I think I made a mistake...should I back out and lose $1700?

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I think I made a mistake...should I back out and lose $1700?

Emily Allred
Aurora, CO · Member since 2017 · 5 posts · 3 votes

We are newbies.  Like typical newbies, we're stupid.  We're about 3 months and 1.5 properties into this biz, and realizing just how inexperienced we are.  I just stumbled across biggerpockets (which is amazing!!!), and am realizing that we are locked in to buy a house that, by no definition, is a "good deal."  I mean, it's a fine deal.  If i were buying it to live in, I'd be totally pleased.  But for rental income, I now realize it's not that great of a deal.  We're set to pay $132,000 for a house that's going to rent at $975, and appraised at $135,000 (original asking price was $160,000...which is part of why we THOUGHT it was a good deal)      

In a crazy turn of events, our LLC partners just backed out of our newly-formed LLC last night. Techinically, we can still afford to buy this property. But not without much belt-cinching. So my question is this--should we back out while we can? We'd lose the $1000 earnest money, plus the $700 we've paid for appraisal and inspection. The realtor says that's all we'd lose.

Our lawyer says it's up to us.  Now that I realize that this house isn't an amazing deal, I'm thinking we should back out, and wait for something better.  But losing $1700 sounds painful. And interest rates are going up, we're locked at 4.25%, which some peeps predict is the lowest it'll be for a long while.  What should we do?!?!?!

Any thoughts/suggestions/advice would be greatly appreciated!

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Jonna WeberPro Member
Moderator
Investor · Boise, ID · Member since 2011 · 1k+ posts · 736 votes
9y

@Emily Allred -  There is no right answer here, but in the $130s in Boise right now is pretty rare.  I have several buyers that would probably pick up where you left off if you walk.  Did you make the offer assignable by chance?  Have you already signed off on inspection?  If not, there is an opportunity to renegotiate at that point as well.  Overall, Boise is facing an inventory shortage and you could possibly also be in a position to put a little sweat equity into it and sell in Summer if needed.  No guarantees, but homes in Ada County under $200k are flying off the shelf.  If it is in neighboring Canyon County...numbers are different.  

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  • Account Closed
    Investor · Charlotte, NC · Member since 2016 · 374 posts · 189 votes
    9y

    What is your monthly PITI? How much do you make W2 income?

    0Reply
  • Adam Drummond
    Investor · Greenville, SC · Member since 2013 · 252 posts · 92 votes
    9y

    @emily 

    @Emily Allred

    Each market is different.  In upstate SC where i live... those numbers do not work for me at all.  Figure out what your monthly mortgage payment is including taxes /insurance.  Also include repair costs to set aside every month, and also management fees.  I just plugged numbers into a mortg calculator:  mortgage of $110k at 4.25% for 15 years $827 per month, and for 30 years is $541.  If you include $2k per year for taxes and ins combined then you're adding another $170 per month.  I would not want to buy this as a rental.

    0Reply
  • Emily Allred
    OP
    Aurora, CO · Member since 2017 · 5 posts · 3 votes
    9y

    PITI is $825, W2 income greater than $150,000 on average

    0Reply
  • Shaun Sullivan
    Keedysville, MD · Member since 2017 · 24 posts · 10 votes
    9y

    Not sure if there's a separate moral issue, but if it's purely a financial decision, I'd rerun the numbers excluding the $1700.  That's a sunken cost.  You're not getting it back either way.  So decide whether it's worth purchasing with the remaining expenses and cash flow involved.  You might also consider the fact that the your remaining time commitment to get this deal done is less than you'd spend starting on another from scratch... so how much is the time savings worth to you.

    3Reply
  • Account Closed
    Investor · Charlotte, NC · Member since 2016 · 374 posts · 189 votes
    9y

    Not a good deal IMO.  If you could get depreciation and it was rent ready, I would consider it.  But you are subject to the AMT.

    0Reply
  • Emily Allred
    OP
    Aurora, CO · Member since 2017 · 5 posts · 3 votes
    9y

    Mark, i'm interested in what you said.  What makes you say that we're subject to the AMT? My hsuband thinks that we aren't, but like i said--we're newbies!  The house is rent-ready, and our CPA says that we could get depreciation, if that helps.  Thank you everyone, for your responses already!! Such a great resource!!

    0Reply
  • Jimmy Cantave
    Miami, FL · Member since 2015 · 154 posts · 38 votes
    9y

    @Emily Allred if I were you I would run for dear life 😂😂😂😂 run as fast as you can! And don't look back...

    Look for a realtor/investor/wholesaler that can  help you analyze a deal.

    0Reply
  • Michael Wagner
    Specialist · Victor, NY · Member since 2013 · 823 posts · 844 votes
    9y

    $1700 is a cheap education compared to what folks pay for a year at college these days!  I dont know your market but unless that property has the potential to be worth a whole lot more within a year or two...like $30-50K more, I'm not sure I would want to own it.  Your cash flow will be minimal or non-existent for as long as you have a mortgage.  Even if you do get your depreciation, you are talking about a couple thousand per year in tax savings.  Remember that those savings are nothing more than an interest free loan from the government.  You ultimately pay that money back when you sell the house through what is known as recapturing depreciation. Its not a reason to buy a house in my eyes. Just my two cents!

    2Reply
  • Account Closed
    Investor · Charlotte, NC · Member since 2016 · 374 posts · 189 votes
    9y

    Do some research on depreciation income limits and the AMT.  If you are going to be successful in the business, you need to know the accounting and IRS side as well.  Pray Trump is successful in repealing the AMT.

    Depreciation

    http://www.bankrate.com/finance/taxes/earnings-too...

    AMT

    http://www.bankrate.com/finance/taxes/alternative-...

    1Reply
  • Andy WebbPro Member
    Rental Property Investor · Carrollton, TX · Member since 2013 · 750 posts · 538 votes
    9y

    If you do walk, just consider it cost of doing business - we have walked twice now from hard earnest money deposits with wholesalers when our due diligence uncovered major issues.  Expense it at tax time.

    2Reply
  • Shaun Sullivan
    Keedysville, MD · Member since 2017 · 24 posts · 10 votes
    9y

    After all the other expenses, you'd likely have negative cash flow, so the only way it could be considered a decent investment is if you're expecting some really good appreciation, which depends on that specific market.  As other people on here have said, that's speculation and more risky.  Even with appreciation, unless it's gonna be about the hottest market in the country, you're still looking at a rent/price ratio of around 0.7%... most places with decent expected appreciation should still be closer to 1%.

    0Reply
  • Adam Michael
    Investor · Providence, RI · Member since 2016 · 30 posts · 9 votes
    9y

    @Emily Allred 

    There seems to be a very simple piece of advice that doesn't get mentioned on here often enough when people ask questions doubting their purchases/deals. If you can't sleep comfortably at night when making a deal then walk away. My parents gave me that advice when I got started in real estate and constantly remind me. They invested in real estate at young age and have years of experience. Anyone can "analyze numbers" and say it's a "good deal or not." If you're not comfortable then walk away. Losing $1700 is much better than being on the hook for $132k.

    1Reply
  • Ronald Wilson
    Palm Bay , FL · Member since 2016 · 14 posts · 4 votes
    9y

    Zero based thinking... knowing what you do now. .. would you be doing the deal had you this current information then.  It is true that the 1700 is spent. . But good money after bad is not a good process, and you know just on lose numbers that it will be a boarder line model at best.  Is that what you want and can afford to do with your early investment money? Think about the numbers without the emotional attachment to your earnest... is this a deal? Even if your partners had stayed, the numbers would not be any different that i can see. . 

    1Reply
  • Sam Shueh
    Real Estate Agent · Cupertino, CA · Member since 2016 · 4k+ posts · 1k+ votes
    9y

    If the conventional wisdom tells you do not do it. I will walk out of a deal that I do not think it is meant for me.

    I have buyers walk out a deal for similar reason and lost $37.5K in deposit. The seller was patient and gave additional two weeks for the loan approval. Loan was approved but he wanted the bank to lower to a lower interest rate. He released all contingiencies and asked for a $37.5K loss.

    0Reply
  • Jonathan PfluegerPro Member
    Ben Lomond, CA · Member since 2016 · 338 posts · 337 votes
    9y

    @Emily Allred

    There is always the chance the sellers will give back your $1,000 in earnest money. If you do decide to walk, write the seller a letter describing your situation and ask if they will refund your money. Worst case scenario they say no and you are still out what you already anticipated. 

    When I was looking for my first primary residence I was in a similar situation and the seller refunded my deposit after I wrote them a letter. 

    Best of luck Emily. 

    3Reply
  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    9y

    @Emily Allred  chump change  try walking from 80k like I did on one development that did not pan out..  1,700 blip not worth discussing

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    3Reply
  • Sam B.
    Investor · Indianapolis, IN · Member since 2015 · 270 posts · 217 votes
    9y

    Google "sunk cost fallacy"

    1Reply
  • Derrick Ward
    Investor · Raleigh, NC · Member since 2016 · 54 posts · 21 votes
    9y

    @Emily Allred Emily, I have an idea. Try renegotiating the sales price with the sellers. Let them know that your partners backed out on the deal, but you are still willing to purchase the property. Offer them a lower number, say for example $99,500.00. All they can do is say "Yes" or "No".  Like I have heard it say many times on BP, "If the offer doesn't make you uncomfortable asking it, then you might be offering too much, from an investor stand point".

    2Reply
  • Emily Allred
    OP
    Aurora, CO · Member since 2017 · 5 posts · 3 votes
    9y

    This property is in the Boise area.  From the 30+ homes we've looked at, not a single one meets that 1% rule, not even close.  In fact, this one is the cheapest house/sq ft that we've seen.  So, i'm hearing what you're all saying, and seeing that you're all on the same page.  But not sure how to apply your wisdom to my situation in Boise.  Nothing in the $130,000 price range is renting for anywhere near $1300/month.  And we're committed to the Boise area, that's one factor that isn't flexible.  

    Thank you all, for your time and generousity in sharing what you've learned!!

    0Reply
  • Sam Newell
    Real Estate Agent · Lehi, UT · Member since 2016 · 136 posts · 91 votes
    9y

    @Emily Allred, @Derrick Ward gave you some fantastic advice, sometimes sellers will come down rather than lose a deal. Even just a few thousand would be a win for you.

     I'm from the Boise area and currently sell investment properties in both Boise and Salt Lake City.  Based on your projected rents and purchase price it looks like your cap rate is around 5.6% which is actually about market average for Idaho and Utah.  The 1% rule does not work in a lot of strong markets at all.  The 1% rules equals a 7.8% cap rate and those types of cap rates haven't been available since 2011 in our areas.

    If you need cash flow from your investment then maybe you need to look for at least a 6% cap rate property.  Here's the thing, you will need to buy a 6.2% cap rate to make about $100 more per month than your current purchase, that would take 17 months to make up the lost earnest money and appraisal money.  Plus a 6.2% cap is going to be hard to find And interest rates are going up so you even if you do find a better cap rate your increased cash flow might be wiped out by a higher mortgage payment from a interest rate hike.

    The Boise market is hot and appreciating, unless the property needs a ton of work I would probably elect to keep it and enjoy the lower interest rate and let it appreciate.

    Unless you're confident that you can immediately find a 6% cap or better and lock in a similar interest rate I would not throw the deal away.  Personally I won't buy less than a 6% cap but $1700 will take a long time to make up when you can maybe get a way with selling it in a year or so for a profit. 

    I don't know all the details but that's my 2 cents. Good luck!!

    6Reply
  • Mike Hanneman
    Investor · Coeur d'Alene, ID · Member since 2016 · 551 posts · 218 votes
    9y

    I too, would first tell the sellers that after running my numbers the property will not work for me at this price. Show them your numbers and the price that the property will make those numbers work. Then ask for that price. Be sure to tell them that the earnest money is theirs either way, (it's only a $1000).

    Don't bring up anything about your partners leaving or any sob stories, be straight and to the point, as this will be a hindurance for the seller.

    Then be prepared to walk away, this will be a cheap lesson.

    3Reply
  • Shaun Sullivan
    Keedysville, MD · Member since 2017 · 24 posts · 10 votes
    9y

    Quick glance at some listings in Boise, and it does seem appreciation is the play there.  Better than 50% increases since 2012, so not surprising to see rent/price ratios on the lower side.  However, along with that big recent appreciation comes the history of 40%+ value drops from 2007 to 2011... certainly not the biggest drops we saw, but bigger than most of the country.  So again, appreciation is a speculation play.

    You can plug in an appreciation rate projection into a spreadsheet and calculate your IRR with both cashflow & appreciation combined. I think a minimum acceptable IRR when depending on appreciation should be higher than a minimum IRR for huge cashflow areas... to be compensated for the additional risk. If the IRR isn't competitive with other passive investments like peer-to-peer lending, REITs, stock market, etc, then buy & hold real estate might not be the best use of investment dollars in that particular area. Maybe wholesaling/flipping/etc are better strategies there. I'm just starting the learn my own area, so I'm not going to suggest that I know your market well enough to know the answer. Just trying to give you some questions that I'd be asking myself.

    One thing it seems most are agreeing on is that this property will not be a cashflow generator with the current mortgage, so consider that if cashflow is your primary goal.

    If appreciation is your primary goal, need to make an educated guess on where it's going.  Decades into the future it's pretty certain that the value will be higher than today, but if you bought in 2007, here we are 10 years later and the values in a lot of places (including Boise it seems) still haven't gotten back there.  The question is what's your expected hold period, and what's your risk tolerance?

    2Reply
  • Dan Walters
    Real Estate Investor · Boise, ID · Member since 2009 · 62 posts · 27 votes
    9y

    @Emily Allred One question I always ask myself after running numbers on a property is "Would I want 10 of these with the exact same numbers?" It's easy to justify buying just one with a certain projection, especially when new.  This question is a simple way to cut through the clutter of justification and stay true to your criteria and your standards. 

    0Reply
  • Jonna WeberPro Member
    Moderator
    Investor · Boise, ID · Member since 2011 · 1k+ posts · 736 votes
    9y

    @Emily Allred -  There is no right answer here, but in the $130s in Boise right now is pretty rare.  I have several buyers that would probably pick up where you left off if you walk.  Did you make the offer assignable by chance?  Have you already signed off on inspection?  If not, there is an opportunity to renegotiate at that point as well.  Overall, Boise is facing an inventory shortage and you could possibly also be in a position to put a little sweat equity into it and sell in Summer if needed.  No guarantees, but homes in Ada County under $200k are flying off the shelf.  If it is in neighboring Canyon County...numbers are different.  

    208-608-4884Podcast Guest on Show #80
    8Reply
  • Kevin Yeats
    Lender · Fort Pierce, FL · Member since 2009 · 825 posts · 486 votes
    9y

    You have only $1,000 on the line with this decision.  The $700 (appraisal & inspection) is gone whether you move forward with the purchase or walk.  Don't let that $700 factor into your decision.

    0Reply
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