First deal too good to be true...?

Question

Hi guys,

I've been stressing out about this current deal so figured why not go to boards and ask the real professionals. This will be new first investment property so I want to make sure I'm not missing anything here.

Basics : duplex - 2bdrm/1bath

Purchase price : 130,000

Assumed value of house : 137,000

Current rent: 750/unit.

Utilities separately metered.

Taxes: $1,200

Insurance : $1,100/yr

Maintenance : $1,600/yr

Cap ex: $1,600/yr

I'm coming up with great numbers on roi for this place so I'm not sure why it's been sitting for a few weeks now. It seems too good to be true. What would prevent other investors from rushing to this? The typical cap rate in this area is 7-8%. Granted, the neighborhood isn't amazing, probably class C tenants. Could that be the reason why no one wants to touch it? It has  a new roof and vinyl windows too. I've walked it and looks in decent condition. No remodeling necessary. I talked to current tenants and they said rent is on par with market. I also looked up market rent and it was accurate.

Please let me know your thoughts or what I'm missing.

Thank you for your time and help!

John Leavelle · Answer

Howdy @Creighton Bertrand

For a Duplex do not use Cap Rate to determine the property value.  You need to use recently sold comps in the area to determine the Market Value and your ARV.  Valuation for SFR and small Multi family properties are determined by comps.

The reason it looks like great numbers is you are leaving out some critical expenses.  You do not indicate any Vacancy or Property Management.  You should be conservative in your analysis until actual numbers can be verified.  I would use 10% for both until you verify the actual costs.  Your maintenance and CapEx numbers are a good starting points.  If you add the suggested amounts for Vacancy and CapEx your total annual expenses becomes $8,620. Cash Flow doesn't look so great now does it.

GSI = $750 * 2 * 12 = $18,000

Annual Expenses = $8,620

NOI = $18,000 - $8,620 = $9,380 ($781.66 per month)

Purchase price = $130,000

Down payment = $32,500 (25%)

Loan = $97,500

Ruff P&I estimate = $650 (4%/30 years)

Cash Flow = $782 - $650 = $132 per month ($66 per unit)

All that being said it is worth looking into in more detail.

John Leavelle · Answer

Account Closed

Like I was saying to Creighton, it depends on what your goals are.  I want to build up enough monthly Cash Flow to quit my W2 job and build enough for retirement.  So Cash Flow is extremely important to me.

This is a Multi family Rental property.  Do not expect it to appreciate over time like a single family property can.  To me that is just a trap to fall into.  I do however expect equity appreciation because I force it through buying below Market and Rehabbing to Market standards.  Any natural appreciation I get is just the cream on top.  Cash Flow is my primary goal.

As far as if this is a good deal or not will depend on what kind of comps he can get to establish a good Market Value for the property.  If the comps show a value closer to $100K - $110K do you think it is good to pay $130K knowing it may not appreciate.  Also take note of what has been said regarding CapEx, Maintenance, turnover cost for a long term hold.  It will be important to establish good reserves to offset those future expenses.  If you do not have good Cash Flow how will you build the reserves needed?

If you read my first post you should notice I said it was still worth looking into the property.  Specifically developing a solid Market Value, verifying all expenses, and he needs to get his financing approved.

For me, and I am not speaking for other investors, the only way I will pay List price is if I know it is absolutely turnkey rent ready, under Value,  and/or rents are below Market rates.  I must be able to force improvement somewhere.  But, then again this is not my strategy.

Did the previous post and this one help?

John Leavelle · Answer

@Creighton Bertrand

First a little helpful info on posting here on BP.  To tag someone that you mention in your post (so they know you mentioned them) and allow them to respond, do the following:  Type the @ sign then the first four letters of their name.  A square will appear below your name with their picture and name.  Click on that square to imbed their tag in your post.

Another reason other investors may be walking away from this property is it may be overpriced (based on the comps).  Getting the Market Value (and your ARV) correct is probably one of the most important things to get right.

@Christopher Blanco is right where he says the CapEx and turnover will kill your ROI if you have little to no Cash Flow and Hold the property for a long time.

Your and my goals may be different.  Therefore, the strategies and criteria will be different.  First I look for distressed properties that need Rehab and/or management improvements.  I must be able to buy the property at a good discount.  I'm looking to force appreciation (through Rehab, operating changes, and rent increases).  The property must at a minimum meet the 1% rule for Rental Income at purchase.  It also must pass the 50% rule for expenses on my initial analysis.  I actually use 55%.  The minimum Cash Flow at purchase is $100 per unit per month.  But, be able to $200 plus after the property is stabilized.

I use the BRRRR strategy exclusively right now.  Using my cash (as little as possible) and a Private Lender to purchase and Rehab the property.  I use local banks and credit unions to refinance after seasoning.  I do not plan on holding any property more than 5 years because of the exact reasons Christopher gave.  Low chance of CapEx or repairs (other than turnover).  I will exchange them for larger Multi family properties at that time and start the whole process over.

When I intend to submit an offer I am basing it on my ARV.  I have an inspection contingency requirement during the due diligence.  I always walk the property with an inspector and my General Contractor to identify all issues with major systems and appliances.  We develop a SOW and my GC gives a tentative bid to use.  I will then negotiate a lower offer based on the needed improvements.  I also develop a more accurate CapEx reserves requirement based on the life expectancy of major components and appliances.

Needless to say I do not get a high percentage of accepted offers.  But, that is ok.  If it doesn't meet my criteria I move on.

Hope this helps.

Christopher Blanco · Answer

@Doug Woodville He didn't account for turnover, property management, vacancy and i would argue his capex and repair budget are low. Again, I have a completely different rental model than the traditional buy and hold so take that as you will.

I would argue that the price of the property is too high for the rent he is getting. I lost a property that I had under contract with repair for half that with the same rent in Cleveland, and its a good thing I did because once I did the analysis I just did for the OP I realized it was a loser as well. If I was OP I would find out why rent is so low and see if I could force appreciate the units by upgrading them and increasing the rent and lowering the payback period. If not, i would not buy this deal.

Tom Ott · Answer

The difficult thing about multi units is that you can never account for all units being filled at the same time. It is almost impossible to sync up leases! Then you have extra costs for water/sewer/grass/snow. Could really add up.

Christopher Blanco · Answer

Financing makes no difference and only makes the payback worse. You are just paying the bank instead of yourself.

Just remember as an investor, it is your job to talk yourself out of deals, not into them. Good luck to you.

Christopher Blanco · Answer

I tend to look at rentals a little differently, but using your numbers and adding 10% for property management and 5% for vacancy, I get an net operating income (NOI) of 9800 a year.  You say your initial investment is 130,000, assuming you pay cash that is a  13.26 year payback. If you finance you need to deduct the cost of money and your payback gets worse.  So that means you will not be making ANY money on this property for at least 13 years from NOI.

In that time frame what do you think you will need to replace? Since you are doing nothing at the onset,  I would say at the very least you will be replacing a roof, hot water heaters, and probably furnaces (lets say $15000 total in cap ex and thats being generous). In addition you have turnover. Average tenant stays 1.3 years, so in 13 years you will have on average 20 new tenants between the two units. Each turnover will cost you on average around 1 months rent + $800-$2000 for repair and repainting, carpeting etc.

So lets run the numbers again:

• 13.26 year payback period so NOI is a wash in 13.26 years until you pay back your investment. 
• in that 13 years you collect $53,300 in Cap ex, repair, and vacancy saving$15,000 of that gone in actual repairsLets go easy and say each turnover only costs you $2500 total (including vacancy). 2,500*20 = $50,000Lets also go easy and say each unit only costs you $500 a year in repair, so again over the payback period: 13*500*2= $13,000 in repairs
• $15,000 of that gone in actual repairs
• Lets go easy and say each turnover only costs you $2500 total (including vacancy). 2,500*20 = $50,000
• Lets also go easy and say each unit only costs you $500 a year in repair, so again over the payback period: 13*500*2= $13,000 in repairs
• Totaling up: $15,000 + $50,000 + $13,000 =$75,000. 
• You've only saved $53,300, You just lost $21,700 over 13 years.

• $15,000 of that gone in actual repairs
• Lets go easy and say each turnover only costs you $2500 total (including vacancy). 2,500*20 = $50,000
• Lets also go easy and say each unit only costs you $500 a year in repair, so again over the payback period: 13*500*2= $13,000 in repairs

This is why I don't do long term turnkey buy and hold. I just don't see the value. In 13 years I could do WAY more with $130,000.

Daniel O. · Answer

@Creighton Bertrand you need to plug these and other numbers into the rental analysis tool available here on BP.  What is your estimate for cash flow after all of your expenses? Are you factoring in vacancies?  You should also build in 10% for a property manager. Even if you think you will manage it yourself, it is good to have room in the cash flow to have someone else take care of that if you have to move or decide that is not how you want to spend your time. If the numbers still work with all of this factored in, then it might just be the good deal you think it is.  At some point you are just going to have to learn to trust your analysis and pull the trigger. Do your work, double check it, and make a decision. REI is a competitive sport: While you are stuck in analysis paralysis, someone else is buying the house.

Good Luck!

Account Closed · Answer

Thank you for the replies gents.

It's alot more clear to me now. I was originally thinking of it as a turnkey single family just because I've been researching them for my potential first property and I was super tired when I posted...

Now that I've had a chance to re-read some post plus the additional posts everything becomes alot more clear. I'm still learning what a good deal looks like vs a bad deal :)

Kudos for your help boys

Account Closed · Answer

@John Leavelle

I'm a new investor still learning and I'd like to understand better. Does this not look like a decent deal?

The cash flow isn't that great but assuming the property appreciates over time combined with the debt paydown creates alot of equity, no?

I guess what I'm asking is...Is this a good deal or a bad deal and why? Please help me understand :)

First deal too good to be true...?

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