How Many Issues is TOO Much to Make a Deal Not a Deal?

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How Many Issues is TOO Much to Make a Deal Not a Deal?

Michael Vu
Rental Property Investor · Cincinnati, OH · Member since 2019 · 60 posts · 25 votes

Hate to be at this point again in the due diligence, but here I am. Ready to learn.

I'm under contract on a duplex (first deal) and after having inspections, I don't know if this deal is worth it anymore. I'd appreciate some input from the BiggerPocket community! 

Here is my deal analysis:

PURCHASE
Purchase Price$120,000.00
Down Payment$24,000.0020.00%
Closing Costs$3,240.00
Mortgage$437.00
INCOME
Monthly Rent$1,200.00
EXPENSES
Property Tax$267.00
Home Insurance$85.00
Vacancy$50.004.17%
Maintenance & Repairs$60.005.00%
CapEx$96.008.00%
Water & Sewer$80.00
Gas$0.00
Electricity$0.00
Total Expenses$638.00
DEAL ANALYSIS
Net Operating Income$562.00
Monthly Cash Flow$125.00
Cap Rate5.62%
Cash on Cash Return5.51%

So when I first looked at this deal, I saw there was long term tenants (so lower vacancy), the living spaces of the property were actually very nice for a MFH, and the price was attractive. It came out to around $125 / month cash flow, not GREAT, but for a first property it's a base hit and gets me in the game.

HOWEVER, here are the main issues that came up from the inspection that really concern me:

  • Horizontal cracks in the poured concrete basement foundation on the back and left side of the house with what looks like attempts to patch it with stucco in the past
  • Knob and Tube wiring throughout the entire house (concerned about getting insurance)
  • Galvanized piping for majority of water supply lines (low water pressure throughout house)
  • Leaking roof from chimney (need to install cricket) and fix upstairs unit walls
  • One of the furnace flues is completely deteriorated and needs replaced, currently releasing some levels of carbon monoxide into basement
  • One of the water heaters is from 1992
  • Some water intrusion damage in main electrical panel and one of the breaker panel is a Pushmatic style

These are what I conclude as the big ticket items. Are these TOO many serious issues to still make this a good deal? It seems that this one has hit the mark on all the main issues (foundation/electrical/plumbing/roof). I appreciate any help/advice. I really want to jump in and get started in 2020. But I wonder if I'm jumping off a cliff here.

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          Michael S.
          Huntsville, AL · Member since 2018 · 579 posts · 864 votes
          6y

          @Michael Vu - try this exercise to change your viewpoint on the deal.  Let's say the roof was new, the plumbing was up to date, electrical was to code and acceptable, there are no tenants, and the price tag on the property was $150k.  Would you pursue the deal?  If the answer is no, then you have your answer on your original question posed to the forum.  This property does not conform to the 1% rule if that was your goal (unless you can get the seller to drop the price over $25k).  In addition, the money for the repairs will either need to come from your pocket or a separate line of credit if available (assuming you are financing the deal).  I'd move on to something else, especially for your first deal.  

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          • Corey Chonsky
            Rental Property Investor · Norfolk, VA · Member since 2014 · 55 posts · 30 votes
            6y

            @Michael Vu, I would move on from this deal if it was in my area. Based on the description, the property is around 100 yrs old and a lot of the issues that have been identified are not going away. You will have to deal with them at some point during the time that you own the property and you are not receiving rent that is worth the risk. Are the current rents at market rate or are they significantly below market?

            1Reply
          • Michael Ablan
            Real Estate Broker · Watertown, NY · Member since 2016 · 1k+ posts · 1k+ votes
            6y

            @Michael Vu -  Is that cashflow for BOTH units?

            You'll never be out of the red.  One missed month of rent will wipe out 6 months of cash flow.  Keep looking.  This deal doesn't work unless you're looking at a huge appreciation play.

            3Reply
          • Joseph CacciapagliaBusiness Member
            Lender · San Antonio, TX · Member since 2020 · 1k+ posts · 1k+ votes
            6y

            Are the current tenants significantly below market rents? This often happens when non-professional property managers have long term tenants. If you're expecting a big bump on your first turn, it may still be worthwhile. However, the knob and tube is a big concern. In some areas I've worked, you can't even get a resale C/O without upgrading the electrical if you have knob and tube.

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          • Michael Vu
            OP
            Rental Property Investor · Cincinnati, OH · Member since 2019 · 60 posts · 25 votes
            6y

            @Corey Chonsky Rents have only recently been raised to $600 each. I'd say it's a C area so it is around market rents, may be a little lower due to long term tenants. You're right, it is just about 100 years old.

            0Reply
          • Michael Vu
            OP
            Rental Property Investor · Cincinnati, OH · Member since 2019 · 60 posts · 25 votes
            6y

            @Michael Ablan Yes, that's rent for both units. It's in a C neighborhood so I don't think appreciation is a big play.

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          • Michael Vu
            OP
            Rental Property Investor · Cincinnati, OH · Member since 2019 · 60 posts · 25 votes
            6y

            @Joseph Cacciapaglia I'd say the rents ($600 each) are in the range of market rents for that neighborhood. Maybe 50-100 under. I am very worried about the knob and tube, didn't realize how big of an issue it was until I did some reading. Would be difficult to sell in the future and even if I didn't replace, the insurance premium would eat into my cash flow.

            0Reply
          • Michael Vu
            OP
            Rental Property Investor · Cincinnati, OH · Member since 2019 · 60 posts · 25 votes
            6y

            Is there a point where price negotiation / seller paying for some repair would make this worth it?

            1Reply
          • Joseph CacciapagliaBusiness Member
            Lender · San Antonio, TX · Member since 2020 · 1k+ posts · 1k+ votes
            6y
            Originally posted by @Michael Vu:

            Is there a point where price negotiation / seller paying for some repair would make this worth it?


             There is almost always a point where a price reduction would be worthwhile. You need to get some quotes from contractors, and then see what the seller is willing to do. In my market, it's very common to negotiate additional concessions/price reductions, if and when items like this come up in the inspection.

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          • Michael Vu
            OP
            Rental Property Investor · Cincinnati, OH · Member since 2019 · 60 posts · 25 votes
            6y
            Originally posted by @Joseph Cacciapaglia:
            Originally posted by @Michael Vu:

            Is there a point where price negotiation / seller paying for some repair would make this worth it?


             There is almost always a point where a price reduction would be worthwhile. You need to get some quotes from contractors, and then see what the seller is willing to do. In my market, it's very common to negotiate additional concessions/price reductions, if and when items like this come up in the inspection.

            Which items would you say are the top priorities to negotiate with the seller? I'm thinking plumbing, roof leak, and electrical? 

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          • Joseph CacciapagliaBusiness Member
            Lender · San Antonio, TX · Member since 2020 · 1k+ posts · 1k+ votes
            6y
            Originally posted by @Michael Vu:
            Originally posted by @Joseph Cacciapaglia:
            Originally posted by @Michael Vu:

            Is there a point where price negotiation / seller paying for some repair would make this worth it?


             There is almost always a point where a price reduction would be worthwhile. You need to get some quotes from contractors, and then see what the seller is willing to do. In my market, it's very common to negotiate additional concessions/price reductions, if and when items like this come up in the inspection.

            Which items would you say are the top priorities to negotiate with the seller? I'm thinking plumbing, roof leak, and electrical? 

             I usually try to figure out what the biggest ticket items are. It seems like you identified the major ones. The foundation may be as well. I would try to get a sense if the seller is going to have any flexibility, before I would take the time to get any quotes though. 

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          • Syed H.
            Developer · NY/NJ/PA · Member since 2018 · 758 posts · 935 votes
            6y

            Just some points without knowing your specific market: 

            4% vacancy, 5% maintenance, & 8% capex is laughably low. Especially on 100+ year old buildings & especially if you don’t have scale.

            For buildings like this, you need to go through a whole building’s mechanicals and capex items and estimate a monthly capex number properly. 

            For yearly maintenance, speak to some small local owners. 

                0Reply
              • Anthony Vicino
                Investor · Minneapolis, MN · Member since 2017 · 95 posts · 130 votes
                6y

                I love the mentality of just getting on-base, Michael, so that you can get into the game, but this is looking awhole lot like you're leaning your head into the strike-zone hoping to get hit by a pitch that might do more damage than you realize.

                Somebody else mentioned it already, but what you have budgeted for Repairs, Vacancy, and CapEx just won't cut it on a property of this vintage. Couple that with how little cashflow you'll realistically generate per month and this property just isn't looking so attractive at its current price point.

                And that's to say nothing of the fairly serious issues you've uncovered.

                The plumbing will go bad at some point. It's not a matter of "if", only "when". Maybe you get lucky and it lasts for a couple years until you off-load, but you're always perched on the razors edge and that can lead to a lot of sleepless nights.

                The knob-and-tube is pretty much a non-starter unless the seller is willing to make some pretty serious concessions.

                Roof leaks are never as cheap as you think they'll be (same for foundation issues). On the foundation side, it sounds like you need a professional to take a look and confirm/deny your suspicions.

                All told, Michael, only you can decide how many issues are too many, but from the sounds of it, this has the potential to really go sideways on you quickly.





                1Reply
              • Michael Vu
                OP
                Rental Property Investor · Cincinnati, OH · Member since 2019 · 60 posts · 25 votes
                6y

                @Anthony Vicino I think I agree with you as well. I came into this deal thinking it was going to be a base hit, but with all these uncovered issues, it's starting to look like it will be an ongoing headache / cash killer and not what I had originally planned. Thanks for the break down and advice!

                0Reply
              • Bryan Devitt
                Contractor · Oxford, MA · Member since 2018 · 807 posts · 745 votes
                6y

                @Michael Vu take the deal numbers, get the price for repairing everything correctly and run the numbers with having to fix/replace it all in the first two years because if you don't have the reserves, they will all fail in the first two years. Figure out how much you can pay for the place based on those numbers or what they need to fix to make it work. If they don't want to, move on but there is always a way to make it work it's just a matter of if the seller wants to do it

                0Reply
              • Michael Vu
                OP
                Rental Property Investor · Cincinnati, OH · Member since 2019 · 60 posts · 25 votes
                6y
                Originally posted by @Bryan Devitt:

                @Michael Vu take the deal numbers, get the price for repairing everything correctly and run the numbers with having to fix/replace it all in the first two years because if you don't have the reserves, they will all fail in the first two years. Figure out how much you can pay for the place based on those numbers or what they need to fix to make it work. If they don't want to, move on but there is always a way to make it work it's just a matter of if the seller wants to do it

                Is it better to have the price reduced the amount of the repairs, or to have those repairs paid for? Or is that dependent on how much reserves you'd like to dig into.

                1Reply
              • Bryan Devitt
                Contractor · Oxford, MA · Member since 2018 · 807 posts · 745 votes
                6y
                Originally posted by @Michael Vu:
                Originally posted by @Bryan Devitt:

                @Michael Vu take the deal numbers, get the price for repairing everything correctly and run the numbers with having to fix/replace it all in the first two years because if you don't have the reserves, they will all fail in the first two years. Figure out how much you can pay for the place based on those numbers or what they need to fix to make it work. If they don't want to, move on but there is always a way to make it work it's just a matter of if the seller wants to do it

                Is it better to have the price reduced the amount of the repairs, or to have those repairs paid for? Or is that dependent on how much reserves you'd like to dig into.

                 There is no right answer to that question. Personally I would rather anything major be taken care of and inspected before purchase. Others would rather credit at closing and hope to get it done cheaper once they have possession. Just make sure you have enough in reserves for anything that isn't taken care of because if it is going to break, it will be in the first two years, probably 2 months really but if you count on taking the profit to pay for repairs after a year or something like that, it won't make it until when you planned. 

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              • Nick Rutkowski
                Rental Property Investor · Ithaca, NY · Member since 2015 · 1k+ posts · 1k+ votes
                6y

                @Michael Vu

                I’m dealing with a house like that now. It’s taking a long time to fix and rent out costing me money. The less major repairs, the less time, stress, and money you spend. On the other hand, you’ll gain experience and wisdom making those big ticket repairs. Either way you’re in the game, time to make it work for you!

                1Reply
              • Matt Vezina
                Rental Property Investor · Bennington, VT · Member since 2017 · 79 posts · 60 votes
                6y

                Every problem except location has a price tag to fix, so there is a number that will work for this property.  That said, it looks like your offer is based on the  1% "rule" considering the $120k contract price against $1200 a month rent.  If you offer 1% of rents on a property in need of major rehab you are likely to massively overpay.  

                As best I can tell from your description it sounds like this property needs to be vacated and gutted to fully address the issues.  The presence of knob and tube wiring and galvanized plumbing "throughout" is difficult to fix with tenants in the apartments.  With problems of this magnitude I would prefer to negotiate a price reduction rather than have the sellers fix anything.  It's been my experience that sellers find the cheapest way possible to do inspection repairs, which may not be what you want with the electrical and plumbing.  Also, I doubt they would be eager to go out of pocket for the major repairs needed while still under contract.   Based only on your description, if this were my market I'm not sure I'd even be comfortable paying 50% of the current price at those rents. 

                I am currently wrapping up gut renovations on the three unit I bought for my first property.  It has taken way longer and cost way more than I ever could have anticipated.  Because I DIY as much as I can I'm coming out of it OK with a good chunk of sweat equity, but this house would have nearly bankrupted me by now if I were hiring contractors for everything.  So it's definitely possible to be successful starting out with a property like this, but you are signing up for the School of Hard Knocks approach vs. getting your feet wet with something in better condition.  

                3Reply
              • Andrew SyriosPro Member
                Moderator
                Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
                6y

                I would think of it more in terms of what will it cost to address those issues and where will you stand afterwards. Don't think of purchase price but total price (purchase + rehab + holding/closing costs) and run your numbers off of that. In this case, replacing the knob and tube and addressing the foundation cracks, leaks and other issues will add up to a pretty sizeable rehab and probably makes it not worth it. But if the market value for such properties is, say, $200,000, then maybe it still is worth it. 

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              • Michael S.
                Huntsville, AL · Member since 2018 · 579 posts · 864 votes
                6y

                @Michael Vu - try this exercise to change your viewpoint on the deal.  Let's say the roof was new, the plumbing was up to date, electrical was to code and acceptable, there are no tenants, and the price tag on the property was $150k.  Would you pursue the deal?  If the answer is no, then you have your answer on your original question posed to the forum.  This property does not conform to the 1% rule if that was your goal (unless you can get the seller to drop the price over $25k).  In addition, the money for the repairs will either need to come from your pocket or a separate line of credit if available (assuming you are financing the deal).  I'd move on to something else, especially for your first deal.  

                4Reply
              • Stephen KeigheryBusiness Member
                Rental Property Investor · New Orleans, LA · Member since 2018 · 717 posts · 555 votes
                6y

                @Michael Vu It sounds like the deal is already marginal so if the terms remain the same I wouldn't move forward on this. The issues you described can all be solved with money so you could give the seller the option of you walking during the inspection period or purchasing at a lower price.

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              • Bill F.
                Investor · Boston, MA · Member since 2015 · 1k+ posts · 3k+ votes
                6y

                @Michael Vu

                On buy and hold deals like this, I'd look at it through the lens of all four means of wealth generation: cash flow, appreciation, debt pay down, tax savings. Only you can answer the later. 

                 The cash flow number is so close to $0, that for the sake of argument let say it is $0 since some months it will dip negative and others will run into the black. If it nets out positive, that's a bonus. As time goes on, rent growth will outpace expenses, but you also don't cater to the tenant class that is the easiest on rentals. 

                100 yr old homes in C class neighborhoods in the rust belt are a dime a dozen, so unless there is a seismic shift supply and demographic trends, I wouldn't bank on appreciation above the inflation rate of 2%. 

                All we have left is debt pay down. As a benchmark, lets assume you hold the asset until the end the loan. Assuming no upfront repairs, you'd have an outflow of $24k and 30 yrs later get $217k ($120k grown at 2% for 30yrs) gives you a Compounded annual growth rate of around 8%. Taking out inflation gives you a real return of 6%. 

                Not bad, but not great. we know there are repairs to be done and that will make the the return go down. So the question is, who will pay for what repairs and how much will they cost. This is where the skill comes into play being a REI. It looks like anything over $10k in repairs out of your pocket cuts returns in half.

                Now this isn't meant to me an accurate model, just a back of the napkin SWAG to let you ask the question: Is 6% worth the risk? If yes, what level of repairs will make this deal not worth it? 

                2Reply
              • Steve Vaughan
                Rental Property Investor · East Wenatchee, WA · Member since 2014 · 10k+ posts · 16k+ votes
                6y
                Originally posted by @Bill F.:

                @Michael Vu

                 The cash flow number is so close to $0, that for the sake of argument let say it is $0...
                100 yr old homes in C class neighborhoods in the rust belt are a dime a dozen...

                This.  I have a couple old buildings. Without appreciation or cashflow?  No way.  The roof, electrical, Windows, sewer, etc are persistent pains. 

                A 1%er in my market is unheard of, so I would approach much differently than in Cinci. This is a vanilla MLS offering, right?

                I'd find something else, preferably off-market.   How hard is it to pluck a 1% C class building from the air in Cinci?  My guess is not hard. 

                I'd step up to B class if you're just MLS shopping. Save the C for a motivated old landlord that sweetens the deal with financing like mine did.

                1Reply
              • Kris L.
                San Antonio, TX · Member since 2019 · 930 posts · 836 votes
                6y

                @Michael Vu

                Too many issues for me for $125/mo. Something like this I would probably need 5x that amount up offset these risks.

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              • Pete Storseth
                Investor · Houston, TX · Member since 2019 · 274 posts · 61 votes
                6y

                @Michael Vu

                I heard somewhere you can add specific contingencies where some of the big ticket items can either be used to lower the purchase price or even be put into the purchase agreement as warranty items. Examples- if the roof is more than half its life, they may either lower the purchase price, make an insurance claim to replace the roof before closing, or pay for it themselves well after selling via warranty clause. Or if the HVAC is older, same three options- lower price, replace themselves before closing, or be liable for the repairs when something comes up. Just a thought.

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