Been awhile - 2nd REO what do you think?

Question

2/1 bath on crawl. Little under 900 sq ft. Very nice area with great schools and other nice smaller homes. Bank is listing it for 39k and we'd offer 31k. The only rehab we can see that it will need that is more than minor is the kitchen was gutted. Meaning it has no cabinets, counters, sink, fridge, stove, or dishwasher. All the plumbing is there and good shape. Also they took all the ceiling light fictures. The carpets are in good shape and just need cleaning. Walls in good shape though we will probably repaint. A/C unit is there, newer hotwater heater and furnace doesn't look ancient. Has a utility room with W/D hookups. Electrical looks updated. Windows look newer. Roof in good shape. Overall it's a really nice little home. It also has a 1 car garage detached.

Homes in this area of town and this size look to be selling for around $60-$70k. Our plan would be to probably put in another $6-8k for the kitchen and other minor things and rent it for $575-$650/month.

Does that sound like a decent deal? I don't think it's a great deal or a steal. But I do think in 10+ years when it's paid off we would be look at retirement income from it as a rental.

Homes in this area of town and this size look to be selling for around $60-$70k. Our plan would be to probably put in another $6-8k for the kitchen and other minor things and rent it for $575-$650/month.

Does that sound like a decent deal? I don't think it's a great deal or a steal. But I do think in 10+ years when it's paid off we would be look at retirement income from it as a rental.

Jon Holdman · Answer

If taxes, insurance, and maintenance (assuming about $55-60 month maintenance allowance) add up to $300, then you're going to be well over the 50% rule.  I infer you're saying taxes and insurance are $250 a month or so.  You will have other expenses, like vacancies, tenant damage, legal fees, roof, furnaces, etc.  Doesn't matter if all these are brand new right now.  If you're in this for the long term, they will all eventually need replacing.

Assuming your taxes and insurance really aren't $250 a month, and that you can stay with the 50% rule, that gives you $3300 a year in cash flow.  Divided by the $39,600 invested is a 8.33% cash on cash return.  Better than CD's, but you're taking on a lot of risk and hassle for a pretty mediocre return.

The reality is that as a cash investment, real estate is rarely a good investment.  Its the power of leverage that makes it worthwhile.  Set up a spreadsheet with different down payments and compute the cash on cash return.  Even though you pay interest on the debt, you'll likely find the cash on cash return is higher with some debt.  Buy three houses, each with 25% down plus closing costs, and you'll probably have a higher return.

Steve L. · Answer

Kel - if you read some of the other threads, what is advocated by many of the full-time landlords here:

1. 50% rule in expenses AKA 50% of the rent is allotted for all expenses.

2. The remaining 50% is allotted for a mortgage on all capital invested at 7% over 30 yrs.  After paying that they want $100 or more per unit left over.

The reason you are getting negative feedback is the deal does not meet those requirements.  Those deals are out there you just need to keep looking.

These numbers are quite conservative, but they have been backed up with real numbers quite a few times.

As Eddie said, if you ended up doing this deal it probably wouldn't end terribly, but if you keep looking there are probably better deals out there.

Eddie Ziv · Answer

In the sea of nay sayers, I would be the one who would say yes.  although they are all right, mathematically speaking, there are couple of elements to be consider as well. You said that your offer is about half of the on-going properties prices in that neighbourhood. If this is correct then you are by far already ahead . Also the longer you keep it the better it is for you from appreciation stand point providing that this is a desirable neighbourhood. I disagree with the notion that leveraging is always the best. In today's market, cash is king and you can get a much better deal with cash. Also, you save on interest. Now, if you - like me - believe that hyper-inflation is on the way, then fix rate loan does make sense however, for such small amount it is hard to get a conventional loan. In any case, inflation also means higher rent and higher value of the property.
One more point. If you seriously consider buying that property, hire a good home inspector just to make sure that all your assumptions are right. Whether you end up buying the property or not, it worth the $300-$350

Good luck

Will Barnard · Answer

Plus, on top of what Jon stated in his example, you would have three houses to appreciate over time & three houses to use as depreciation deductions.
Leverage is power when used appropriately and responsibly.

Will Barnard · Answer

Kel, going by the 50% rule, if your gross rents monthly are $575, then your NOI (net operating income) before any debt leverage is the same as your monthly expenses which = $287.50
Now you have to allow for your acquisition of $39,000 at 7% interest = $227.50 interest only! That means your cash flow is only $60 monthly less any principle paydown if you don't get an interest only loan.

You need to have better rnets or lower acquisition costs to get to the $100 per door cash flow target most of us investors want/need.

Jim -  That is great! You have a great investment. If you get more and can't take them all down yourself, let me know, you can assign them to me or we can set up a double close so you can make some wholesaling money.
I'll be happy to keep my mouth shut as to where it is and would even sign a doc stating that if you like.

Kel S · Answer

Thanks guys. I guess I still don't "get it". Let me give you an example:
          
          House purchased for $31k
          Repairs: $8k
          Total invested: $39k
          
          Rents for: $575
          Minus taxes, Ins, maintanence:  - $300
          Total: $275 a month
          
          $275 x 12 years = $39,600
          
          Taking into account that there may be several months in between tenants when it's vacant. So add a cushion of 3 years for payback of our investment. That is still puts it free and clear by the time we hit 55 years old. Any positive rent monies at that point would be positive cash flow and possibly by then the house values will have gone back up. How is that not a solid investment? Sure a better investment would be to get a house like that for $20-25k, but those are extremely hard to find in the areas I'm looking and I just have no desire to buy something in the bad areas of town.

Will Barnard · Answer

Yes, you are correct that the increased cash flow due to no debt payment IS your return on the cash inside your walls, but in many cases, that return would be much more by applying leverage properly. Also, your scenario of numbers above are incorrect. By the 50% rule, you stated that your cash flow is $600 monthly? That means you are able to rent out your $30k duplex for $1200 monthly? That seems high, but if so, congrats, where can I buy some?

You also have more liability risk in that you have all that cash sitting in the home for sue happy lawyers and tenants to go after. That is a risk I don't necessarily want to expose myself to.

Tom C · Answer

There are a lot of nice REO's in nice areas that I would love to jump on at the $30 to $35K range, but I still cannot get much more in rents, then I can get for a REO in a less desirable area at the $15 to $20K range.

An extra $50.00 per month in rent does not justify paying $15K more for a home. The trick is to find REO's that are in the middle of the road area of your market. Places where renters feel safe, but are not necessarily full of all home owners and well kept lawns.

When you find this area, that is where you want to target. Also, if a REO has been on the market for 6 months or more, don't be afraid to offer 1/2 of the listing price. My last deals were exactly that and I got them both.

Been awhile - 2nd REO what do you think?

Most Popular Reply