A few deals analyzed - needs constructive critique

21 Replies

Hello there!  Before I start on the deals, just want to say thank you in advance to those reading this, and the BP community overall for this incredible resource.

I've got a few opportunities available for our first buy & hold rental.  Some context - wife and I are looking to diversify a bit out of the market, get some passive income that we can reinvest in more properties over time.  We live in Colorado, which is a difficult buy + hold market, so we're looking at out-of-state turnkeys with property management.

Deal 1:

2 bedroom, 1 bath, 768 sq. feet. Memphis, 38128.

$45,000 listed - $650 rent

Taxes: $42, Insurance $40.

Assuming 3% Closing Costs, 20% Down, 30y loan, $171.49 Monthly Mortgage.

$10,058 Cash Required

14% Management Fee (including tenant finding), 5% Maintenance, 5% CAPEX, 8% Vacancy Allowance.

That's a 45% Expense to Rent Ratio.  Round up to 50% and it's $325 in monthly expenses.

Annual Numbers: $7,800 Gross Rent, $3,900 Net Income, $2,057.85 Mortgage = $1,841 Annual Cash Flow.  18% Cash on Cash Return, 8.7% Cap Rate.

Seems like a winner?

Deal 2:

4-plex, Cleveland.

$150,000 listed - $2,855 in rents.

Assuming 3% Closing Costs, 20% Down, 30y loan, $611 Monthly Mortgage.

$35,840 Cash Required

14% Management Fee (including tenant finding), 5% Maintenance, 5% CAPEX, 8% Vacancy Allowance.

That's a 53.4% Expense to Rent Ratio. That's $1,524 in monthly expenses.

Annual Numbers: $34,260 Gross Rent, $15,970 Net Income, $7,333 Mortgage = $8,637 Annual Cash Flow. 24% Cash on Cash Return, 10% Cap Rate.

Seems like another winner?

What am I missing?

Thanks again in advance!

Those look like great deals!.....But for someone who lives in cleveland... If you have never had a rental, you should try and find one in your area to manage it from closer. Even if it doesnt make a huge cash on cash return, I know colorado has excellent appreciation and allthough you might not want to account for that in your annual return, it will teach you so much more then you know.  good Luck! @Jeff Tropeano

Your expense assumptions are low. Maintenance on a SF should be $75/month minimum. Cap ex on a SF should be $100 min, but probably closer to $150. Do you pay any utilities (you will when its not rented)?, no bookkeeping/accountant fees, no legal fees (ie, evictions), assuming you will have rental inspection/licensing fees. Same on the 4 plex. Your maintenance should be at least 10% - I would use 12-15%. 

Also, what type of area are they in? 

@Jeff Tropeano so here is my advise. Unless you know the out of state areas you are buying in (like grew up in the area and have family there) you are taking a huge risk. IMO more of risk than betting on appreciation in our market. It's huge red flag that you are looking at deals in two different markets. Real estate is about three things location, location, and location. If you insist on out of state, pick your area first, then drill down to find a deal in that area. These two properties could be in very different areas. If one is on the rise and the other on the decline you could end up owning a lot with a shell on it plus very high back taxes and City fines.  

@Jeff Tropeano I would be wary of that low level sfh in Memphis. Nothing that rents under 800 a month today is where any out of state buyer should go. Let me know how I can help.

I just bought a house that is a worse deal, across the country, that I haven't (And don't plan to ever) see in person, and I really couldn't' afford it when I bid on it, and it will all work out and be profitable. So you're in the zone!

Some people call this risky but everyone's risk tolerance is different, a lot just depends on your ability to maneuver. If you stay on top of your business and can be aggressive with running things then you'll probably be fine. Being close to a property doesn't' really help if you're subbing out contracting and management. If the tenant doesn't pay, being able to drive to the house isn't going to help.

I say go for deal #2 (and renegotiate your PM fee)

Maintenance % are a tad low....but otherwise look good to me. The cardinal rule for investing out of state...... go see things in person for yourself before you finalize anything...... the $$ you invest for the travel will be pennies compared to a bad investment. SO the numbers pass the first test of whether its worth going to the next step, which is going to see it in person.....

I can't say for the Cleveland 4plex so much, but I can definitely say about the Memphis property... $45k for a property in a market like Memphis that has been so hot for investors (meaning the prices have been driving up over the past few years) is almost definitely going to be risky. A $45k property back when prices were cheaper bordered low quality, but it certainly would now. Or at least, I can't imagine it wouldn't be. The problem with that is lower-quality comes with all sorts of higher risk levels. If that's okay with you, then that's cool, but that can be tough being long-distance to it. 

Both Cleveland and Memphis are markets I've avoided for my own personal investments. Not a fan of either, but I don't argue anyone investing in them either.

Any reason in particular for those two markets or those properties? Are they just ones you found or are you focused on those for a specific reason?

@Jeff Tropeano I want to give you some advise from someone who actually lives and invest in Memphis. You don't list the address but be careful when looking at 38128, the area is shaky especially for an out of town investor. I also think a 14% management fee is too high, your boots on the group should run you around 10-12% in my opinion. Besides that the number one reason why should walk away for this deal is because it is a 2 bedroom. You should always look for a SFR with at least 3 bedrooms.

@Jason Hopkins Thanks a bunch for that advice!  I had 14% management as 10% for management fees, and 4% for filling vacancies (assuming yearly turnover).  Will be sending you a connect request - would love to pick your brain on Memphis.

@Ali Boone Thanks for your advice as well.  These are the two markets I've targeted for lowest price to rent ratios.  I'm aware of the risks and downsides to the markets, and out of state investing as well.  Lots of great advice here saying to stay away from OOS, especially without good knowledge of the area.

And just generally, to all of the great responders to this post - I am not going to move on these particular properties. I want to make sure that I'm going through the proper analysis process, and not missing things in my assumptions. Lots of great feedback to fold into my assumptions and analysis (about lawn/snow, higher maintenance and CAPEX for lower priced properties, etc...). I'm not moving on these deals, just working out my deal analysis muscle in markets that I am considering, and taking counterpoints to investing in those markets (or out of state investing in general).

Thank again!

@Jeff Tropeano - Welcome to the site!  For quick background, I started as a real estate investor while living in Denver back in 2003.  I owned a few long-term buy & holds in Denver, did a few fix-n-flips and eventually began  acquiring passive properties in Memphis.  Just as you stated, I wanted to maximize cash-flow from my passive investments, but I had a major advantage.  My family lived in Memphis, owned an investment company and I had lived there for years.

So, with that in mind, let me tell you that the investment you are thinking of making in Memphis in particular is not a good one.  There are a few reasons, but hopefully I can help you view this from a different perspective and help you make good decisions.

A $45,000 TURNKEY investment is never going to be a good investment regardless of market.  As an out-of-state, passive investor, you are looking for ease of transaction and a low-headache investment that protects your investment and allows you to make money on it.  First and foremost - PROTECT YOUR INVESTMENT!  At $45,000 sale price - whomever is marketing that to you as a turnkey investment is looking for a buyer who is attracted to the word Turnkey - not someone interested in quality nor protecting their investment.  

There simply is not enough money at that sales price for a company to buy a quality property, do a high-quality renovation where ALL deferred maintenance has been addressed and allow for the company to make a profit.  Something has to be cut and you can be assured that no one is doing anything for free.  What is cut is the renovation.  So my advice is to avoid these price points.  I do speak from experience.  I have passively owned properties at this price point in my history as an investor and they NEVER pay off as you expect.  Not when buying them as a Turnkey, passive investment.

Now - your property in particular.  These are all my opinions.

 - Never buy a 2-bedroom property in an area where most properties are larger.  2 bedroom properties work well in college and university areas.  I can't imagine an area in 38128 where you would want to purchase a 2-bedroom property.

 - At $700 a month rent, you can expect to lose great than 50% of your rental revenue due to uncollected rent, vacancy and maintenance.  This price point attracts a resident that is most likely insecure.  Job insecure, food, medicine, transportation insecure ~ and the first thing they need to give up is rent in times of crisis.  They are simply more transient. A resident looking to qualify at this price point is going to be making between $22,000 and maybe $30,000 per year.  

To be fair, there are great residents at this price point.  But that is not the norm.  As you get into higher rental price points, you attract more stable residents.  Fewer are able to be as stable at lower rents simply by fact that they are not earning as much income.  If they were earning more, they would be looking for better housing.   Keep that in mind.

 - Why you should expect to lose greater than 50% of your rent is that these properties tend to go vacant more often.  With each vacancy you will have costs to get the property ready.  Accounting for only 8% vacancy yearly means 30 days lost rent.  Unfortunately, with a higher rate of transience at this price point, leases will be broken with uncollected rent, and once the property is vacant, it needs to undergo a make-ready and then has to be marketed.  You can expect 60 days lost rent when you include lease-up.  That is 24% vacancy in a year and you will find that these price points perform that way on a regular basis.  At a minimum, expect 16% vacancy on average.

- Lastly, your maintenance and Capex costs will most likely be higher than 10%, but I do like that you have this number higher. You have to expect that your property will not be renovated to a high level at $45k. There will be a lot of deferred maintenance that will be a constant draw against your rent. I would be prepared for 15% or higher for maintenance and Capex at this price point.

 - You noted that you would like to put 20% down.  Unfortunately, you will find it very difficult if not impossible to find a lender willing to lend such a low amount on a property - especially an investment property with an out-of-state investor.  

I've been working with out of state investors buying in Memphis for going on 14 years.  My family has been managing here actively for the last 12.  I can tell you that this price point in this city is not a good investment for out-of-state investors.  Especially not when it is being marketed as Turnkey.  I have no idea, nor does it matter who you are working with.  These are not good investments no matter who the company is you are working with.  These properties are better left to local investors who will own this type of property for considerably less than you will own it for and they will self-manage.  Their costs will be lower and their returns will be much higher than you are looking at because these are very, very risky investments. 

Be patient with your investment decisions.  Don't rush.  The opportunity still exists for you to make a great passive investment and you can find quality Turnkey investments.  You just have to remember to protect your capital investment first which means making the highest quality investment you can when buying Turnkey.  Then, look to maximize your return.

Best to you

@Jeff Tropeano , hope you are well! My first thought as I'm reading your post is about the same as what @Bill S. said first, I would really like to know more about the areas these properties are in from a local expert/boots on ground.  As far as your first OOS investment goes, I would want it to be a home run.  

Is the one in Memphis TK or is it a rehab? That would make a big difference but the price is too low if its TK.  Although the numbers look good upfront you will spend more with turnover and tenant issues in that price point.  That would add a lot of stress for me being out of state and I think it would add peace of mind to have a higher quality tenant, especially on your first one.

So as you're evaluating your first oos investment keep in mind what you can do to minimize risk--

3/4 bedrooms are ideal (a tenant might upgrade from 2 to 3 bedrooms but very unlikely to go from 3 to 2 bedrooms.  Plus with 3/4 bedrooms they might stay more than one year, or forever--less turnover and less leasing fees), and get feedback about the area--find your local expert and then cross reference his opinion with other local neutral parties (I even called the local PD when I was buying my first one).

Well just to clarify for you and anyone reading... people do caution a lot about OOS properties on here, but I'm one of many who has always done OOS investing and it's been great. There's tons of success stories from people doing it--whether it's me who does turnkey or others who DIY--so if someone wants to do it, there's really no reason not to. Choosing your market is key and how you manage the property management is key, but both of those can be learned. Of course choosing your property is key too but that goes for local or OOS investors. So I just want to throw out there that despite the backlash on OOS properties, lots of people do it successfully (and it's odd how you never hear of successful OOS investors bashing investors who choose to buy locally instead, but yet the local investors for some reason always knock the OOS investors...I'm really not sure why they care.)

When you say lowest price-to-rent ratios... does that mean highest cash flow?

@Jennifer S. The SFH (deal 1) is a turnkey. The MFP is not. Great tips on the # of bedrooms. I'm looking forward to getting back in touch when I'm closer to shopping for a purchase!

@Ali Boone Thanks for that.  And yes, lowest Price to Rent ratios = cash flow, and better likelihood to meet or exceed 1% rule.

And yes, lowest Price to Rent ratios = cash flow, and better likelihood to meet or exceed 1% rule.

 Just to be clear, if you are being pitched that meeting the 1% rule will equate to positive cash flow or a solid investment, think again. At thebprice points you are looking at, that equates to negative cash flow long term. At higher price points in certain areas, 1% can get you a tiny cash flow return but those plays typically take into account appreciation, along with some other strategies to maximize the return, they are not plays for cash flow only.

Originally posted by @Ali Boone :

Well just to clarify for you and anyone reading... people do caution a lot about OOS properties on here, but I'm one of many who has always done OOS investing and it's been great. There's tons of success stories from people doing it--whether it's me who does turnkey or others who DIY--so if someone wants to do it, there's really no reason not to. Choosing your market is key and how you manage the property management is key, but both of those can be learned. Of course choosing your property is key too but that goes for local or OOS investors. So I just want to throw out there that despite the backlash on OOS properties, lots of people do it successfully (and it's odd how you never hear of successful OOS investors bashing investors who choose to buy locally instead, but yet the local investors for some reason always knock the OOS investors...I'm really not sure why they care.)

When you say lowest price-to-rent ratios... does that mean highest cash flow?

 I believe you hear about so many people bashing OOS investing because there is a lack of control.  People will always say to invest local because if there is a dumpster fire, you can drive over to the property and be able to handle/assess the situation much better than having to hop on a bird, go through the airports, rent a hotel, get a rental car, take time off work, etc.  With local investors, they want to know that they can get and see the property at a moments notice.

Now not all people are the same in that aspect, where they want to hire the handyman or contractor to change a water heater when a property manager can do the same job for a fee.  If you do have a good management company that is competent and reliable then OOS shouldn't be viewed so negatively.  Maybe good management is hard to come by . . . .