Purchase analysis: What do you think of this deal?

25 Replies

Hi,
I want to run some numbers by you, and see if my purchase would make sense.

I live in NYC so I`m trying to be creative with my approach. I will be managing this property on my own, and do fixes on my own.

Here you go:

This is a 2-family house (frame) with unfinished basement with 3 garages. Listing price $799K
- first floor (2 bedrooms)
- second floor (2 bedrooms, with enough space that I can add an extra bedroom, so I eventually I would have 3 bedrooms)

Expenses:

- Mortgage $3,643 a month (10% down-payment with 4.5% on a loan)
- Taxes $425 a month
- Insurance: $160 a month
- W&S: $160 a month
- Heat: $140 a month
- CapEx: $54 (2%)
- Vacancy: 54 (2%)
Total expenses: $4,636

Income:
1st Floor apt - $1800
2nd Floor apt - $2000 (because of the 3 bedrooms)
Basement – $900 (after I finish it)
Garage #1- 200
Garage #2- 200
Garage #3- 200
Total income: $5300

Does this make sense to you? Am I missing something? Should I add more to expenses, especially for CapEx and vacancy?

Love to hear your thoughts.
Thanks!

Krystof, I would 100% add more to the expenses. If you did 8% for CapEx that brings you to $216. I'm still learning myself, but 2% seems way too low along with the vacancy.

Hi @Matthew Gangi,

Thanks a lot! Let me revise those numbers and see what I get.

Kris

Hey @Krystof Pilisiewicz ! Seems like your expenses are deff low. I'm still trying to learn analysis myself and hopefully somebody will correct me if I'm wrong. What about property management (usually around 10%) also smaller repairs in addition to cap ex. 5-10%? Could make a huge difference in your numbers.

Howdy @Krystof Pilisiewicz

Your analysis is way too optimistic going into the deal.  The safest thing to do is be very conservative initially.  Use 2 "Rules of thumb " to start with. 

 The 1% rule says the total monthly income needs to be 1% of the purchase price.  Even with your optimistic rent rates you do not meet this one ($799,000 * .01 = $7,990).  Your $5,300 is not even close.  The purchase price is way to high.

The 50% rule says to use 50% of your total monthly income for expenses.  Expenses do not include mortgage payment.  Therefore, your expenses would be $5,300 * .5 = $2,650. Not $933.  Use the conservative expense numbers until you can verify all existing expense amounts.  Then you make adjustments (up or down).

What is the current rent for each unit (including 3 garages)?  That is what you need to base your initial income analysis on (not future hypothetical income).  Yes, you can still evaluate the possibility of future income increases,  You still need to analyze on current conditions.

As far as your expenses go they are extremely low.  As @Matthew Gangi suggested your CapEx and Vacancy rates should be closer to 10%. CapEx will depend on the age and condition of the property. You will need to have an inspection done to identify any problem areas and condition of major systems (Electric, gas, plumbing, HVAC, etc.). You will be able to estimate the usable life of those systems and determine when they will need replacing/upgrading. That will give you the amount you need to accumulate in your CapEx reserves. Then divide it by the total number of months (i.e. 6 years or 72 months). Now you know how much to hold out for CapEx each month. Additionally, you mentioned adding a 3rd bedroom and finishing the basement. If you do not complete these additions when you first purchase the property (during a Rehab phase), then, it will need to be included in your CapEx calculations.

You also need to include an expense item for repair/maintenance which can be 5 - 10% of your monthly income.  You should also include Property Management in your expenses (10%). Even though you plan to self manage (your time is worth something, right?) you may decide later that you need a PM.  Most investors will be including it in their Cash Flow analysis of your property if you ever decide to sell.

There are other miscellaneous expenses to consider (Lawn care/snow removal, pest control, legal, accounting, marketing, etc). I use 5% to cover these.

The last thing is where are you getting a loan with a 10% down payment and at 4.5% APR?

Hope this helps.  :)

Hi @John Leavelle,

Thanks so much for your reply. It makes sense to me.

A couple of questions for you:

- If I go with 10% for CapEx and Vacancy that would mean that nearly after 10 months I would expect someone to move out. I think we can minimize this by renting the place to a family, rather than an unmarried couple. I mean you can try to do things to reduce this aspect. As far as CapEx if you buy property in good shape, meaning new or right after the renovation that could be minimized as well. I think my assumption 2% is too small (and thanks, everyone to point this out for me) but 10% it might be too high. Regardless, the point is taken!

Also, I think a lot depends on the market, so we need to consider this too. If I go with the 1% rules, that means I would never buy anything in NYC or high priced markets. Does this mean I should not look into this market? I think I have to bend the rule a bit, take some risk and see how I can make this work.

I love your idea that I need to put aside some money for PM. I mentioned that I want to do the work myself, but the idea is that eventually, someone else will be doing this.

For the loan numbers, I was thinking to get FHA with 10% downpayment. When I spoke with my banker, she said the rates are: 3.5% mortgage + 1% loan insurance till you reach that 20% pay off for the house. Eventually, I would take out a conventional loan so I can use an FHA to buy another property

I`m just starting on this adventure, but it seems you are very knowledgeable. I truly appreciate your reply.


Kris

This is not a good deal. If you can get this to cash flow it will only because you have taken on the job of property manager. Do you want a job or an investment?

This is a terrible deal.  If you want deals like that, you will have hundreds of people willing to sell you deals, but you will go broke on them quick.

@Krystof Pilisiewicz

Do not rent to family unless you are willing to evict them.  Most people are not willing do this so in the end you will get taken advantage of and lose money. 

Always include at pm cost of 10% whether its for you or the pm. Vacancy and Capex needs to be at the 10% range. Make sure you have good numbers for utility cost as this can break you.

I bet the 2% rule wont work for your area as it doesn't for most of the country but try it at 1% instead.  50% rule is a better guide to follow.    Run your numbers thru the BP calculator. 

Typically you want to profit $100 min per door otherwise its not worth it.  Without crunching numbers this looks bad...

@Jim Adrian

Thanks so much for you advise. I will take all those advices into consideration. I might be naïve at this point, but I`m glad I can get advice from someone like you.

Rock on!

Kris

Looks like anything I would say, has already been said. You are correct, some rules have to be broken in a higher market like yours because you can make it possible. But not on properties like this. Your numbers in the initial breakdown are way too low and will drive you broke quick! And I agree with everyone here about renting to the family. It is NOT a good idea. I have already learned that the hard way in life, and luckily it wasn't something major. 

Bashing your deal aside, good luck in finding a great deal!

@Jeff Filali

Why do you think this deal is terrible? Can you give me some rational behind your thinking?

I noticed that people mostly say that I should go with 10% CapEx or Vacancy. I'm not sure if I agree with this, but now I know that 2% was too low.
Here is my thinking: If I`m planning to collect rent around $5,300 a month and go with 10% for CapEx that would mean I would have to put away $6,360 per year on this type of expense. I don`t know what would cost so much money on a yearly basis for a 2-family house? Some examples: a hot water boiler cost $800 (it last for about 10 years) A new roof can be replaced for 4K-5K, and it can last for 20 years. Would I be changing windows each year ($250 per window with installation) in the entire house? And what if the house was just built?

To demonstrate that going by % numbers, might not always work, let me give you an example:
-I own a house that is worth $850K. I pay $5,300 in yearly taxes. That is way below 1% of the value of the home. Do others pay way below 1% for their taxes as well? My house insurance is 1,300 a year for a home that is worth so much? Where is the logic behind %?

If we go with the reasoning that all houses in all the markets should use the same % rule, why they cost differently, and what is the point of buying anything in NYC or SF?

I would love to hear your opinion.

Cheers!

Hi @Tim Vecchioni,

Thanks for your reply.

Why do you think a family is a bad idea for tenants? I think just the opposite. I think a family will stay longer, and if you do a proper screening, you can find a great family that will remain years in your property paying rent on time.

The 1% rule is based on your monthly income, not your yearly taxes. So at $5,300, you would want to find a home more in the $500k range. Also, your Cap Ex does not need to be 10% because like you mentioned, what if it is a brand new house? Then sure, you could account for 2% there. However, I have found 5% is a good number for vacancy. Let's look at the numbers on that. 5% of $5,300 is $265 x 12 = $3,180. So if one of your units say worst case the 2nd floor that you have listed at $2k a month is vacant. You would be covered for a month and a half. To me, this is just good practice. The Cap Ex on the other hand really is what you feel after an inspection of all the possible major repairs will likely be. An older home should account for 10%, maybe even more. A brand new house, you could get away with the 2%, but long term, I would look to change that as things start to wear. Hope this helps!

Originally posted by @Krystof Pilisiewicz :

Hi @Tim Vecchioni,

Thanks for your reply.

Why do you think a family is a bad idea for tenants? I think just the opposite. I think a family will stay longer, and if you do a proper screening, you can find a great family that will remain years in your property paying rent on time.

 As stated above, if the family is renting, that means they can't afford to buy or there is a reason they aren't buying. The risk we take with any tenant for that matter. Not saying this would happen to you, but like myself, it has happened and you feel TERRIBLE when it comes time to take action with it. No one wants to start controversy in the first place, let alone with family. 

OP - those 1% or 2% rule only work for locations that you need help to find on maps.... not for NY or SF....

In my experience, with A location, you need to prepare to carry the property at a loss for 3-5 years, before it turns positive with rent increase....

So depend on the location... the better the location, the bigger the upfront loss....

That said, your income projection is assuming the absolute best case scenario

Expenses are crazy optimistic.
Cost of debt is way too high for the return
You don't have cost of PM included.
Cash on cash return is abysmal.

No upside to this deal other than hope. 

@ Diane G.,

Aha! So those 1%- 2% rules not always make sense. and pretty much any rule to that fact. You need to know the market and use a common sense based on a mixture of experience, knowledge (books, BP) and some luck. SO because I don`t want to put 10% on vacancy doesn`t mean this is a terrible deal.

What @Tim Vecchioni said, 5%, make more sense to me.

Tim, to add to your comment about 'that means they can't afford to buy or there is a reason they aren't buying' I would try not judge people because many factors come into play why they act in a certain way. I have tenants that between a wife and a husband they make $140K per year. The husband doesn`t have a checking account, yet he makes 80K per year. He pays cash every month to me. It doesn`t make sense to me why he doesn`t have a checking account, but who am I to judge him?

Some people don`t realize they can do things, like buying a house and if you live in an area with houses for sale for 800K-1 million for a 2 family house I can`t judge them. It can be a scary thought.

 

First, not sure you can get a loan with 10% down on an investment property unless you are planning to house hack the first year. Maybe you have a lender you can use, but most will require 25% down for residential houses. Perhaps 20%. 4.5% is optimistic as well. But I'll go with it. I used the BP Rental calculator and just plugged in numbers:

According to this, you'll lose money the first year. By year 10, assuming 1% increase in all costs except mortgage, you'll make $3,786 for the year. I don't know about you, but if I am going to have $80,000 invested somewhere, and I have to do the PM on it, I want to make more than a 4.5% return on my money.

I used a repair budget of 5%, a vacancy rate of 5% and a CapEx of 5%. Your results may vary.

I'm not familiar with the New York marketplace. But I've heard about the challenges of making money there. And about things like rent control. Are you sure there isn't a better opportunity for your capital a little further away?

@Krystof Pilisiewicz

Don't get confused by the word family.  Don't rent to "blood relative" family.  Do rent to the Joe Blow family that you don't know.   Blood family will want a deal on pricing and late payments etc...  Joe Blow will respect you as there in no emotional connection.   You wont feel bad when you need to enforce the lease etc.

Thanks @Jim Adrian. That is good advice!

@ Ronald Perich,

I was planning to live there for now and get an FHA loan. I think in markets like NYC or SF it`s hard to get cash flow right from the start and that phase might take some time. However, the place I'm interested in has a new roof, heating system, sidings, windows, appliances. I need to finish the basement so I can rent it out, but I think that is it as far as fixes and renovations.

The thing about markets like NYC is that the properties go up in value very fast. Last year my other property went up by 12%. Prediction for this year is 6%, but I think it might be higher. Regardless even if I lose some money and have to put 300$-500$ a month, when I sell it the house after 2 years I will make a good chunk of money. It seems a majority of people are fixed on cash flow, but that is just one aspect of making money in RE.

Thanks for your feedback, Greatly appreciated it!

You're welcome. Please don't get me wrong. You asked if this was a good deal. And since you're living there, it makes a much different calculation. I'm personally not buying for appreciation because I cannot control what people are willing to pay for residential homes. I can control things like expenses much easier, so that's what I bank on. My best to you!

@Krystof Pilisiewicz  The gap between people who like the deal vs don't comes down to adding in appreciation to your total return.  You're trading low cash flow/returns in places like NYC for future appreciation.  That's where the returns come from. 

I'm a lender and can tell you that 3.5% on an FHA loan like this is not going to happen. It will probably be closer to 4% plus the 1% mortgage insurance, so I would use 5% as your rate. Also, the FHA mortgage insurance is for the life of the loan. You'll need to refinance in order to get rid of it.

Hi @Michael J Bensimon,

Thanks for the note. I will start putting 5% as a loan rate in my calculations and see how this effects everything.

Kris

@Krystof Pilisiewicz

As a Brooklyn Investor for the past 2 DECADES, I will say that a lot of the Cashflow Rules DO NOT APPLY to high quality markets like Brooklyn, NY.

If you are buying a $2 Million Dollar Investment, which is what I now do, putting aside 5% for CAPEX = $2 Million x .05 = $100k PER YEAR...... that's just ridiculous! I'm sorry, but we need to think about the Math. And NO... a toilet in NYC is still about the same exact cost as a toilet in Detroit. Labor costs might be higher, but toilet replacements happen just as rarely if not more rarely because of better quality tenants than in lower quality neighborhoods. In fact, there are some BP Podcasts that mentioned how incorrect making an assumption on CapEx like this is just not correct for higher priced Investments in Major Metropolitan neighborhoods.

Some costs might be higher, but then some costs will be much cheaper.

For instance, it's very typical that one of my $2 Million Investments have Property Taxes that are SUB $10k. So, using the same percentage, a $200k Property would need to have a $1k Property Tax and a $100k property would have an equivalent $500 PER YEAR Property Tax! So, tell me where you will find this kind of advantage and still have very LOW vacancy rates and LOW Crime?

In terms of Vacancy Rates, these Rates are a Factor of Market Rents when it comes to high quality markets. When we have vacancy rates below 5% (which has happened for the past 40 years in NYC), as long as you are slightly UNDER Market Rents, Vacancy generally does not play a factor in this expense.

An example would be an Apartment in NYC which normally rents for $5k per month. Advertise it for $2.5k and you will get an ENDLESS amount of responses... literally thousands of replies!!

How do I know this? I do my own ads. Once I incorrectly advertised a $2k apt for $1k  My inbox exploded, I immediately checked the Ad and discovered the mistake. It took me only an hour to make the corrections but I had to call the 20 or so responses that inquired about the apt.

Once I put back the apt to the $2k slightly below Market Rent, it slowed down and I generally receive around 10 to 20 replies per week. From that, I take the best candidate, usually with a 700+ Credit Scores (and I will get some 800+ Credit Scores) and incomes typically far above my minimum of 45 x monthly rent.

The last re-rental I had done which was a month ago was a Veterinarian and his Corporate Lawyer Girl friend, combined income was $350k+ for a $3k apt.

An assumption that if you are not making a Cashflow DOES NOT mean you are somehow losing! There are at least 4 ways to make money in Real Estate of which Cashflow is just one! You are missing Appreciation, Tax Savings and Mortgage Balance reduction. In high Quality Markets, over time, you will get all 4 of these.

If you wind up taking a $1 Million 30 year fixed rate Mortgage where the Cashflow breaks even... and let's say the Cashflow breaks even for the next 30 years, and let's hypothetically say that the Investment NEVER appreciates.

Given these assumptions, ZERO Cashflow and ZERO appreciation, in 30 years that $1 Million Mortgage disappears. 30 years from now you will be $1 Million richer. The Math tells me that $1 Million / 30 years = $33,333 per Year. Divide that by 12 for the monthly and you get $2,778 per month in Equity Growth. This is the power of Mortgage Balance reduction. Why are most Investors I see on BP not even considering this? It's PURE MATH and PURELY PREDICTABLE! You cannot go wrong with the Amortized Mortgage of a Fixed Rate Mortgage. If you even want to do a 15 year Mortgage, even better, especially if the Cashflow breaks even!

What's missing in most Investors toolbox is the understanding of Future Calculations and therefore cannot see how money is made OTHER than current cashflowing properties.

Then, when they get some rules which are NOT for high quality markets, they apply these rules towards high quality markets instead of asking themselves, hey... does it makes sense given this scenario?

PLEASE..... don't make the assumption that all rules work for all kinds of markets and properties.

JUST do the appropriate calculation for each property in every market that you wish to analyze. If you only know one kind of calculation, then just stick with that kind of market. But you are severely limiting yourself. I would say learn as many markets as you can and understand sophisticated calculations like Internal Rates of Return (IRR) and then apply them appropriately.

While I'm not going to recommend that the OP buy this property, I will say that I don't know enough to do all the appropriate calculations because I don't know what would be an appropriate Rents/Expenses/Appreciation Growth Rate for the next 10 years in order for me to get the Internal Rate of Return (IRR) for this property and compare it to other properties that I know will Return at least 10% to 12% per year IRR.

BTW, a 10% IRR is a compounded Rate of Return per year. If you were to compare a 10% IRR with a 10% Cash on Cash Return (CoCR), the 10% IRR is hands down much better. You just have to know the difference.

Another problem with the "Cashflow NOW" crowd is that they cannot understand that your Cashflow now can also become NEGATIVE, which has happened to millions of Cashflowing Investments during the Financial Crisis of 2007-8. MILLIONS! But somehow you think there is NO RISK to your cashflow EVER going negative? PLEASE THINK TWICE!

I'm hoping that there are others who read this post that may wish to delve further into the world of sophisticated Financial calculations and open their minds to recognize other opportunities.

Investor Llew

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here