I wrote a blog awhile back about the shoe being on the other foot when looking for property here in Phoenix, AZ. I’ve been searching for a juicy cow (can that be a new phrase for a cash-flowing property that’s a great deal?) and will share my experience here.
In any case, I went under contract on a 4 plex and was ready to move forward. Here’s the play by play
- I found this deal on the MLS, and it caught my eye for several reasons. It was fully occupied, appeared to have been updated in the last couple years, and was in an area of town that I really like.
- Details: asking price, $175,000, rents $495 (with potential to be $500+), NO HOA, all 2 bedrooms, 1 bath, parking in rear, each unit was individually metered for electric and healthy rent market in the area. The one thing that jumped out at me though was listed in the Income/Expenses section was an exorbitant water allotment. I inquired about that and the listing agent said he wasn’t quite sure about it but they could provide all paperwork during escrow. Fair enough.
- I pulled comps and saw similar properties going for $160-$170k, so inquired if there was wiggle room, which there was. I drove the property, liked what I saw, drove the neighborhood several times, and felt good about the location. I checked in with my lender, got the A-OK, and moved forward to go under escrow. I was willing to go near market value for several reasons, so long as the numbers made sense from day one.
- Within a few days I received the leases, title report, and management expenses. I was planning on self-managing, as management companies can really eat up costs if you don’t really comb through what you’re being charged for, when, and how.
- I called up the utility companies to verify water costs, since the owner (ie me) would be the one responsible for this expense. I was nearly in disbelief when the customer service rep let me know there was an annual expense of nearly $6,900, which had gone up this year, based on a 2 year average. So, the listing had in fact been pretty close to the truth.
- The annual gross income was $23,760 but with a 10% vacancy rate, making gross operating income to $21,384. With all the other operating expenses (maintenance, common area electric, Repairs,Advertising and promo, and rental tax,)… and a monthly water bill of approximately $575, the income is nearly eaten alive.
- This puts the annual operating expenses at $11,000. So, my net operating income is around $10,000. In this scenario we’re approaching it at a 20% down payment, 30 year fixed mortgage. (PLEASE NOTE – in the video I had the interest rate too low at 4.5% so the projections are actually slightly worse!) So if you factor in the debt service (ie the mortgage payments on the loan) the cap rate becomes anemic, my cash on cash return nearly made me vomit, and cash flow becomes nearly non-existent. And, you have to pay taxes on any cash flow. My hopeful juicy cow had turned skeletal hag.
Check out the following video for the complete story:
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Where’d it All Go Wrong?
During the escrow period, the Seller provides all paperwork showing the actual expenses, income, leases, and agreements relating to the property; It’s like reviewing a tiny business.
When I began reviewing the leases, it started to make sense. In 2 of the units, there was a families of 4. In the other two units, there were 5 people living in each unit. My god, I would be paying nearly $600 a month for 18 people to shower, do laundry, wash their hands, give baths, and use the restroom. I shuddered at the thought.
Digging further, the units had been listed in MLS for rent for quite some time, and the management company had gotten them filled. This then became a fully-occupied 4 plex in good condition, an immediate draw for any investor. The catch is quality, over quantity…and there really was quantity, in this case.
Let’s Just Be Friends
I did it, I’m guilty. I did the “How, but if, well we can..” game. What if we install low-flow fixtures, change the commodes, charge a monthly water usage fee, cycled out these tenants? The catch is, if the 4 plex is predominately occupied by families, single people and childless couples are less likely to want to live there. (and, there are Fair Housing laws that you must abide by). Point being, the problem is the high occupancy, but you can’t just solve the problem by kicking people out, trying to only rent to couples, or charging fees. So, there really wasn’t much room for me to try to lower the water bill creatively or otherwise to have it makes sense, now, if ever. I couldn’t commit to this, and decided to break it off.
I quickly emailed the escrow officer, my loan officer, and the agent and simply let them know after reviewing the breakdowns, this did not make financial sense, and to please cancel the escrow. The listing agent was very kind, but understood.
The better news is, another opportunity popped up nearly immediately from a different source. Because I didn’t need the cash to close on the 4 plex, we were able to jump on a better, more profitable deal to make some quick cash and keep the money moving.
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Photo: Kansas Sebastian