buy and hold, flip, or emotionally attached?

Question

A neighbor urgently needs to sell their home due to medical issues & moving out of state. They want to sell for around $235,000. It’s a 2 bed / 1 bath historic home near central Phoenix, AZ. My home is also historic & I’ve done a lot of work on it, which I don’t mind. The home needs work, maybe $15,000 in repairs. A recent appraisal was $275,000 in it’s current state. Homes in our neighborhood that are move-in ready sell for around $310,000, so it seems to be a good price. I want to get into the real estate business to own rental properties long-term. I want to offer $220,000, make the $15,000 in repairs and rent it for around $1,650 per month. Cashflow will be about $60 (Mortgage $1,143 – Taxes $183 – Insurance $80 – Vacancy 5% $83 – Repairs/Maintenance 3% $50 – Management Fees 3% $50 Total Expenses $1,589). This looks good for the area and I want to hold onto it for the long-term as well as acquire more properties each year.

The problem I am having is financing. I can get a hard money loan for the few months it takes to rehab the property. But when it comes to refinancing, how can I refinance it?

My debt to income ratio is already being used up for my own home’s mortgage and student loans, so it doesn’t look like I could afford another mortgage unless the new properties’ rental income is counted. I talked to a lender and they said in order to count rent as income to help with financing I need a 1 year rent history of a property.

I plan to open an LLC to establish a rental property business. I am willing to get very creative and I know I’ll probably pay more because it is my first property.

Is there some way to count projected rental income as income?

Could I get a renter in during the hard money loan period and extend it for a few months to prove income to take to a bank?

Should I bring a plan to a regular bank to see what they might do before I get under contract?

Joe Villeneuve · Answer

No...every house doesn't have a deal.  That's a very romantic saying...but totally unrealistic.

You're right about it being a numbers game, and the numbers with $ in front rule the game.  Don't argue with them, or you'll lose.  Trying to make a deal that doesn't exist, is a form of arguing...and this property qualifies as one he77 of an expensive argument.

What do you base reduction in rehab from $15k to 5k?  You're not going to save $10k (2/3 of the cost) by doing it yourself.  Was the original number accurate or a guess?

How did you arrive at 3% Management fee?  Try 10%...and eventually lower when you have a volume of properties.

To calculate the maximum offer price, you start with your rent, and work your way back from there to the max. monthly payment.

Here are your expenses:                                                         Rent:                   $1650Taxes       $183                                                                         TOTAL Exp   -           828Ins              80                                                                         Max Mort Pmt     = $822Mngt         165                                                                      ..... assuming 20% down, 4% over 30 yearsTOTAL    $428                                                                       Max mortgage   =   $172,000 ($821/mo)Min CF   $400  (always pay yourself first, or why bother)     Max offer = $215k - $15k (rehab) = $200k - closing costsTOTAL    $828

Cash on cash return calculation:  (Your profit doesn't start until you've recovered all of your costs (cash you put in)Cash in:  $43kCash recovery (CF/yr):  $4800Number of years to profit:  12 years  (way too long)

My goal for CoCR is 2 yrs or better.  By the time you hit 12 years, you will be out of pocket for at least one (or 2) roof, 2 kitchens, 4 paint jobs, 2 new floors, driveway, and other misc items that will add up.  All of these items add to your out of pocket, and will move the "profit needle" down the road even more.

The two most expensive terms a REI uses, are "rationalization" and "emotion", and when the two team up against you, you lose big time if you can't fend them off.

Sometimes the best deals are the ones you don't make.

Wes Blackwell · Answer

@Joel Carrasco

Here are some recent nearby leases in that part of Phoenix to give you an idea of what you can get:

2/1 -- 1132 sq ft -- $1395/mo

3/1 -- 1073 sq ft -- $1500/mo

3/2 -- 909 sq ft -- $1650/mo

3/2 -- 1253 sq ft -- $1850/mo

2/1.5 -- 1580 sq ft -- $2,650/mo

The sq ft of the property and it's condition after remodel will be your biggest deciding factor in the rent you'll be able to get. I've got a good lender referral if you need one. Best of luck.

Joe Villeneuve · Answer

The problem you're having is thinking this is a good deal.  It's not.  It's a terrible deal.  Even if you got it for $220k, and you got financing (thank the bank for NOT giving it to you) with 20% down, you would be spending $44k and only getting $720/year back.  That means it would take you 61 years before you broke even.

This is NOT a rental property...in any way shape or form

Wes Blackwell · Answer

@Joel Carrasco

I'm assuming this is in the Encanto area of Phoenix. If you're on the west side of 15th & 17th Ave there is only one 2/1 that sold in the last 6 months. Went for $361k in November, but it was 1,372 sq ft (large for a two bedroom).

So depending on the size of the property, it seems the upside potential is there. Challenge is the ability to refinance. Definitely want to talk to a lender and see what's possible. Also, I'd recommend reaching out to any close friends or family members who may be able to co-sign with you and make financing possible.

Another potential option would be to move into this new property and rent out your old one, as that would help your debt-to-income ratio. You could always move back into your old home after a year if you prefer that one better.

Joel Carrasco · Answer

@Wes Blackwell similar location and size to the recent sale you shared, thanks for digging that up.  Appreciate the advice on the financing, we are going to talk to lenders and family/partners as our next step and simultaneously running numbers again to squeeze this as much as possible before making a final decision.  Thanks again for your feedback and support!

Joel Carrasco · Answer

@Joe Villeneuve appreciate your feedback, considering the numbers we’ve provided, reducing repair costs to $5k assuming we can do repairs ourselves) what purchase price would make this a buy and hold deal?  I heard and read that every house has a deal it’s just a numbers game, so I’m curious where you think the threshold is?

Also any input on the financing question, thanks!

Joe Villeneuve · Answer

Please don't buy this property?  Your original question?  The answer is "emotionally attached".  If the ARV numbers are correct, and your rehab numbers are also correct, this is a flip property...ONLY!!

buy and hold, flip, or emotionally attached?

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