I'm getting ready to do my first deal and I wanted to get some sense of whether the numbers work well...
Fully renovated, new roof, new interiors, granite countertops, LVP on all floors, etc. Basically look like luxury apartments. Place is completely redone.
Fourplex around 3,800 square feet.
Sale price: $400,000
No off-street parking. That's common in this city. In a medium-sized city. Not major city. Real estate prices here are generally reasonable.
Rents are $1300 in 3 units, and $1225 in one of them.
We're going to do owner-occupied and put 5% down.
The place is beautiful on the interior, and we won't have to put any work in at all because they just completely redid the place...
PITI total should be around $2900 per month. Taxes are around $7,500. Principal and interest around $1800. Tenants pay their own utilities.
Trash, sewer, water is picked up by landlord.
Is this a good deal or should I look elsewhere? I don't want to get in over my head... Will reserves and cash flow be good on this? Thanks for any guidance you can provide.
When looking at an investment, you have a few expenses that you need to consider. These are not concrete expenses such as taxes or bills, and are instead calculated as percentages of the income (I call them "Percentage Expenses")
Maintenance: 10%. This is for every day wear and tear, repairs, removing bee nests, etc
Capital Expenses (CapEx): 10%. This is your major repair items - basically, you're saving up for when the roof needs replaced, the water heater needs repairs, etc
Property Management (PM): 10%. Even if you plan to manage the property at first, you might decide not to later. Also, your time should be worth something
Vacancy: 8%. This should be based on the average of your market, but 8% is a safe, conservative number.
A quick method for evaluating is to assume 50% of your income will go toward your percentage expenses and your utility expenses. The remaining income will be an estimate of your monthly NOI. As a side note, 5% down on a $400k loan would make P&I closer to $2040 rather than $1900, and that doesn't include PMI or taxes.
So say you rent out three of the units for $1300 = $3900 monthly income.
Now, subtract 50% for expenses and you're left with $1950 as your NOI.
Take out your mortgage payments of $2040 = -$90 monthly cash flow
So you'll have negative cash flow based on this very loose evaluation, and assuming you live in one unit. If you rented all four units out, your number would change to $560 monthly cash flow.
On paper, it's actually not a bad deal, and you can live in one unit for only $90 per month. Once you move out, you can have $560 cash flow, which is better than $100 per door.
Now, the major "but":
This was done using 50% for expenses, which doesn't take into account PMI or the higher taxes. This is a good example of where the 50% Rule might not be a great first analysis.
My suggestion would be to do a full analysis of the property rather than depending on the 50% Rule. For the sake of keeping this post a little shorter, I'll run a full analysis in a second comment ;)
@John Garretson I ran the numbers and this looks like a solid deal. You can cash flow a couple hundred bucks per month.
All the best!
@John Garretson - in my previous comment, I used the 50% Rule to do an initial analysis. While the property looks good on paper using that method, I then went on to argue that this is a situation where the 50% Rule is not the correct tool.
You could use something higher than 50% for your expenses and still apply that rule, but at that point you're guessing how much more your taxes and PMI will raise the expenses above 50% of your income. So instead, let's do a deeper analysis of this property.
First things first: Income. Since you're thinking of putting 5% down and house-hacking, I'll assume 3 rented units at $1300 each.
Total monthly income: $1300 x 3 = $3900
PM (10%): $390
Maintenance (10%): $390
CapEx (10%): $390
Vacancy (8%): $312
Taxes ($7500 annual): $625
Insurance ($2000 annual): $166.67
Utilities ($3500 annual): $291.67
I estimated insurance and utilities, but you can call around to get the insurance quote, and get historical amounts for the utilities.
So your monthly NOI: (Monthly Income) - (All of the above) = $1334.66
Assuming you put down 5%, 30 year loan, 5% interest, with 0.8% PMI, your monthly payment would be $2230.
Cash Flow: NOI - Mortgage = -$895.34
The 50% rule said that your cash flow would be -$90, which is a far cry from -$900. If you rent all four properties at $1300, you would have -$80 per month cash flow.
As anticipated, the PMI and taxes hurt this deal a lot. My advice: Find a better deal, or see if you can partner with someone to collect the 20% down payment.
I hope this helps!
@Shawn Ward - take another look at the taxes, the fact that he will have PMI due to 5% down, and the fact that he's only renting out three units. Even at 4 units, I'm not seeing a positive cash flow, but maybe you saw something that I missed
@Ben Wilkins I added the taxes (which are def high), but I did include the fourth unit. Take that away, and yes, you lose + cash flow.
|Monthly Operating Income||Scenario A|
|Number of Units||3|
|Average Monthly Rent per Unit||1,250.00|
|Total Rental Income||3,750.00|
|% Vacancy and Credit Losses||5.00%|
|Total Vacancy Loss||187.50|
|Other Monthly Income (laundry, vending, parking, etc.)||-|
|Gross Monthly Operating Income||3,562.50|
|Monthly Operating Expenses|
|Repairs and Maintenance||166.00|
|Real Estate Taxes||416.67|
|Rental Property Insurance||300.00|
|Homeowners/Property Association Fees|
|Accounting and Legal||(60.00)|
|Monthly Operating Expenses||692.67|
|Net Operating Income (NOI)|
|Total Annual Operating Income ( Gross Monthly x12)||42,750.00|
|Total Annual Operating Expense (Monthly Operating Exp x12)||8,312.00|
|Annual Net Operating Income||34,438.00|
|Capitalization Rate and Valuation|
|Desired Capitalization Rate||8.00%|
|Property Valuation (Offer Price)||430,475.00|
|Actual Purchase Price||400,000.00|
|Actual Capitalization Rate||8.61%|
|% Down Payment||5.00%|
|Acquisition Costs and Loan Fees||4,000.00|
|Length of Mortgage (years)||30|
|Annual Interest Rate||5.800%|
|Monthly Mortgage Payment (PI)||2,229.66|
|Total Annual Debt Service||26,755.94|
|Cash Flow and ROI|
|Total Monthly Cash Flow (before taxes)||640.17|
|Total Annual Cash Flow (before taxes)||7,682.06|
|Cash on Cash Return (ROI)||32.01%|
This is what I came up with
@Jay Orlauski - No CapEx? You only have $416 monthly in taxes, when the poster stated $7500 annual ($625 monthly). I assumed he had actual numbers, but it might be less. No property management? Your only savings for each month is 5% vacancy plus 4% maintenance....
It's possible to make any property look good on paper, but you have to account for something breaking eventually. $166 monthly maintenance will barely cover lawn care, snow removal, basic repairs when a tenant moves out. All of your "profit" from the past five years will go toward replacing the furnace, water heater, roof, siding, etc and you'll be left with a loss or deferred maintenance.
For a first investment and someone who is putting down 5%, it would be risky not to set aside savings for CapEx items. He doesn't have other properties to float the repairs, and I'm afraid that your analysis doesn't set anything aside except for vacancies.
Other than that, your spreadsheet seems fairly well laid out. Are numbers in parentheses one-time expenses? Do you include an escrow account for one year of taxes such as most lending agencies request? Would that be included in your initial investment?
@ben - the Capx I used is the $166 /month which is $2000 / year labeled ( repairs & Maintanance) - probably doesn't cover snow removal and what not -I use it mainly as a way to account for a $2,000 repair bill once a year. I did not use a manager in this case because he is living in one of the units - if he rented out all 4 units , I would add management and the numbers would be different obviously. I used the local ( Fresno) vacancy rate of 5% which came from the last U.S census bureau - you're right about the taxes though I missed that one and used my own local taxes - I should have took note of that better - I usually try to make deals look worse on paper and if they look too good , I will start to undermine it with heavy expenses and higher vacancies - just because , I would rather be pleasantly surprised than to have a bad surprise. Other factors these numbers do not account for is the PMI that will be due until there is 20% equity in the property - and also doesn't account for special conditions like flood insurance if required or other local taxes. These are the numbers I run to see if the property is worth looking into further. If they pencil out here - then I will do a much deeper analysis and due diligence on the property. I hope this was helpful.
@Jay Orlauski - fair enough explanation. I am more a fan of putting the expenses and higher vacancy in from the start rather than if it looks too good, but that's just me I suppose. If you have Repairs and Maintenance as your CapEx, what do you use for general maintenance for wear and tear, or when a tenant moves out?
PMI changed, and is now on an FHA loan for life or until refinanced rather than just until 20% - welcome to the new world. It wasn't exactly touted to the general public, and is an easy fact to miss. Because of that, I include PMI in all FHA loans for life during my analyses, or at least account for refinance fees.
Good explanation of your thoughts, but I would rather run safe numbers on my expenses rather than try to undermine it with heavier expenses halfway through my analysis. I'm pretty sure you don't mean it like that, but "undermine" is a strongly negative word ;)
How do you keep from getting into an analysis paralysis mindset if you put in heavier expenses for a deal that looks too good? What if a deal is only "OK" in your first look, so you don't put in the heavier expenses? I would think that it would be better to use conservative numbers from the start based on the individual market - this would give you safer investments and would evaluate properties with a structured approach (if that makes sense)
Hi Ben - great questions - I start with a basic set of parameters that are typical for my investment area .. if I like what I see - I do a little more digging. I avoid analysis paralysis by understanding that I am loading up the expenses as more of a "just in case" scenario. If a deal just looks "OK" I will still play with the numbers to see what my break even point is and what would have to happen to get there - if there are too many red flags then I walk away - there are still many other factors that I will look at such as location, age of property, type of property , local comps, ARV , potential add-ons and other factors that would affect the cashflow and/or resell value.
On this particular subject property - it appears that everything is brand new which is one of the reasons I didn't add more for the Cap x - but I understand the importance of building it into numbers. Tenant moveouts are partially covered by repair & maintenance. I am aware of the PMI for life with FHA mortgages , which is one of the reasons I try to avoid FHA myself. He does not indicate if this will be FHA or Conventional though.
Overall - I like to see more than $100 / door in cash flow - I don't put a lot of stock into cap rates as it really more of comparison ratio of one property to another - it's the cash flow I like to see and I want to be sure it is making more for me than a (totally ) passive investment - I have to go - I am heading up our weekly meetup group today and need to head over to the meeting space - It was great sharing with you all .. I look forward to more engaging dialog.