Rental Property Investor · North Texas · Member since 2014 · 13 posts · 16 votes
Hi BP!
I currently have one rental property (primary residence turned rental) and this will be my true investment property purchase and wanted to make sure I'm on the right track.
Anyway, my agent who is also a builder/investor is selling his 3 years old duplex (1450 sq ft, 3bd/2ba per unit) , built ground up with all new/relatively high end amenities (tiled bath, quartz tops, custom kitchen, laminate everywhere). This is in north Texas so cash flow is typically weaker than other regions.
Here are the numbers:
Purchase price: $300K Closing: $5K Down (20%): $60K Rental Income: $1250 per unit ($2500 total)/ mo
There are no comps for a new duplex so I've analyzed a few single family homes with similar square footage (1300 to 1600 sq ft range) and most of them perform at around same or slightly lower CAP and CoC rates.
I know the numbers aren't too strong but I believe that I can consistently get high quality tenants and can easily utilize one of the units as a short term rental because of the nice finishes. Also this is the perfect house hack duplex for other buyers in the future (My wife refuses to house hack so no go for me)
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
5y
Here's what you have. A property that cash flow $4140/year and a cost to you of $65k (DP = C.C.). That means it will take you 15 and a half years, assuming no problems that add more out of pocket costs to you, before you recover your cash...and start making a profit. That's a looooong time to break even.
If a real estate agent is involved in helping you buy an investment property it’s almost always a mediocre or lousy deal . If you want a great deal you gotta get belly to belly with the seller . An agent is a just a salesman and their job isn’t really to “help deserving families find beautiful homes “ their goal
Is sell at highest prices to get maximum commission . You’d be naive to believe otherwise .
Steve that’s an awesome looking deal. I can’t find a deal that good around my area at the moment. If you can quickly get it rented out that’s a cash cow. I would say run the numbers two and three times over just to be completely sure your not missing anything. My advice, I would definitely go for it.
He's selling because he's building his dream forever home and needs cash.
There are handful of other properties that are performing at >10% CoC are at least 50 years old and are all very outdated and in C class neighborhoods which I assume will have significantly larger maintenance/CAPEX costs and lower quality tenants.
So I guess my question is, how do you factor in the age of the property and its higher end finishes?
***
I think you have to make a decision: do you want less risk (maintenance issues) and less return (ROI)
or
Do you want to put in more money, effort and time into the property initially to make a higher return and more initial equity?
At $300k
Can you find a duplex in this better area that's a fixer for $200k? (if the answer is yes and you can renovate them both with 50k (25k each unit) and now you can compare apples to apples) the renovated fixers will now have newer systems and less maintenance for almost the same time that the new construction ones. If these numbers are ridiculous in this market - then you can choose to go for the the opportunity presented by your realtor.
But if the numbers are reasonable, then spend some time and effort looking for them. There should not be any rush: enjoy the process.
Further more: this is the deal he is presenting: does not mean that you cannot negotiate. He will not be paying commissions to close- is that factored in?
and have you seen comps for new construction homes (duplexes) in that area? How do they compare?
Food for thought.
At the end of the day- if you keep these units for 10,15,30 years... this conversation would be irrelevant and a waste of time lol
Your units will appreciate over time and you will pay the mortgage down. You will either make a good investment or a great one. Either way you are winning!
I think of real estate assets similarly to stocks and bonds.
For example:
Highest risk - requires high expected short term return to consider deal
Penny Stocks > D class properties in bad areas with large vacancy/non payment risk and low appreciation potential or potential decrease in value
Medium Risk:
Growth Stocks - B or C class, medium aged assets in average quality neighborhood with low vacancy - property maybe has some deferred maintenance or major systems nearing end of expected life - probably will be a little smoother ride than the high risk ones, you'll likely get some appreciation long term but have some updates to deal with in the near future.
Low Risk
Bonds - Best/safest assets in a market - highly desirable neighborhood/school district with strong, diverse job growth, high quality building that's newer or has has had a full cosmetic and mechanical rehab. These properties will likely have lower vacancy, higher rent increase potential and in some cases may not need any capex items for years.
The return you expect in terms of cash depends on which category you fall in. If it's in a low risk area, it's unlikely you'll hit the 10% COC return in todays market. Not familiar with your area but around here it's very hard to get those numbers on a high quality asset but that doesn't mean that you're a fool for purchasing due to all the other ways you can make money.
For example - If your duplex falls into the high quality/low risk category, the low cashflow on those low risk assets is offset by a variety of things:
Appreciation potential 300,000 * X%
Principal reduction $6500 in year 1 assuming 3% mortgage for 25 years
Depreciation: your $4500 of income is offset by $8700 of depreciation leaving you with a $4000 passive loss assuming your land is 20% of the value. This may be able to be applied to your W2 income or carried over to future years when your rent goes up or you pay off the property.
Therefore, before factoring in any potential appreciation your actual internal rate of return is:
$4200 cash (would need to be a return of closer to 6000 in taxable investment vehicles)
$6500 of principal reduction
$4000 of passive loss which is worth 4000 * your tax rate in either this years taxes or a future year. let's assume 25% and assign this a value of $1000.
Therefore, with 60K down, you have $4500+$6500+$1000 = $12,000 of value generated before any appreciation which is about a 20% internal rate of return. There are some caveats i.e. principle reduction isn't liquid and only a benefit if values don't decrease, things like depreciation are recaptured at sale and you pay some tax then but if you're in a high quality market, buying and holding for the long term, etc it may still make sense to consider below the 8% CoC level if your confident in your numbers and have appropriate reserves. The low risk assets are a longer term plan and probably not ideal if you're goal is to generate max cashflow now but could be good if your goal is to generate max wealth 20 years from now. It's up to you to make that determination given your situation, market, and long term goals/cash flow needs but thought I'd share a perspective and some metrics I don't see shared as often on this site.
...or, instead of rationalizing a bad deal, look at it this way.
He's paying $60k in cash, for $4000/year, for 15 years. That means he is in the negative for 15 years. The $4k per year isn't a profit/gain, it's a reimbursement on the $60k cost. Saying there is a 20% IRR just masks the losses. It's simple math, as in plus/minus applied to dollars. Percentages just lie to you. Here's what I mean:
$60k in cash goes in (cost) and after 1 year, we are $56k behind,...year 2, $52k behind,...year 3, $48k behind...and...
I'm sure that over those 15 years there will be added costs/rehab that will have to be done, which just adds to the total cost behind at that point, pushing the net backwards even more.
Now before you say "what about appreciation", I will tell you that appreciation isn't cash. It's not real until you can use it. Until then, it's an imaginary number that has value in the future, but not now. What if, and I know this has never, and will never happen, the property values drop...or remain stagnant for a year or two? What kind of control do you have over appreciation? None. You do have control over cash, and the ability to invest it...while you are waiting to get access to your equity.
As equity grows, it grows at a 1 to 1 ratio, meaning every dollar of equity is equal to each added dollar in property value. As cash, it has a 1 to 5 ratio, meaning every dollar in cash, reinvested, has a property value of 5 dollars. So the longer it takes you to get your cash back from the "paid for equity", the more that cash is sitting dead...and NOT returning a $5 on the $1.
Oh, and if you insist on percentages, that's not a 20% Internal RR, it's a 500% External RR.
Rental Property Investor · Camas, WA · Member since 2020 · 284 posts · 202 votes
5y
@Steve Kim
Thanks for this question as it has added a lot of awesome discussion.
As for how to factor in the age and finishes:
Age of home is a factor. A younger home can have many advantages as you point out lower maintenance costs as well as avoiding things like led based paint and asbestos.
Finishes- this is actually a double edge sword. You never defined the neighborhood for this property but did point out comps in a C class so I’m assuming this is B or better. Nicer finishes attract better tenants to some extent but also cost more to maintain and replace as a property ages. Also a really nice house in a not so nice neighborhood isn’t likely to draw the right type of tenants to keep up those nice finishes.
Finally. If your friend is really only looking for cash and has equity in this property consider a deal that would allow you less out of pocket capital with additional gains for both. Possibly a seller carry of some portion of the down payment that would allow you not to pay PMI and utilize the cashflow, if there is any offer the tax situation pointed out, to pay him a shorter term loan. That could dramatically increase your COC and leave you cash in hand for either other deals or reserves for this property.
Just to clarify, I'm not saying to go for a marginal deal, rather that I don't know this particular local market to know whether this is good or bad and trying to say that in some circumstances a 6 or 7% COC isn't necessarily bad (around here I'd be looking hard at it). I agree with all points about looking at comps, saving on commission, negotiating down on price but depending on @Steve Kim's goals and the local market climate, rejecting this deal solely off of the CoC return % may not make sense. My math I shared above assumes zero appreciation as I think things will level off in the next few years if rates go back up.
If this is @Steve Kim's first multi family, he has a plan to hold long term with long term fixed debt, likes the location of this property and has a day job he likes/doesn't have time or interest to invest in tons of direct marketing or investing out of state then this may be worth considering as his first multi-family. Especially if he confirms he can get it for a fair or better than fair price for the market and validates his costs (including budgeting for increased taxes and capex which he already included at 10%). In my market, an off market deal like this is usually worth looking hard at, if only for the fact that you can take your time and don't have to complete with 5 other buyers who have all cash and offer over asking once it hits MLS (all listed decent multi family around here is under contract in a matter of days with multiple offers). Even if not the best deatl possible, this would likely beat the alternative of earning .5% in a high yield savings account in a 2%+ inflation environment.
When I think of CoC return, I think of it no differently than you would if buying dividend stocks. You buy the shares (equity) and then get the dividends (rental income) and have the potential for appreciation just as a stock that could go up or down (similarly not realized until sale) but unlike dividends that are immediately taxable, you get to wash out all taxes in this case and then some using depreciation and also get the ROI enhancement due to leverage from the principal reduction component when compared to buying shares of stock outright (as opposed to on margin).
@Steve Kim What I would do is check the assessments of newly sold (2019) multifamilies in your appraisal district to see what they are paying. So, for example, if there's been a couple of duplexes in the $250K-$400K range sold about 12-18 months ago, you'd want to see what they're paying now and how far off their appraisal is from what you think their market value is.
The only 2-4 units in town are 70+ years old and are in C-/D neighborhoods ... so no real comps at all.
He said the price was based off of price per sq feet of single family homes in area. The most recent home that was sold with very similar amenities sold for $135/sq ft so the seller is saying I'm already getting a discount at $104/sq ft.
Rental Property Investor · Wichita Falls, TX · Member since 2014 · 9 posts · 0 votes
5y
If you are in Wichita Falls and they appraise you at the $300,000 range your taxes will be around $7660. The bigger news is that Wichita Falls in November 2020 passed the largest school bond in history. That will be raise it even further.
Rental Property Investor · Valley View, TX · Member since 2018 · 174 posts · 87 votes
5y
@Steve Kim If he's basing a multi-family property's value off of single-family home values, that's a red flag and a guarantee that he's priced too high. I'd be suspicious of the $104 off of $135 comparison. First, is $135 actually accurate for nearly new construction. Second, is a 30% discount from sfh valuations justified.
Lender · Vancouver, WA · Member since 2015 · 482 posts · 316 votes
5y
@Steve Kim
Here is what I see based on feedback and my own comfort level.
Income per month = $2,500. Vacancy of both units 1 mo = $208. Tax = $500. Cap ex = $250. Debt servicing = $1,030. Insurance = $100. Net = $412. If you don't self manage then subtract another $250 per mo for $162 net.
If you get a conforming loan you need to put down 25%, or $75000. Add in realistic closing costs of $7,500 all divided by $412 = 200 payments to get your money back.
If you house hack with a 5% down of $15,000+cc of $7500 = $22,500. Though you have an added expense of PMI $206+/- per month, so net is $412-$206 = $206 net per month. But because of lower down, break even point is 109 payments or 9 years. And if you use a property manager, you never break even on it. 9 years is a long time to break even imo. And the variable I didn't change is the debt service although it should be assumed to go up, which will lower net and pushes break even point.
How can this deal be improved? Lower purchase price, or use seller financing. Or the only win here may be appreciation, if it exists.
Lender · Vancouver, WA · Member since 2015 · 482 posts · 316 votes
5y
@Steve Kim
It's your money, take what the Seller says with a grain of salt. With Seller quoting why you should buy with $/sqr ft. that's the salesperson in them. If you think its a good deal based on your numbers, then buy it. Otherwise don't.
You've been given some great advice. Some other things to think about.
If your seller is the agent and also the builder, the seller should have equity and room to negotiate, terms or price. How motivated is the seller?
I know the high end trim and appliance level is appealing but when the time comes to fix, it's not cheap to maintain to the same quality.
If you tie up your money in this deal, can you continue moving forward in your real estate investing or are you stuck for five or six years? If you are stuck, I'd pass.
Investor · Fort Washington, MD · Member since 2014 · 1k+ posts · 1k+ votes
5y
There are tons of varying perspectives here and so many aspects are going in multiple directions. Sometimes things are over analyzed. Also, you can't apply one mindset or cookie cutter philosophy to every situation because it's not a one size fits all. The notion of breaking even or not paying down debt for several years actually depends on how you look at it. Yes, when I pick up a 30k unit in Baltimore I may try to throw all profit to it to pay down the note in 5 years. If it's a matter of paying down 60k it won't apply in my book. Make sure you have somewhat of a decent return on what you do put in, but your down payment didn´t get sucked up into a vacuum cleaner. It didn't go anywhere because it's your equity so you can't be breaking even or losing from that aspect since you never relinquished anything In addition, you have someone else paying down that debt service, dropping tens of thousand of more equity in your lap. This could be a mediocre deal or a great deal depending on several characteristics. If this was in a place like Hagerstown MD I wouldn't touch it. If it were in DC it could be a massive slam dunk. You have to evaluate several things like the community, asset class, equity plays, interest rates, amortization, appreciation, rent increases, tax benefits and so much more. I give you props for jumping out there and executing. You have to start somewhere and for many it's the hardest part of the process. Just really think about it and how it fits your personal goals and investing strategy. If it fits and you feel it will be a sound and stable asset for some time I'd say go for it. I wish this had been my first play because I would have been much better off acquiring a haunted house! Congratulations and best of luck.
Real Estate Agent · Palm Coast, FL · Member since 2018 · 39 posts · 10 votes
5y
@Steve Kim I would go look at the older C class buildings and update units to increase the overall value of the property and then refinance. Don’t pay for the previous owner over priced improvements. Don’t be quick to dismiss low end rentals. Looks like affordable housing is about to be the the hot commodity and new normal heading into 2021
Here's what you have. A property that cash flow $4140/year and a cost to you of $65k (DP = C.C.). That means it will take you 15 and a half years, assuming no problems that add more out of pocket costs to you, before you recover your cash...and start making a profit. That's a looooong time to break even.
Hey Joe. I see your posts a lot on the forum and I like the feedback you give. What do you consider a reasonable amount of time for an investor to recover their cash in an investment to break even as you stated?
Here's what you have. A property that cash flow $4140/year and a cost to you of $65k (DP = C.C.). That means it will take you 15 and a half years, assuming no problems that add more out of pocket costs to you, before you recover your cash...and start making a profit. That's a looooong time to break even.
Hey Joe. I see your posts a lot on the forum and I like the feedback you give. What do you consider a reasonable amount of time for an investor to recover their cash in an investment to break even as you stated?
It depends on your REI plan. This will be different for everyone. This will always be based on where the cash will be going next.
@Joe Villeneuve How do you go about getting that capital back in 2-3 years? Whenever I analyze a property it usually takes at the minimum 8 years to my initial investment back.
...Think always in terms of compounding returns, and make sure every decision you make follows that principal. Never spending your "seed money"...use it to infinity, buy never spend it. Realizing that REI is mostly a math problem, and then spend all of your time on the left side of the equal sign.
@Joe - What do you mean by never using your seed money? Are you describing the capital an investor would use to purchase property? For instance, I have $30k cash and I plan on buying a $100k property. In this case the $30k is my seed money right? If so, it sounds like utilizing the BRRRR strategy to be able to keep all of your seed money.....so you can put that cash to work elsewhere.
It depends on your REI plan. This will be different for everyone. This will always be based on where the cash will be going next.
After I sent this reply, I saw where you responded to someone else and said 2-3 years for you is the goal, but 5 years max. That's around the same amount of time that I have been considering in my mind as well. Ideally, I want to BRRRR properties. If I can't, I do want to recoup my "seed money" as fast as possible. To me, that would be 2-3 years. Like you, to leave my money in a deal for more than 5 years, then there needs to be some other type of upside to the deal.
It depends on your REI plan. This will be different for everyone. This will always be based on where the cash will be going next.
After I sent this reply, I saw where you responded to someone else and said 2-3 years for you is the goal, but 5 years max. That's around the same amount of time that I have been considering in my mind as well. Ideally, I want to BRRRR properties. If I can't, I do want to recoup my "seed money" as fast as possible. To me, that would be 2-3 years. Like you, to leave my money in a deal for more than 5 years, then there needs to be some other type of upside to the deal.
BRRRR isn't getting your own money back and reusing it. If it was, you wouldn't have to pay for it with each new refi. Brrrr isn't an exponential return either...it's linear. What you want are exponential returns.
BRRRR isn't getting your own money back and reusing it. If it was, you wouldn't have to pay for it with each new refi. Brrrr isn't an exponential return either...it's linear. What you want are exponential returns.
How is BRRRR not getting your own money back? Since BRRRR isn't, can you explain what is? How would one get exponential returns?
BRRRR isn't getting your own money back and reusing it. If it was, you wouldn't have to pay for it with each new refi. Brrrr isn't an exponential return either...it's linear. What you want are exponential returns.
How is BRRRR not getting your own money back? Since BRRRR isn't, can you explain what is? How would one get exponential returns?
When you refinance, your money is still in the original house, and being used as collateral for the new money the lender is "selling" to you. If it was your money coming back out, you wouldn't have to pay for it (interest, fees, etc...) again.
Focus on a few different ways of thinking:
1 - Exponential returns are based on never spending your seed money, but using it to infinity. 2 - When you flip, you're flipping your cash...not properties. Every time you flip your cash, you get your cash back with "friends". When you reinvest/flip your cash plus the friends, you get your cash back again, plus the first friends, plus new friends. 3 - Your cash should be restricted to the DP only. That's paid for equity, and equity is just a form of cash that is temporarily dead. 4 - New equity, that comes from YOUR TENANT paying down you mortgage, and appreciation, is free. 5 - Your paid for equity has a true value of $5 for every $1 of cash you put in, which is represented by the 20% DP. That's 20% of the value of the property. 6 - The new equity (#4 above) comes in at a $1 to $1 value. 7 - As the new/free equity adds up, the potential "cash value" is also adding up, but is useless so long as it remains as equity...dead cash. 8 - Flipping the cash/equity, ir selling the property, retains the same equity...you're just moving it to a different location(s). 9 - When the equity is released (#8 above) into the real world, it goes from the 1 to 1 value as equity, to a 5 to 1 value.
Example: $100k property originally paid 20%DP ($20k); Cash flow = $5k/year; Avg. appreciation 10%/year A - PV = $100k; Equity = $20k = your cash in the deal B - After 1 year: PV = $110k; Equity = $30k; CF = $5k/y C - After 3 years: PV = $133k; Equity = $53k; CF = $5k/y; ACCum CF = $15k D - Sell property for $133k E - After C.C., cash available = $45k F - Buy 2 properties just like the original G - Total # Properties = 2; Total PV = $225k; Total Equity = $45k; Total CF = $10k/y H - After 2 years (total of 5): PV = $275k; TE = $95k; Total CF = $10k/y; Accum CF = $35k I - Sell properties J - After CC, cash available = $80k K - Buy 4 properties just like the first one L - Total # Properties = 4; Total PV = $400k; Total Equity = $80k; Total CF = $20k/y
M.....rinse and repeat...
Alternative: Keeping original property building up equity an accumulating CF A - Total # Properties = 1; Total PV = $100k; Total Equity = $20k; Total CF = $5k/y B - After 5 years (where the first example ended): Total # Properties = 1; Total PV = $161k; Total Equity = $81k; Total CF = $5k/y C - After 10 years: Total # Properties = 1; Total PV = $260k; Total Equity = $180k; Total CF = $5k/y; Accum CF = $50k
Specialist · Los Angeles, CA · Member since 2018 · 291 posts · 231 votes
5y
@Sebastian Marroquin people don't only sell bad investments. I'm in escrow currently selling a single family home in Southern California that after management is a 10 cap rate. In an appreciating market I believe in. I'm selling because of the velocity of money. I have made over 300% on my money in 13 months after tax. If I leave the money in the property I could keep 30%+ IRR with 0% appreciation but I know I can get 100% plus if I move it. I'm also a full time active not passive investor so that changes things.
