Which is the better deal?

Question

Hey guys,

Stumbled upon here by accident and really love this site...coincidently was faced with a decison on a couple of properties..I'm just starting out so please be kind..wanted to get an idea of what would be a better investment...I have 2 rental properties to choose from...keep in mind I will be financing with the traditional 20% down conventional loan:

Prop 1:  $200K...2 units...total rent $3,075/mo...$24,497 net operating income...section 8 tenants..property needs tlc

Prop 2:  $235K...sfr but renter is using it for his business...20 years he been there and has a lease until 2014...$2,400/mo...$25,110 net operating income...renter pays for all repairs and maintenance

It may seem like a no brainer but I'm stuck...any thoughts or opinions?  I plan to hold on to the property for a while but want the flexibility to sell if I decide to move onto something bigger...

Thanks everybody in advance!

Raymond B. · Answer

Tyson,
Welcome to the forum.

I suggest that you spend some time in this forum:

http://www.biggerpockets.com/forums/52-rental-property-questions-landlording-issues

Also, take some time to read this as a guide for rental properties:

http://www.biggerpockets.com/forums/52/topics/18371-help-me-understand-this-deal-and-5-2-rule

Raymond

Jon Holdman · Answer

I'll disagree and say the first one is an acceptable deal.  The 2% rule only works for rents around $500/month.  Yours are much higher.   Your NOI estimates are much higher than reality, though.

First deal:
$200,000
Down: $50,000 (25%)
Loan: $150,000
Payment: $899.33 ($150K, 6%, 30 years)
Rents: $3075
Expenses, capital, vacancy: $1537.50 (50% rule)
NOI: $1537.50/month, $18,450/year
Cash flow: $638/month, $7658/year
Cash on cash return: 15%

That looks reasonable.

The second deal is terrible, assuming its a regular SFR rental.  If this is a triple net lease, it might be an OK deal.

Jon Holdman · Answer

With $5000 in "TLC", deal 1 is still OK, IMHO:

Cash flow: $638/month, $7658/year
Down: $50,000 (25%)
TLC: $5,000
Closing costs: $6,000
Total Investment: $61,000
Cash on cash return: 12.6%

Now if "TLC" is really $50K, and I'll say you can't really do squat for $5K, then its not much of a deal.

Your analysis of the second deal if far, far, far to optimistic.  Just because the forumer owner has had someone in there for 20 years doesn't mean he's sticking around for you.  He could leave tomorrow.  You MUST account for realistic expenses.

What sort of business does this guy run?  Is it in conformance with zoning regulations? Has it in some way damaged the property (e.g., restaurant, car repairs, landscaping service that has lots of gas small engines)?

If you buy rental properties assuming only taxes and insurance for your expenses you WILL go broke.  Don't make this mistake.

Ken Ly · Answer

Okay I can't help but try this...here is my formula but I tweaked the expenses because although it is not a triple net lease, my only responsibility would be taxes and insurance.

2nd deal:
$235,000
Down: $58,750 (25%)
Loan: $176,250
Payment $1056.71 ($176,250, 6%, 30 years)
Rents: $2400
Expenses (only property tax and insurance) $450
NOI: $1950/month, $23,400/year
Cash flow: $893.29/month, $10,719.48/year
Cash on cash return: 18%

Did I do this right...I know my expenses may be wack but property owner is on a lease and has been in business for 20 years (runs a business out of the home) so I don't assume vacancy for any period.

Ken Ly · Answer

Wow thanks for the replies guys I must have a lot to learn..

I thought the 2nd deal was favorable because the only expenses I would have is insurance and property tax...

plus the renter has a lease until 2014 and is willing to sign a long term lease upon change of ownership..

there so many formulas i feel like i'm in math class...i guess i have a lot more to learn..

can someone point out why prop 2 is bad? please excuse my ignorance!

Stan Jackson · Answer

But, considering he is only putting down 20% and the property needs TLC, which we all know what that means, the COC is only 10%.  Isn't there better deals that produces 10% COC returns?

With $5k in TLC, this because horrible, wouldn't you agree Jon?

It does start looking better around 10 years of holding.

Jared K. · Answer

Sorry to be negative here but I would have to agree with Stan Jackson. The numbers dont seem that great on either one to me. There are a lot of great deals to be had right now out there with better returns.

Stan Jackson · Answer

Especially the 50% and 2% rules as Ray suggested.

Then, confirm and re-post your numbers. I thinking neither of these are good deals.

Will either of these properties produce additional income other than rent?

Tyson S. · Answer

My thoughts: the SFR is going to be easier to move but you could be stuck with a difficult property to rent in 3 years.  I like the idea of Prop 1 better depending on how much improvement it needs.  Prop 2 is ridiculously low on expenses and even though the current tenant might be great there is no guarantee what will happen in 3 years.

Personally, Prop 1 seems like the more flexible, realistic choice unless it needs a lot of work, bad area, or something else that just the numbers don't show.

Which is the better deal?

Most Popular Reply