit is compared to the average RE investor.

    You'll thank me later.

    0Reply
  • Logan Hicks
    Business Owner/Investor · Millersville, MD · Member since 2015 · 191 posts · 71 votes
    10y

    hey that finally sent lol. A day later XD

    @matthew

    Ask them why the soft cost is listed at 13.5 per lot.

    At 10 lots (which isnt many) thats 135k, which is massive.

    Also, ask them why the lot cost is listed at two separate rates, one at 25 per lot, and then at 17.5 per lot.

    if its a duplex, it should be 25 total.

    If their profit is marked on at a flat fixed, why are they making 35k per physical unit lot when they paid 25k for it?

    Thats 10%+ 40%+ (lot), or per unit cost, 10%+ 10%, or 20% profit per unit.

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

    @Matthew Brill, you said "I'll keep going along with it until something shakes out". But BEWARE of the guilt-trip that will be ever so subtly put on you by them the moment you look to back out, because of all the time (read: grooming) that they have already "invested" in you! 

    PLEASE, don't let their guilt tactic work on you. All the best...

    0Reply
  • Aaron Mazzrillo
    Investor · Riverside, CA · Member since 2011 · 2k+ posts · 3k+ votes
    10y
    Originally posted by @Matthew Brill:

    Hello BP community,

    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

    How many duplexes are they building? If it is a whole tract of them, can't you just picture your For Rent sign out on the front lawn, along with every other pretender investor's sign vying for the one or two potential tenants driving up and down the street? 

    And who says they will appraise for $160K? Their appraiser?

    Their market analysis is $1,320 rent, but there is also a waiting list of 125 people? I don't buy that. Not even for your dollar. If 125 people are standing in line to rent one of my units, guess what the rent is? How about as high as I can get. Also, 125 is such a nice number. Just large enough to get the greed glands pumping full power.

    Your loan is an adjustable rate loan. It is toxic.

    Negative cash flow isn't an investment. It is a loss. You're investing in a loss. Equity is a myth until the escrow check clears the bank. Even if your numbers correct, and I didn't check them, you are getting zero equity. This is 100% a speculative play based on appreciation. Your $22K in pretend equity today will get eaten alive in sales costs and rehab when you go to sell. Have you ever seen a rental property after 5 years of tenants?

    I wouldn't do this deal at my current position and I can easily afford to write a $68 check every month so I definitely cannot green light this for a new investor. Way to many unknowns and pure speculation. All you're seeing is the fluff their selling you; nothing down, free equity, 125 tenants standing in line, brand new building - it just sounds like complete sales pitchy BS to me.

    Learn to be more of a pessimist when it comes to investing your money. You should be making a real profit today. In this business, there is only one truth; buyers are liars and sellers are story tellers and it sounds to me like you're being fed one heck of a fishing story.

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