Proposed offer - do my number make sense?

Question

I'm looking at making an offer on a FSBO SFH in Louisiana. I'm estimating rent to be about $1100. The expenses are:

• Insurance (including flood) = $225
• Taxes = $140
• Maintenance and Capex = $110
• Vacancy = $110
• Management = $110

I thought I would give the owner two options, both with a 20% down payment:

• I do a typical 30 year mortgage and offer $77k
• I offer $93k, but pay it in installments to the current owner for 20 years.

My goal is to cash flow $100 after expenses. What do you all think?

Sean Morrison · Answer

I think 3% would be cash flow after all expenses, including mortgage payments. I thought cash-on-cash was supposed to be calculated without mortgage, which would be about 14%. Am I calculating that correctly then? Anyway, you're right, it's not a great return without the equity.

As an update, he finally realized that this was essentially a zero interest loan. His new counter puts this way outside the realm of something that would make sense. Thank you everyone for your insightful answers!

Andrew Johnson · Answer

@Sean Morrison Well you either pay the bank (interest) or the government (taxes).  You should look how much taxable income the property would generate (after depreciation) and see:

1. How much you'd pay in taxes on that (typically ordinary income).

2. How much mortgage interest you'd need to "zero it out"

There's not a defined right vs. wrong answer for this.  A lot of it depends on your personal marginal tax rate, if you want immediate income (even if it's taxable), etc.

Sean Morrison · Answer

@Andrew Johnson, I hadn't thought much about the tax side, and I definitely don't know that side well enough. Would a mortgage interest deduction be more valuable than not paying interest at all?

Sean Morrison · Answer

Of course! This is a free and clear house, with no major repairs needed. Seller bought it for his daughter, who rented it from him for a few years, but just moved away. He simply doesn't want to be a landlord. Just spoke with him this morning and he said he'd do a monthly payment plan (think seller financing at 0% interest) for 20 years at a purchase price of $105k.

You're correct about the options. I looked at 20% down because anything less made it difficult to cashflow. And if he does seller financing, he would like a solid down payment.

At 105k, it would be a $23k down payment and monthly payments of $341.67. Which should still cash flow $60 per month. Does that seem correct?

Mitch Messer · Answer

Hey @Sean Morrison. I'd love to give you feedback, but I'm not certain I know all the critical facts yet. Is this a free-and-clear house? Why is the seller selling? I think your Option 1 is bank financing, while Option 2 is seller financing. Either way, why are you offering 20% down? What interest (if any) are you assuming in each scenario?

More info, please!