First deal - 3 units in PA - feedback welcome (show your stuff!)

Real Estate Deal Analysis & Advice
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First deal - 3 units in PA - feedback welcome (show your stuff!)

Steve Lundy
York, PA · Member since 2017 · 5 posts · 0 votes

New guy here. Thanks in advance for any help or guidance you can provide. I am looking to purchase a 2-4 unit MFR as my first foray into real estate investing. My goal is to have a property management company manage the property. I have a realtor, I've been pre-approved for a loan, and I've been watching the MLS.

A 3-unit property became available recently, which intrigued me primarily because of its location (highway accessible, proximity to major city, and proximity to new 500-employee office building).

Projected Purchase price:  $150,000 

Initial costs
Down payment: $37,500
Closing costs: $7,500
Initial renovations: $2,000
$47,000 = Total Initial investment

Monthly rent: $2,025 (total from 3 units)


Expenses

Monthly taxes: $186
Monthly insurance: $63
Monthly utilities: $255 (sewer, water trash)
Monthly management: $203 (10%)
Monthly maintenance: $203 (10%)
Monthly vacancy: $169 (1 month of rent)

$1,078 = Total Monthly Operating Expenses


I am planning on using a HELOC entirely to fund the purchase of this property (down payment, closing costs, initial renovations).

Debt service
Monthly P&I - Primary: $586
Monthly P&I - HELOC: $285

$871 = Total debt repayment

$1,949 = Total Monthly Expenses

My thoughts/questions:

  • In this scenario, the cash flow is next to nothing ($76/month). Is it absolutely silly to do this deal? Any upsides you can see? 
  • If I do the property management myself (increasing cash flow to $279/month), does its outlook improve? I noted in the beginning of the post that the property is in what I perceive to be a great area to keep it rented regularly. 
  • To what extent should I be considering or not considering the debt repayment expenses in my analysis of this purchase? 
  • If for some reason you think I should proceed, how would you envision paying off / paying down the HELOC so that I can free it up for another property's purchase? How to move forward after a purchase like this seems difficult, since all my cash would be tied up.
  • What would need to change for this deal to be worth it (e.g. how much lower would purchase price need to be, or any other ideas)?

As an aside, I have studied various "rules of thumb" and "real estate investment guidelines" calculations, picked some target thresholds, and plugged this deal in. Most thresholds say I'm not meeting the mark, but some do. How to best navigate and prioritize these?

Return on Investment 1.95% Target above 6%
Cap Rate (Net Rental Yield) 7.58% Target above 10%
Gross Rental Yield 16.21% Target above 10%
One Percent Rule 1.35% Target as close to 2% as possible
8 Times Yearly Rent Rule 6.2 Target below 8
15 Year Mortgage Rule $1,321 Target below rent
50% Rule 47% Target above 50%

Interested in any feedback or insights you have! Thank you very much.

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James C.
Rockledge, FL · Member since 2016 · 493 posts · 427 votes
9y

Steve,

At 150K and 100% financed, it's silly, really, really, really silly. Upsides: If and only if you can get it at a price that makes the cash flow worth it. Don't shortcut yourself on property management, you wouldn't manage property for a customer for free. You are correct in considering your debt repayment, paying it back is a required part of having debt. If you proceed, make sure you get your price down to something where you get enough of a profit. I usually consider 10% on my money, and 10% of my money to be "enough", less than that, no deal, more is better. You move forward by buying at reasonable prices relative to cash flow. You are doing 100% financing of your deal, so your price probably has to be 90K to get it to work. Trying for 100% financing (HELOC/Loan) is rough on numbers.

Generally, you should have a spreadsheet where you can plug in values and have the numbers update automatically. Doing a "Goal Seek" operation in Excel can get you to a price that makes sense for your business model. You would set your monthly "profit" and the computer does the math to calculate a purchase price that gives you that monthly "profit".

Keep looking for a deal that fits your model (or change your model).

Good Luck!

Jim

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  • James C.
    Rockledge, FL · Member since 2016 · 493 posts · 427 votes
    9y

    Steve,

    At 150K and 100% financed, it's silly, really, really, really silly. Upsides: If and only if you can get it at a price that makes the cash flow worth it. Don't shortcut yourself on property management, you wouldn't manage property for a customer for free. You are correct in considering your debt repayment, paying it back is a required part of having debt. If you proceed, make sure you get your price down to something where you get enough of a profit. I usually consider 10% on my money, and 10% of my money to be "enough", less than that, no deal, more is better. You move forward by buying at reasonable prices relative to cash flow. You are doing 100% financing of your deal, so your price probably has to be 90K to get it to work. Trying for 100% financing (HELOC/Loan) is rough on numbers.

    Generally, you should have a spreadsheet where you can plug in values and have the numbers update automatically. Doing a "Goal Seek" operation in Excel can get you to a price that makes sense for your business model. You would set your monthly "profit" and the computer does the math to calculate a purchase price that gives you that monthly "profit".

    Keep looking for a deal that fits your model (or change your model).

    Good Luck!

    Jim

    1Reply
  • Harold Leanos
    Buffalo, NY · Member since 2017 · 6 posts · 3 votes
    9y
    James do you have such an excel spread sheet you can share?
    0Reply
  • Steve Lundy
    OP
    York, PA · Member since 2017 · 5 posts · 0 votes
    9y

    @James C., thanks for your response. I do have an Excel spreadsheet I developed which calculates all this for me fairly easily, including a decreasing sale price (in decrements of $10K). The key question I have is how to analyze the numbers, and is cash flow truly the only metric I should be paying attention to.

    When you say "10% on your money", do you mean ROI? (which I define as annual cash / total initial investment; in this case it is a paltry $916/$47,000 = 1.9%)

    As I showed in my table above, there are all kinds of metrics for analyzing a property. The issue does come down to financing and how that impacts analysis of a property. If I did have a large wad of cash sitting around, this property would look like a much better investment, even at $150K purchase price - the monthly cash flow would be around $950, ROI around 7.5%. Perhaps not the greatest deal though, since the cap rate would still be less than 8% and the "One percent rule" is at 1.35%.

    This is what it boils down to - for someone like me, who is investing with a bank loan for the purchase price and a HELOC to cover the closing costs, I feel I only have 2 options:

    1) Find a property that is such a "steal" that the cash flow numbers work. I've been monitoring the market for months and nothing in my entire county seems to come even close. Even if I do end up finding one, I'll definitely wonder "what am I missing?" about the condition of the property, if it truly is this much of a "steal", and likely hesitate to pull the trigger. 

    2) Take a risk on a property in the city near me (cheap prices, high turnover, poor schools, low income), which is not a great city for real estate, that I can buy entirely using my HELOC. My realtor (who has a bunch of properties of his own) recommended against buying anything in the city.

    Any ideas for other options besides these to get started?

    Thanks!

    0Reply
  • James C.
    Rockledge, FL · Member since 2016 · 493 posts · 427 votes
    9y

    @Harold Leanos

    Try this: https://www.biggerpockets.com/files/user/JamesC243...

    It's very basic, but you should get the idea.

    Good Luck,

    Jim

    1Reply
  • James C.
    Rockledge, FL · Member since 2016 · 493 posts · 427 votes
    9y
    Originally posted by @Steve Lundy:

    @James C., thanks for your response. I do have an Excel spreadsheet I developed which calculates all this for me fairly easily, including a decreasing sale price (in decrements of $10K). The key question I have is how to analyze the numbers, and is cash flow truly the only metric I should be paying attention to.

    When you say "10% on your money", do you mean ROI? (which I define as annual cash / total initial investment; in this case it is a paltry $916/$47,000 = 1.9%)

    As I showed in my table above, there are all kinds of metrics for analyzing a property. The issue does come down to financing and how that impacts analysis of a property. If I did have a large wad of cash sitting around, this property would look like a much better investment, even at $150K purchase price - the monthly cash flow would be around $950, ROI around 7.5%. Perhaps not the greatest deal though, since the cap rate would still be less than 8% and the "One percent rule" is at 1.35%.

    This is what it boils down to - for someone like me, who is investing with a bank loan for the purchase price and a HELOC to cover the closing costs, I feel I only have 2 options:

    1) Find a property that is such a "steal" that the cash flow numbers work. I've been monitoring the market for months and nothing in my entire county seems to come even close. Even if I do end up finding one, I'll definitely wonder "what am I missing?" about the condition of the property, if it truly is this much of a "steal", and likely hesitate to pull the trigger. 

    2) Take a risk on a property in the city near me (cheap prices, high turnover, poor schools, low income), which is not a great city for real estate, that I can buy entirely using my HELOC. My realtor (who has a bunch of properties of his own) recommended against buying anything in the city.

    Any ideas for other options besides these to get started?

    Thanks!

     Steve,

    No cash flow isn't the only metric. If it's off the rest of them won't go either (usually). Your metrics are all good to look at (check your calculations and assumptions). They don't meet because of lack of cash flow.

    Yes,10% return on money is ROI. I want both 10% "Interest" and 10% "Return of my money" per year. Your ROI calculation is wrong. You have no cash in the deal, it's all financed (100% levered). Your ROI is undefined, since you are dividing by 0 (no cash in).

    Your best bet is to find some cash to put into a deal. It can be an equity injection, but it will make the numbers work. Maybe start by doing some fix-flips to get some cash. You could find a partner that will inject cash for a piece of the cash flow and equity kicker. 100% leverage is tough. Equity (cash) injections make the numbers work. 

    Good Luck!

    Jim 

    0Reply
  • Patrick LiskaPro Member
    Investor · Verona, NJ · Member since 2014 · 1k+ posts · 832 votes
    9y

    Steve,

    You have in your numbers under dept services a primary loan and a HELOC. from what you said, you are using the HELOC for the property, so why are you including the primary mortgage of your house in those numbers ? you should only be figuring it with the HELOC. so you are making over $600. I would not take out the figures for a PM . your time is money, also what if you decide it's too much work for you and you hire a PM, if you leave it in then it's already figured in your numbers.

    0Reply
  • Kyle McCorkel
    Rental Property Investor · Hummelstown, PA · Member since 2015 · 638 posts · 653 votes
    9y
    I like using HELOCs if I have a quicker way of paying it off. So in your case, if you can buy UNDER ARV so that you can refinance in 6 months to a year, and pay off the HELOC. But to answer your question I don't think this deal would be worth it at the current price and cash flow. I wouldn't take $76 a month, even on a SFR, much less a multi unit. You would want at least $100-$200 cash flow per unit.
    0Reply
  • Steve Lundy
    OP
    York, PA · Member since 2017 · 5 posts · 0 votes
    9y
    Originally posted by @Patrick Liska:

    Steve,

    You have in your numbers under dept services a primary loan and a HELOC. from what you said, you are using the HELOC for the property, so why are you including the primary mortgage of your house in those numbers ? you should only be figuring it with the HELOC. so you are making over $600. I would not take out the figures for a PM . your time is money, also what if you decide it's too much work for you and you hire a PM, if you leave it in then it's already figured in your numbers.

    To clarify, the "primary mortgage" I am referencing is the bank loan I would take out to fund the purchase of this property, not my own house's primary mortgage. Apologies, it was probably worded in a confusing way.

    0Reply
  • Patrick LiskaPro Member
    Investor · Verona, NJ · Member since 2014 · 1k+ posts · 832 votes
    9y

    Steve,

    Not a problem, now that you cleared that up, I did notice you based your figures on different "tests" and one of them being a 15 year mortgage, is that what your mortgages are based on? Most investors put in for 30 years, yes you pay more interest over the years, but your payments are less, therefore giving you more income in the mean time. I usually figure 20 years on mine ( I been able to get commercial loans) try looking into a commercial loan and see what your local bank can do for you.

    0Reply
  • Ted Woolley
    Petaluma, CA · Member since 2014 · 15 posts · 1 vote
    9y
    Something else to consider if relying on HELOC. Your HELOC has an adjustable interest rate. If your going to be holding that debt long term, be sure you understand how fast, how often, and how much your payment can change. Figure out the worst car scenario. It could quickly turn a small positive cash flow to a negative.
    0Reply
  • Daniel Hanson
    Investor · Waukesha, WI · Member since 2011 · 199 posts · 97 votes
    9y

    @Steve Lundy I'll echo a few concerns and maybe add a few thoughts.  Cash flow is the starting point because it minimizes risk.  Risk of having to pay for property expenses out of pocket, risk of timing issues causing you to be late on property taxes or utility bills and putting the whole property in jeopardy.  I haven't done the math but it seems that in the 100% financed situation it would be better to go for the 30 year loan and use the excess cash flow to pay down the heloc faster.  But still do the math, it could be a VERY long time before the heloc gets paid down significantly, and in the meantime you have effectively zero cash flow and higher risk.

    0Reply
  • Daniel Hanson
    Investor · Waukesha, WI · Member since 2011 · 199 posts · 97 votes
    9y

    @Steve Lundy also note that the 1% rule of thumb, the 8 x gross rent rule of thumb, and the gross rent yield rule if thumb are all doing equivalent math and giving different conflicting screening rules.  For example 8 x gross rent = 8 x 12 x monthly rent = 96 x monthly rent or another way to say it is monthly rent should be 1/96 of purchase price.  1/96 = 1.04% , or another version of the 1% screening rule of thumb.  Out of these 3 just pick one screening tool that makes the most intuitive sense to you- using all 3 will confuse the issue.

    0Reply
  • Steve Lundy
    OP
    York, PA · Member since 2017 · 5 posts · 0 votes
    9y
    Originally posted by @Daniel Hanson:

    @Steve Lundy I'll echo a few concerns and maybe add a few thoughts.  Cash flow is the starting point because it minimizes risk.  Risk of having to pay for property expenses out of pocket, risk of timing issues causing you to be late on property taxes or utility bills and putting the whole property in jeopardy.  I haven't done the math but it seems that in the 100% financed situation it would be better to go for the 30 year loan and use the excess cash flow to pay down the heloc faster.  But still do the math, it could be a VERY long time before the heloc gets paid down significantly, and in the meantime you have effectively zero cash flow and higher risk.

    Thanks for the reply. My loan would be a 30 year loan. The "15 year mortgage rule" I included in the table above is simply another metric I came across. I don't really give it much value. The premise is to ensure the rent minimally covers a 15 year mortgage payment, taxes, and insurance. 

    0Reply
  • Steve Lundy
    OP
    York, PA · Member since 2017 · 5 posts · 0 votes
    9y
    Originally posted by @Ted Woolley:

    Something else to consider if relying on HELOC. Your HELOC has an adjustable interest rate. If your going to be holding that debt long term, be sure you understand how fast, how often, and how much your payment can change. Figure out the worst car scenario. It could quickly turn a small positive cash flow to a negative.

     Great point, thanks Ted!

    0Reply
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