Should I overpay for a property I can't resell but gets 13% ROI?

Question

I wanted to get some advice on the following opportunity.

I have an opportunity to purchase a condo in a good location and whose complex overall has had a historical vacancy rate of about 5%.

Single family homes in my area are making a small comeback, and over the past few years the area has seen 7% avg annual appreciation rate for residential homes.

Condos in this area, this one too, are the exact opposite. The units in this building were selling for $50k 3 years ago, and 3 units just this year have gone for $28k. Not updated, these condos are renting for $600 per month; updated, around $700 per month.

The unit I am considering I've negotiated down to $32k; I'll paint and replace the carpet, but other than that the unit is in great shape (although I do foresee replacing the HVAC unique within the next few years).

In the title I mentioned "a property that I can't resell." This will be my first condo, and I've learned a lot. In particular banks have policies that don't lend on condos if the renter to owner ratio exceeds 20% to 25%. This is particularly true of my bank, and my banker suggested that this had a lot to do with the falling prices - banks won't lend against them so owners (landlords) are having to sell to other investors at prices that are easier for another investor to pay cash for. Whether or not this is all true, I don't know so feel free to comment if you have experience with that. But, when I do sell, I estimate getting what has been market for these - $30k ish - and that's if prices don't continue to fall.

In any case, here are the numbers:

$36,000 - Purchase price plus make ready repairs

$4744 - Annual NOI (with 5% vacancy calculated)

$4744 / $36000 = 13.17%

I am calculating that I get 0 appreciation benefit from owning this property. Another con is I'm about to tie up $36,000 that would be hard to liquidate (compared to SFDH in the area) But a 13% ROI is a heck of a lot better than the money sitting in my bank account.

Thoughts?

Thanks!

Barry H. · Answer

BLUE - I own condos and have owned condos in the past. You are 100% correct that they are hard to unload when you are ready to unload them. That is why I have NEVER calculated equity build in the value of a condo when I consider purchasing - I ONLY consider ROI.

There are only two (2) obvious red flags I would consider:

1) Is the HOA healthy ? In other words, has there been any special assessments (SAs)for landscape redesign, pool rebuild, roof replacements etc? Are any of these things potentially on the horizon? Talk to a long-time resident in the complex (unless you already know the history yourself). IF there is a SA on the horizon, that could kill your 13% ROI for at least a couple years, if not longer, depending on how big the SA might be. That said, I joined the Board on an HOA that was bleeding money and I saw a SA potentially coming. I found out the other Board members were stealing funds from the HOA and I put a stop to it (unfortunately no one went to jail). I only mention it because if you see potential in the complex to pick up more units in the future as the prices fall, it may be a good idea to get yourself on the Board to assure the community stays healthy.

2) Are there indicators in the town/city where this property is located that might indicate it will become a new Detroit? If a major employer in the area is leaving or threatening to leave and it could lead to further vacancies, your rent value "could" go down. I say "could," because in the long haul, rents stay pretty steady or go up - but a huge wealth creator leaving a smaller area could have an effect.

OK - those are my humble words or wisdom. If you can reasonably rule out those two red flags, you have found a solid ROI you will not get very often and it sounds like a good deal.

BEAR :-)

Should I overpay for a property I can't resell but gets 13% ROI?

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