Author Topic: Help on Evaluating Investment Property  (Read 1316 times)

netloc

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Help on Evaluating Investment Property
« on: March 23, 2019, 10:15:31 AM »
Hi All,

I have been lurking here for a while and planned on introducing myself via a case study, but an opportunity has presented itself that seems like it deserves some urgency on my part. First though, thank you to all who have posted here (not just about real estate); you have really helped me set my life course.

A brief summary of my current situation. My current debt consists of my mortgage on my primary residence (SFH), and small amounts left on my car and student loans (I had previously planned on paying them off prior to looking into real estate, but am reconsidering based on this potential deal). Taking into account my income plus that of my wife, being conservative, we can pay for general living expenses, make all our minimum payments on loans, max my 401k, and at the end of the year, we would be very close to being able to max two traditional IRAs (or Roths, we haven't made up our minds yet).

Through a mutual acquaintance, I learned that the owner of a 4-unit apartment building 1/4 mile from my house is looking to sell the property a few years earlier than anticipated due to unrelated circumstances (health), and that his asking price was essentially break even for him -- [purchase price + improvements - net income from the property].

I was privy to the numbers from 2012 to 2018, but they are slightly skewed as a few of the years a unit at a time was being renovated and so the total rent was lower that year. So going by the 2018 numbers, when all the units were livable (I am going to round slightly to try to keep things as anonymous as possible):

Gross rental income: $26,000 (94% occupancy)
Water: $4500 -- units are not separate so seller pays
Electric: $550 -- shared entryway/stairwell and basement, plus vacancy was in winter
Insurance: $2200
Taxes: $2300
Maintenance: $750 -- snow removal, lawn care; I would plan on doing this myself as I will be close
Other: $995 -- last year they tore up the streets and lots of mice moved into the surrounding buildings. This cost was for a pest control service. Not sure how to factor it in.

So, the mutual acquaintance doesn't know my financial situation completely, and essentially told the seller I would likely be interested but could not make a down payment. So the seller was willing to seller finance 20%, and I could secure financing through a financial institution for the remainder.

This week, I went to see the property and meet the seller. A summary/things I need help thinking through:
-- The seller did very little repairing, and instead mostly replaced things. So, 3 of the 4 units had entirely new kitchens (cabinets, appliances). A lot of new flooring, raised floors to level them, replaced hot water heaters, etc. So the method for calculating the price seems pretty reasonable if not favorable to me.

-- The seller has been very open with current tenants (two of which are long term) that while he is offering affordable housing, it is a business. So, he has done things like the following:
     - If tenants are unsure about renewing a one-year lease, they can switch month-to-month for an increased price. If they want to go back to a year-to-year, they keep the increased price.
     - When the water service increases in price, he adds that to the total rent.
     - Tenants sign the lease agreeing to the number of people that will live there. While he was showing me a unit, he realized that there was one more child than they had agreed to (and not a new-born). He said he would re-evaluate and likely increase the rent slightly.

-- He has "no smoking" in his lease agreement. However, one tenant (whom I met) has been there for almost a decade and smokes inside. I did not like this, but I think it would be hard to buy the property and then enforce that rule. How hard will it be to get rid of the "smokiness" after this tenant moves out?

-- At least one current tenant gets there funding through HUD. I am not familiar with HUD at all -- should this be a concern, or could this possibly even be a good thing?
     
-- There are two parking spots behind the property. When the seller bought the property, he thought both belonged to the property but now thinks one of them may belong to the neighboring property. How easy will this be to sort out?

-- Three of the units have washer/dryer hookups (and as the seller pays for water, so I do not like this). Prior to his decision to sell the property, part of his long-term plan was to partially finish the basement (a typical early 1900s basement, very dirty but fairly high ceilings) and install one or two coin-operated washer and driers and have the tenants use them. I would consider this as well.

So the big thing then. I brought up seller financing. His initial proposition was what I mentioned earlier. He would supply the 20%, which he wanted paid back within 5 years, and I could get the 80% elsewhere. I did not like this, because initially I would essentially be paying him and the bank, and the cash flow would be negative.

As I mentioned earlier, I had originally planned on paying off my car and student loans. I have the cash right now to do so. And that being the case, I have enough to make a 10% down payment, and I told him this. He seemed somewhat surprised by that. So I asked if, with the 10% down, he would be willing to entertain seller financing the whole deal. I explained the advantages a few times, and he seemed intrigued and said we should both think it over. He got back to me the next day.

He is leaning toward accepting a 10% down payment to seller finance completely at 4.5%, 20 year amortization, with a 5 year balloon. I don't think I'm crazy, but aren't seller financed deals usually a higher interest rate? Some more questions:

-- I think he would be indifferent if I instead asked for a 15-year amortization. But I could have done this with my house too (did a 30 year). It stinks to look at the amount of interest you pay with the longer amortization, but it really is better. Especially if it only grows at 4.5% during that time. It would be stupid to get a great interest rate, and then essentially pay it off quicker. Right?

-- After 5 years, I could refinance. Is this ever a hassle? Is there any chance I could apply for a new loan (now with over 20% put into the property) and be denied?

-- It would be great if the seller would be willing to do a longer period for the balloon payment; say 10 years. I think it could work then that I never refinance, or at least keep the low interest rate for a longer period of time. Is a double balloon payment a thing? Like, after 5 years I pay a certain percentage balloon payment, then at 10 I pay off the rest?

-- By completing the deal entirely by seller financing, what closing costs should I still expect?

The numbers.

Asking price: $172500
Loan amount: $155250 (90% of asking price)
Interest Rate: 4.5%
Amortization: 20 years
Balloon: 5 years
Monthly Payment: $982

Monthly income: $287 -- counting principal as an expense

So my return would be: monthly income * 12 / 10% down payment
which equals ~20%

In five years, when it comes time to refinance, I would have over 20% into the property. Would it be fairly simple to get financing at this point? Does the bank care what the previous terms were (i.e. could I get a new 20-year amortization?). What should I project as the interest rate here?

Say the new interest rate is 5.5% on a new 20-year amortization, no balloon.

My new monthly payment would be $887 (the 5 year balloon payment would be ~$129000).

My return would then be up to almost 26%.

Okay. I know this ended up a sprawling mess. Any help/advice/insight would be greatly appreciated. Feel free to ask any questions; I may have answers to some things (I talked to the seller for almost two hours). And my most important request is that you please correct me if I am doing any of the math wrong. I haven't done this before, so I haven't seen it play out in real-time.

Thank you all.

Finances_With_Purpose

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Re: Help on Evaluating Investment Property
« Reply #1 on: March 23, 2019, 10:29:51 AM »
This may all be moot.  Bank may not give you the loan with so little equity. 

Timing is everything.  Personally, I wouldn't think it's the right time...you're already pretty leveraged.  You're not experienced in the landlord business.  If things go a little sideways, you're done, and selling at a loss, most likely. 

You mentioned changing the numbers slightly to account for not having to renovate/etc., but I would do the opposite, and assume that you won't be as efficient as the current owner, who has done this for a long time. 

Plus, you don't mention anything about a sinking fund - especially for a building of that size - and I'm wondering what it would be or where it would come from since you don't have the down payment and already have significant leverage.  Again, I'd have a slightly larger one at the outset as you learn to adjust to being a landlord and may need to hire more out, etc. 

You don't give your overall financial picture, though, just a sense of it. 

Urgency is the mother of most bad financial decisions...don't let it get the better of you.  Take your time, and if you're not really sure about it, be fine walking away.  There will always be other deals. 

I'm not just saying that; I had to walk away from a fantastic deal recently.  It probably would have worked out phenomenally well, and it was only cash going in.  But I got into the deal far enough into it that there was urgency, and just not enough time for diligence.  So I passed on it, even though I'm pretty sure it'll work out.  Better that than taking a big, fat loss because I missed doing my diligence. 

waltworks

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Re: Help on Evaluating Investment Property
« Reply #2 on: March 23, 2019, 01:06:55 PM »
You don't appear to be accounting for Capex and management expenses in any way (ie, how much time will it take you to take care of the landscaping and shovel snow? That's a job, not an investment).

I'd look at it as:
$26k gross rents (these are ~$600/mo units?)

Minus -
$3000 management/maintenance. It's going to suck at least a little and you should expect to put in significant time if you DIY. A management company will charge you 8-10% plus some costs when they call in plumbers or electricians or what have you.
$3000 Capex - and this is probably being very generous. Lots of things go wrong in a low-end apartment building situation.
$10k insurance, utilities, taxes
$12000 principal and interest. You'll need to roll closing costs into the loan, presumably, and for the sake of simplicity I'm just going to assume a 30 year amortization with zero down.

That puts you at about -$200 per month.

Even if this was a reasonable deal (it's not), not being able max tax-advantaged accounts says to me you're not ready. Stick with simpler investments and change your lifestyle - having a car loan is a sign that you're not really serious about this whole FIRE thing.

-W

« Last Edit: March 23, 2019, 01:12:05 PM by waltworks »

tralfamadorian

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Re: Help on Evaluating Investment Property
« Reply #3 on: March 23, 2019, 03:34:53 PM »
+1 Walt and FWP's comments.

However, I think they may have overlooked this bit from your post:
Quote
He is leaning toward accepting a 10% down payment to seller finance completely at 4.5%, 20 year amortization, with a 5 year balloon. I don't think I'm crazy, but aren't seller financed deals usually a higher interest rate?

That is an unicorn of a seller financed interest rate. For that reason alone, I would run all the numbers to see if you can make it work.

Quote
Gross rental income: $26,000 (94% occupancy)
Water: $4500 -- units are not separate so seller pays
Electric: $550 -- shared entryway/stairwell and basement, plus vacancy was in winter
Insurance: $2200
Taxes: $2300
Maintenance: $750 -- snow removal, lawn care; I would plan on doing this myself as I will be close
Other: $995 -- last year they tore up the streets and lots of mice moved into the surrounding buildings. This cost was for a pest control service. Not sure how to factor it in.

Rent- As walt mentioned, these sound like ~$600/unit. Is that correct? You also mentioned that at least one tenant is on section 8 (HUD). What type of neighborhood is the property in? Signs point to not great or rural.

Vacancy- not all the units are updated, correct? At least the smoker's is not? And what is the rental vacancy rate for the MSA the property is in? (you can get this data from deptofnumbers.com for larger MSA and usually google for the smaller)

Water- ~$94/unit/mo feels high to me in general and particularly given the low rents. Is water particularly expensive in your region? If not, I would be concerned that there's a problem- ie: a tenant is doing laundry at home as a side gig (I saw this last year with a 4-plex I ran numbers on in a semi-rural area). Do any neighboring properties bill back for utilities? If the rental market supports it, you should do it.

Management: You should always pull out 10% for management even if it's going to be you for right now because at some point, you may want to hand off the nitty gritty to someone else and you should compensate yourself for your time.

Maintenance/Other: As mentioned above, rule of thumb is 10% of rent per month each for capex and maintenance. If the rent/unit is ~$600/mo and the building is older, then 10% is probably too low. From your finance picture outlined above, your family doesn't appear to have a lot of extra bandwidth in the budget. Rental properties, particularly (older?), larger ones can have very expensive capex. How old is the roof? The hot water heaters? Cast iron plumbing? Terracotta sewer line? The furnace(s)? Does the exterior need to be painted?

Regarding turning over a long-term smoker's unit- everything will need to be cleaned or replaced. Painted surfaces then primed with kilz max or similar then painted. A lot of times you can just prime and paint but since it's been 10 years, there can be enough nicotine that it just oozes through any crevice unless it's scrubbed with tsp or equivalent first. Carpets replaced. Ducts will probably need to be ozoned (and other tenants moved to a hotel for a day and night if duct work is connected).

netloc

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Re: Help on Evaluating Investment Property
« Reply #4 on: March 23, 2019, 03:44:31 PM »
This may all be moot.  Bank may not give you the loan with so little equity. 

Timing is everything.  Personally, I wouldn't think it's the right time...you're already pretty leveraged.  You're not experienced in the landlord business.  If things go a little sideways, you're done, and selling at a loss, most likely. 

You mentioned changing the numbers slightly to account for not having to renovate/etc., but I would do the opposite, and assume that you won't be as efficient as the current owner, who has done this for a long time. 

Plus, you don't mention anything about a sinking fund - especially for a building of that size - and I'm wondering what it would be or where it would come from since you don't have the down payment and already have significant leverage.  Again, I'd have a slightly larger one at the outset as you learn to adjust to being a landlord and may need to hire more out, etc. 

You don't give your overall financial picture, though, just a sense of it. 

Urgency is the mother of most bad financial decisions...don't let it get the better of you.  Take your time, and if you're not really sure about it, be fine walking away.  There will always be other deals. 

I'm not just saying that; I had to walk away from a fantastic deal recently.  It probably would have worked out phenomenally well, and it was only cash going in.  But I got into the deal far enough into it that there was urgency, and just not enough time for diligence.  So I passed on it, even though I'm pretty sure it'll work out.  Better that than taking a big, fat loss because I missed doing my diligence. 

Perhaps I misunderstand how seller financing works, or my post was poorly written.

So for the situation I described, I would put 10% down, the seller lends 90%. There is no bank to approve the loan, right? The seller is the bank.

Then at the 5 year mark when the balloon payment must be made to the seller, then I go to the bank. At that point, I would have paid almost $30k against the principal, plus my initial down payment, so I would be at roughly 27% equity. The bank would not require an additional down payment, correct?

I didn't change any of the numbers. I rounded them just to be vague and not end up in any confrontation about sharing information on the internet (he did not ask me to keep the information private). I actually rounded to make the numbers slightly "worse" for me, certainly not to try to fudge them. The lowest year of rent since 2012 was $19.5k, and that was a year they put on a new roof and renovated the top floor. The average is $22.5k. Would it make sense to count those null months for that unit as vacant months?

The property was purchased by the current owner 8 years ago and in need of rehab (hence the units being unoccupied for periods of time). Should I expect that they will be in that condition -- meaning unlivable and requiring extensive upgrade costs -- consistently? That seems pessimistic, but I'm willing to listen to experience. I didn't state it in my post (sorry), but I included that 5% of rental income would go toward Capex/repairs, but then clearly was doing some inadvisable accounting in other places.

What info would be helpful about my overall situation to make it easier to analyze? After a down payment, I would still have ~$13k cash if needed and would probably keep about that much available at all times for the property.

My non-mortgage loans are approximately $20k at 2-5% interest.

And perhaps urgency was the wrong word. I basically meant that I wasn't actively looking for the opportunity, and so I wasn't really ready to jump onto this forum and ask for advice, since I haven't interacted with anyone here yet.

You don't appear to be accounting for Capex and management expenses in any way (ie, how much time will it take you to take care of the landscaping and shovel snow? That's a job, not an investment).

I'd look at it as:
$26k gross rents (these are ~$600/mo units?)

Minus -
$3000 management/maintenance. It's going to suck at least a little and you should expect to put in significant time if you DIY. A management company will charge you 8-10% plus some costs when they call in plumbers or electricians or what have you.
$3000 Capex - and this is probably being very generous. Lots of things go wrong in a low-end apartment building situation.
$10k insurance, utilities, taxes
$12000 principal and interest. You'll need to roll closing costs into the loan, presumably, and for the sake of simplicity I'm just going to assume a 30 year amortization with zero down.

That puts you at about -$200 per month.

Even if this was a reasonable deal (it's not), not being able max tax-advantaged accounts says to me you're not ready. Stick with simpler investments and change your lifestyle - having a car loan is a sign that you're not really serious about this whole FIRE thing.

-W



The units are not all the same, but they rent for an average of $585.

I was accounting for 5% Capex/repairs. Should I increase that number?

What sort of costs would be associated with a low-end apartment? I'm not being purposefully obtuse when I ask this. The current owner replaced most of the appliances, the roof and gutters, windows, toilets, bathtubs, plumbing, most of the flooring, electric service, heaters. That is why I was only accounting for repairs at 5%. He is fine with me bringing anyone to look it over.

Management consists of screening tenants, handling complaints, and arranging for repairs, correct? I would plan on doing that myself. Same with snow removal / yard work. The yard work is barely anything, especially since I live so close. He currently has a tenant pay a neighbor 10 bucks to trim and mow, and there are about 30 yards of sidewalk that need shoveled when it snows. I would basically consider them paid exercise. And yes, I realize this is not passive income. And that is fine. I'm not at a point where I have something more profitable I could be doing, so I can think of it as a side job. Maybe I'm naive. But it is a fair point. Should I basically bill myself and factor that in, and only pursue it if the numbers come out as a solid passive investment after that?

None of this is set in stone. I could make an offer lower than what the seller suggested. Or I can request a longer amortization period, or ask the seller to cover closing costs, or whatever. Obviously I don't have the experience and that's why I'm here. What price and amortization period would allow the numbers to work from an objective outsider perspective?

I appreciate the criticism. Our cost of living is around $25k/year for the two of us, and about $4k of that is toward vehicle expenses to allow me to commute thirty minutes to a job that pays $30k more than the same job that is ten minutes from where I live. I know a lot of people on here live within walking distance of their job, but I do not, and at this point that is intentional as it is the most financially advantageous thing to do.

On the other hand, the car was bought before I had any inclination about personal finance, FIRE, frugality, etc. Anyway, it was bought new and is one of those deals where at this point the best option is to drive it for 20 years rather than take a huge loss selling it.

Essentially what it comes down to is this: with the cash I have on hand, I could make a down payment on this property (or a different one), or I could pay off my car and student loans. Based on the first two replies, it seems that your general advice for me is to pursue some lower hanging fruit. Or more specifically, if I reach for higher fruit, this particular one isn't a great choice to reach for.

netloc

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Re: Help on Evaluating Investment Property
« Reply #5 on: March 23, 2019, 05:38:34 PM »
+1 Walt and FWP's comments.

However, I think they may have overlooked this bit from your post:
Quote
He is leaning toward accepting a 10% down payment to seller finance completely at 4.5%, 20 year amortization, with a 5 year balloon. I don't think I'm crazy, but aren't seller financed deals usually a higher interest rate?

That is an unicorn of a seller financed interest rate. For that reason alone, I would run all the numbers to see if you can make it work.

Quote
Gross rental income: $26,000 (94% occupancy)
Water: $4500 -- units are not separate so seller pays
Electric: $550 -- shared entryway/stairwell and basement, plus vacancy was in winter
Insurance: $2200
Taxes: $2300
Maintenance: $750 -- snow removal, lawn care; I would plan on doing this myself as I will be close
Other: $995 -- last year they tore up the streets and lots of mice moved into the surrounding buildings. This cost was for a pest control service. Not sure how to factor it in.

Rent- As walt mentioned, these sound like ~$600/unit. Is that correct? You also mentioned that at least one tenant is on section 8 (HUD). What type of neighborhood is the property in? Signs point to not great or rural.

Vacancy- not all the units are updated, correct? At least the smoker's is not? And what is the rental vacancy rate for the MSA the property is in? (you can get this data from deptofnumbers.com for larger MSA and usually google for the smaller)

Water- ~$94/unit/mo feels high to me in general and particularly given the low rents. Is water particularly expensive in your region? If not, I would be concerned that there's a problem- ie: a tenant is doing laundry at home as a side gig (I saw this last year with a 4-plex I ran numbers on in a semi-rural area). Do any neighboring properties bill back for utilities? If the rental market supports it, you should do it.

Management: You should always pull out 10% for management even if it's going to be you for right now because at some point, you may want to hand off the nitty gritty to someone else and you should compensate yourself for your time.

Maintenance/Other: As mentioned above, rule of thumb is 10% of rent per month each for capex and maintenance. If the rent/unit is ~$600/mo and the building is older, then 10% is probably too low. From your finance picture outlined above, your family doesn't appear to have a lot of extra bandwidth in the budget. Rental properties, particularly (older?), larger ones can have very expensive capex. How old is the roof? The hot water heaters? Cast iron plumbing? Terracotta sewer line? The furnace(s)? Does the exterior need to be painted?

Regarding turning over a long-term smoker's unit- everything will need to be cleaned or replaced. Painted surfaces then primed with kilz max or similar then painted. A lot of times you can just prime and paint but since it's been 10 years, there can be enough nicotine that it just oozes through any crevice unless it's scrubbed with tsp or equivalent first. Carpets replaced. Ducts will probably need to be ozoned (and other tenants moved to a hotel for a day and night if duct work is connected).

Rent - average is $585, they are not all the same though. It's a very rural town, but definitely still in town. For reference, my primary residence (PITI) which is fairly close by is just over $500/month (PITI) for a 3-bed, 2-bath, 1400sq with a detached garage and a small yard. But 3 miles away there are hundred acre farms.

Vacancy - I believe the smoker's unit had new kitchen appliances and the bathrooms were updated, but the flooring was not new. I can verify this if I decide to investigate further. I am having trouble finding a vacancy rate online. CensusReporter.org (not sure at all if this is a reliable source) says that 87% of housing units are occupied, 80% are owner occupied.

Water - 2 of the 4 had a washer and dryer, a third had the hookups but did not have them installed. There is a laundromat close by, so I could simply tell the tenants they could not have them, I suppose. Or I could install coin-operated washer and dryers in the basement, and eliminate that cost. I don't see any way to bill the tenants for water as the units are all tied together right now. How would you go about it?

Management - Fair. I thought this through a bit in my previous post.

Maintenance/Other - New roof and gutters in 2015. 2 of the 4 water heaters had been replaced in the past 4 years. The other two he said he had replaced since he bought the property but they didn't have dates written on them and he didn't know off the top of his head. I didn't see any of the plumbing (and wouldn't have really known what I was looking at) but for the updated units it was redone. I would have someone knowledgeable take a look at that. No idea on the sewer either. All electric heat, but another thing I don't know a whole lot about. I do not know how to judge the exterior other than cleanliness, and it looked fine. The front porch (also the entrance to the stairwell for 2 of the units) was old, but functional.

Noted on the smoker unit. Could appliances get bad enough that they need replaced?

As far as my budget goes, a few considerations/questions:
-I don't account for my spouse's "side-gig" of wedding/portrait photography. She hasn't been doing it long, but has been getting ~$3k/year two years in. I don't want to rely on that, so I simply don't factor it in. Whatever she makes will likely go toward previously mentioned loans. She was recently approached with an opportunity to be a "second-shooter" for a more established photographer on days that she herself isn't booked.
-She also teaches piano, and has been getting 3-4 new students each year. For this I factor in her number of current students but any new students are a decent bump in income by the end of the year.
-My company does profit sharing quarterly, half in cash, half in 401k. I'm new, so I'll be eligible starting in 2020. But I've been here for two announcements, of 14% and 16% of base salary. When the time comes, I'll conservatively take this into consideration when budgeting. I don't account for it right now.
-I also have sporadic work at a relative-owned business, that varies from 0-10 hours/week at $20/hr. I do not account for this either.
-As I said, this is with me maxing my 401k, and we should be close to maxing IRAs as well. Part of me wants to simply forget that my 401k exists (with an adjustment here and there) and only think of my take home pay as income, and same with the IRAs. But at anytime I could stop contributing to them if I needed to put money into something else.

I will rerun the numbers and post my math, so it can be critiqued and improved upon for future use. What should I set aside for Capex? 15%? 20%?


tralfamadorian

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Re: Help on Evaluating Investment Property
« Reply #6 on: March 23, 2019, 06:52:30 PM »
*snip*

*snip*


It's difficult to find vacancy numbers for rural areas. 13% could include units that are left purposefully vacant; if it's the rental vacancy rate, that's quite high.



I own properties in MSAs that range from 1.9% to 5.6% vacancy. The 1.9% makes your landlording life really easy. The 5.6% is okay. I can't imagine working in a double digit vacancy rate area.

I would call a few property management companies that service your area and interview them as someone who is considering purchasing a rental property. They should know the vacancy rate for their portfolio and the general vacancy rate for the area. They would also know if utility bill backs are common.

The property management folks also will know how much having w/d in unit adds to the monthly rent. Having to lug laundry down flight(s) of stairs to the basement is a turnoff and will shorten the length of time your tenants stay on average. Most new landlords will do the opposite- remove coin laundry, add w/d to units, then starting bill back for water. In general tenants are so happy to have laundry in unit that paying for water seems like a fair trade-off. Unfortunately you already have two units that have the best of both worlds (laundry in unit and free water) so that's a tougher conversation. As the landlord, you'll lose less with bill back plus w/d for easy 3rd unit and eventual 4th than water bill minus coin laundry and will not have the hassle of playing interference because of friction between tenants sharing the coin laundry.

Bill backs are typically calculated using a RUBS method in anywhere except for perfectly equivalent units.

That's great that the current owner has done so much work on the property but I can't know whether 10% is okay or more is needed. And you probably wouldn't know for sure until after inspection but you can estimate. What I would do is sit down with a start of 10% for capex and calculate that it would be $58.5/unit/mo = $702/unit/year in capex. Then I would make a comprehensive list of all capex items and remove the items that the owner has replaced recently. Look at what's left and estimate how many months/years of capex budget it would take to replace. Look hard at the things that are expensive to replace and don't result in nicer/higher renting units- furnace, sewer, plumbing between updated kitchens/bath and leaving the house, electric.

That's good that you all have some side income. It feels like every time I've bought a house and thought "the roof/furnace/etc isn't new but looks like it will hold for a couple years," it fails within six months of closing and I have big bills I need to float. So, just make sure from your capex list that if you had that happen to you, financially it wouldn't be fun but that you all would be okay.

I've never had to/heard of having to replace appliances.

waltworks

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Re: Help on Evaluating Investment Property
« Reply #7 on: March 23, 2019, 08:28:25 PM »
Let me get this straight - you are saying you should buy the place because you/your wife can work a bunch of side gigs to pay for problems?

Just work the side gigs and slam the money into maxing your tax advantaged accounts. Or offer the guy $100k. That's about what I would pay for the place.

-W

netloc

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Re: Help on Evaluating Investment Property
« Reply #8 on: March 24, 2019, 07:25:26 AM »
It's difficult to find vacancy numbers for rural areas. 13% could include units that are left purposefully vacant; if it's the rental vacancy rate, that's quite high.

I own properties in MSAs that range from 1.9% to 5.6% vacancy. The 1.9% makes your landlording life really easy. The 5.6% is okay. I can't imagine working in a double digit vacancy rate area.

I would call a few property management companies that service your area and interview them as someone who is considering purchasing a rental property. They should know the vacancy rate for their portfolio and the general vacancy rate for the area. They would also know if utility bill backs are common.

The property management folks also will know how much having w/d in unit adds to the monthly rent. Having to lug laundry down flight(s) of stairs to the basement is a turnoff and will shorten the length of time your tenants stay on average. Most new landlords will do the opposite- remove coin laundry, add w/d to units, then starting bill back for water. In general tenants are so happy to have laundry in unit that paying for water seems like a fair trade-off. Unfortunately you already have two units that have the best of both worlds (laundry in unit and free water) so that's a tougher conversation. As the landlord, you'll lose less with bill back plus w/d for easy 3rd unit and eventual 4th than water bill minus coin laundry and will not have the hassle of playing interference because of friction between tenants sharing the coin laundry.

Bill backs are typically calculated using a RUBS method in anywhere except for perfectly equivalent units.

That's great that the current owner has done so much work on the property but I can't know whether 10% is okay or more is needed. And you probably wouldn't know for sure until after inspection but you can estimate. What I would do is sit down with a start of 10% for capex and calculate that it would be $58.5/unit/mo = $702/unit/year in capex. Then I would make a comprehensive list of all capex items and remove the items that the owner has replaced recently. Look at what's left and estimate how many months/years of capex budget it would take to replace. Look hard at the things that are expensive to replace and don't result in nicer/higher renting units- furnace, sewer, plumbing between updated kitchens/bath and leaving the house, electric.

That's good that you all have some side income. It feels like every time I've bought a house and thought "the roof/furnace/etc isn't new but looks like it will hold for a couple years," it fails within six months of closing and I have big bills I need to float. So, just make sure from your capex list that if you had that happen to you, financially it wouldn't be fun but that you all would be okay.

I've never had to/heard of having to replace appliances.

Thanks for the advice. I will try calling a property management company and see what they tell me. I was thinking that way about the washer and dryer regarding lugging up and down stairs, but the current owner seemed like it was something he knew would be a good idea, and he's been land lording for a while. But the RUBS method sounds great. Of course it would work better if they weren't all not paying anything currently.

Let me get this straight - you are saying you should buy the place because you/your wife can work a bunch of side gigs to pay for problems?

Just work the side gigs and slam the money into maxing your tax advantaged accounts. Or offer the guy $100k. That's about what I would pay for the place.

-W

No. As I said before, by my calculation we will be close to maxing out both of our IRAs. My additional comments were to say that we are at that amount before I take into account any side-gig income. So we will very likely be over.

One thing that I have been toying with since I started reading MMM is essentially treating 401k/IRA as an expense. As in, I should not even think about putting my money elsewhere until I have paid into them. That kind of seems to be what you are suggesting here. Can you confirm this, or possibly elaborate a bit?

Like I also said previously, I had been leaning toward using the cash I have now to pay off my car and student loans. If I do that, I should be well in the clear on the IRA.


Anyway, this is the equation I used to calculate return:
a Rental income [$26000]
b Taxes [$2300]
c Insurance [$2200]
d Utilities [$4500 + $550]
e Principal & Interest [$12000]
f Property Management [$2600] -- previously was $0
g Vacancy [$0] (built in to gross rent number -- maybe a bad idea to do this)
h Repairs [$2600] -- previously was at $650

a-b-c-d-e-f-g-h = yearly net income
yearly net income / down payment = return

With those numbers yearly net comes out negative by a few hundred. So, like waltworks said, if I want it to be positive I would basically be giving myself a job as a property manager, and like everyone has said, I shouldn't have to be the property manager for the numbers to work. Also, that it is unwise to simply take the seller's word for anything that helps my projections come out better (i.e. that his updates will reduce the need for repairs in the near future).

I think I am leaning toward just getting rid of my student and car loans. I know for certain what the return on those are, and they don't cost me any of my time.

I might dig into it a little more but it seems like the really good seller financed interest rate doesn't really do enough against the negative aspects of the deal.

edit: I had brackets around my variables and the b bolded the rest of the post.

waltworks

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Re: Help on Evaluating Investment Property
« Reply #9 on: March 24, 2019, 09:29:20 AM »
1: Read the investment order post. https://forum.mrmoneymustache.com/investor-alley/investment-order/

2: Your numbers now look reasonable. Offer the guy $100k. He almost certainly won't take it, c'est la vie.

-W

tralfamadorian

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Re: Help on Evaluating Investment Property
« Reply #10 on: March 24, 2019, 12:12:55 PM »
Anyway, this is the equation I used to calculate return:
a Rental income [$26000]
b Taxes [$2300]
c Insurance [$2200]
d Utilities [$4500 + $550]
e Principal & Interest [$12000]
f Property Management [$2600] -- previously was $0
g Vacancy [$0] (built in to gross rent number -- maybe a bad idea to do this)
h Repairs [$2600] -- previously was at $650

a-b-c-d-e-f-g-h = yearly net income
yearly net income / down payment = return

With those numbers yearly net comes out negative by a few hundred. So, like waltworks said, if I want it to be positive I would basically be giving myself a job as a property manager, and like everyone has said, I shouldn't have to be the property manager for the numbers to work. Also, that it is unwise to simply take the seller's word for anything that helps my projections come out better (i.e. that his updates will reduce the need for repairs in the near future).

I think I am leaning toward just getting rid of my student and car loans. I know for certain what the return on those are, and they don't cost me any of my time.

I might dig into it a little more but it seems like the really good seller financed interest rate doesn't really do enough against the negative aspects of the deal.

Great job running all the numbers and coming back to let us know how it penciled out.

Personally I max out all my tax advantaged accounts because the built in rate of return on tax advantage (my current top tax bracket - my expected top tax bracket in retirement) is greater than any RE return I can find at the moment.

I would run the numbers and find out how much the purchase price would have to be to get a 12% return or whatever your goal ROI is. Also, I would adjust the amortization on the seller financing to 30 years and the balloon payment to 7 years if you decided to make the offer to him. The 30 years would help the offer price not drop quite as drastically while still giving you the ROI you want and the 7 year would give a little more time to help build the equity you would need to refinance.

Ie: Right now, you're at $172.5k, 10% down, 4.5%, 20yr --> $982/mo PI, -$62.5/mo net, -4.3% ROI
At $172.5k, 10% down, 4.5%, 30yr --> $786/mo PI, $133.5/mo net, 9.3% ROI
At $165k, 10% down, 4.5%, 30yr --> $752/mo PI, $167.5/mo net, 12.2% ROI
(I ran these number quick and dirty, please do your own math and don't rely on mine)

Sounds a lot better to offer $165k w/ 30yr than $100k, doesn't it? I haven't done it but I have talked to investors that seal the deal on this by calculating how much more interest the seller would be receiving during the longer amortization and 7 year payment schedule than the 5 year original. "I need to structure it this way for cash flow purposes but you would come $xx ahead."

Then if you could push that $4.5k/yr water bill to the tenants, your ROI would jump to 39.4%. That would be the clincher for me- talking to the prop management folks to see if bill back is done in your area and to nail down that vacancy rate.

netloc

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Re: Help on Evaluating Investment Property
« Reply #11 on: March 24, 2019, 01:36:41 PM »
The investment order thread is great, thank you for the link waltworks.

tralfamadorian,
I am open to requesting a 30 year amortization. Is that common on investment properties, or is 20 more common? At the 7 year mark will a bank have an issue with a 30 year? I wouldn't want to get to the balloon payment and be forced to use a 20 year when I had calculated using 30.

Also, at the time of refinance, do I get a completely new loan? In other words, does the bank care what the terms of the previous loan were, or do they just see that I need $x and I could get a new 30 year amortization for it?

Another question. Suppose I use the calculations for the 30 year. It is cash flowing. But then I actually use a 20 year. Can I equate the cash flow on the 30 year to the extra principal being paid on the monthly payments for the 20 year? I guess my real question is should I factor in principal payments or simply call them an expense at this point?

But I don't want to get caught up trying to do clever math. If it doesn't work it doesn't work.

Even if bill back for water is common for the area, would it be as simple as showing the tenants how it is distributed?Wouldn't that cause problems with the current tenants?

tralfamadorian

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Re: Help on Evaluating Investment Property
« Reply #12 on: March 24, 2019, 02:50:35 PM »
I am open to requesting a 30 year amortization. Is that common on investment properties, or is 20 more common? At the 7 year mark will a bank have an issue with a 30 year? I wouldn't want to get to the balloon payment and be forced to use a 20 year when I had calculated using 30.

You see everything in selling financing. Both 20 and 30 year are common. At the ~6.5 year mark, you would go shop loans at the amortization length of your choosing. 1-4 unit property loans are classified at banks as "residential" loans. 5+ unit property loans are classified as commercial/investment/portfolio (interchangeable terms) loans. Residential loans are the same type that you used to purchase your primary residence so 15, 20 and 30 year amortization are all available. Each person can have up to 10 residential loans in their name. Even though you are purchasing an investment property, the banking term is a residential loan.

Commercial/investment/portfolio loans are typically 20 year amortizations with a 5-7 year balloon payment. However, they are underwritten by each bank so the actual terms vary.

Quote
Also, at the time of refinance, do I get a completely new loan? ...do they just see that I need $x and I could get a new 30 year amortization for it?

Exactly

Quote
Another question. Suppose I use the calculations for the 30 year. It is cash flowing. But then I actually use a 20 year. Can I equate the cash flow on the 30 year to the extra principal being paid on the monthly payments for the 20 year? I guess my real question is should I factor in principal payments or simply call them an expense at this point?

But I don't want to get caught up trying to do clever math. If it doesn't work it doesn't work.

Principal payments increase your equity but they are still an expense on your cash flow. Equity is illiquid, can only be accessed with a fee (refi closing costs or realtor/selling fees) and decreases your ROI. In real estate where your goal is ROI on your investment, equity is dead.

Quote
Even if bill back for water is common for the area, would it be as simple as showing the tenants how it is distributed?Wouldn't that cause problems with the current tenants?

It would be easy for unit #3 with w/d hookups and no w/d. Same for unit #4 depending on your plumbing costs to do the hookups. For units #1, #2 (and possibly #3, #4 if they declined w/d for water bill), you would tell them at renewal time that water was no longer included in the rent. Personally, I would phrase it somewhere along the lines that since everyone has w/d's now, the water bill can be split up fairly between units but that there would be no other rent increase this year.

This is presuming they are good tenants you want to keep and that the rents are already at or ever slightly below market. You might lose one or both of them but if your rent is priced correctly and the area vacancy is low, finding new tenants is worth $4500/yr.

Another Reader

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Re: Help on Evaluating Investment Property
« Reply #13 on: March 25, 2019, 06:42:52 AM »
Off topic question:

"Each person can have up to 10 residential loans in their name."

Last I heard, the conforming loan limit was 8.  Has that changed?  Most major banks stick with the 4, Chase in my state will go to 6.  Who will go to 10 at reasonable fixed rates and terms?

tralfamadorian

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Re: Help on Evaluating Investment Property
« Reply #14 on: March 25, 2019, 09:34:43 AM »
Off topic question:

"Each person can have up to 10 residential loans in their name."

Last I heard, the conforming loan limit was 8.  Has that changed?  Most major banks stick with the 4, Chase in my state will go to 6.  Who will go to 10 at reasonable fixed rates and terms?

Fannie Mae has allowed 10 since 2009 or so:
"If the borrower is financing a second home or investment property that is underwritten through DU, the maximum number of financed properties the borrower can have is ten."

Just found through googling to get the above quote for you that Freddie also recently increased their limit to ten.

I haven't had to jump into the waters of 6-10 but yes, I've heard that it's a pain. The big banks don't do them because there's more paperwork. My plan is to check biggerpockets when I get there for some leads of banks to do 6-10; I've seen this discussion there in the past.

Another Reader

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Re: Help on Evaluating Investment Property
« Reply #15 on: March 25, 2019, 09:44:58 AM »
I'm pretty sure it was 8 when I did my HARP loans in 2012 and 2013.

It's now ten if your file can be run through DU.  If not, it's six.

Thanks!


Mother Fussbudget

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Re: Help on Evaluating Investment Property
« Reply #16 on: March 25, 2019, 02:50:15 PM »
Back to the "Evaluating Investment Property"...

If this deal came to me, the only part that would get my interest... would be the INTEREST at 4.5%.  Everything else about it - especially the long-term renter under section 8 - would make me want to seek other deals.  And there are other / better deals out there. 

All the best!

netloc

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Re: Help on Evaluating Investment Property
« Reply #17 on: March 27, 2019, 11:41:33 AM »
Thanks for all of the input everyone.

I decided not to pursue it.

I was a little bit suspicious of the asking price calculation (purchase price + improvements - net income), which he described "breaking even." I think that likely included all repairs as improvements -- so 10% of rent each year should have been counted as an expense for regular repairs, and so not added to the purchase price. I would have probably offered $158k, 30 year amortization, 7 or 8 year balloon at 4.5%.

But, I decided to put my money into things that won't require any additional work from me.

Rick Imby

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Re: Help on Evaluating Investment Property
« Reply #18 on: March 27, 2019, 06:33:11 PM »
Before quitting I would look at other rents in the area.  How large are the apts? If you could up the rents by $100 per door that would help a lot.

The 4.5% interest would have me interested if it was stretched to 8 years or 15 years.

When the balloon needs to be paid off the refi will depend upon the appraisal of your property---nothing to do with your initial deal. 

Commercial rates are usually 1-3% higher than residential.   

The water bill seems way out of whack.  If that came down to $30 per unit per month that makes a big difference too.

There are companies that can put in post meters to meter the water to each unit. 

Good luck, With all your side hustles and the Mustachian influence you will be FI in the not too distant future.

netloc

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Re: Help on Evaluating Investment Property
« Reply #19 on: June 11, 2019, 12:06:53 PM »
An update.

I had told the owner that I was going to pass on the property.

He sent me a message last week, saying that he was likely going to list the property soon but was still interested in doing the seller-financed deal. He said he would be willing to seller finance with the following terms:

$172.5k sale price
10% down
3.75% interest
30 year amortization, 5 year balloon payment

I hadn't really thought about it too much since my last post.

I am thinking at this point it may be worth a second look. This is how I think the math would shake out.

(Hypothetical offer from me)
$168k sale price
10% down
3.75% interest
30 year amortization, 8 year balloon payment
Split closing costs (assume 4% of sale price), and roll my half of them into loan (is this a normal request?)


a Rental income [$26000]
b Taxes [$2300]
c Insurance [$2200]
d Utilities [$4500 + $550]
e Principal & Interest [$8600]
f Property Management [$2600]
g Vacancy [$0] (built in to gross rent number)
h Repairs [$3800] -- ~15% gross rent

a-b-c-d-e-f-g-h = yearly net income
yearly net income / down payment = return

return = 4.3% (on my spreadsheet with non-rounded numbers).

I think my assumptions are all fairly conservative at this point, after my first post (deservedly) received some solid critique.

Would it be reasonable to say 4.3% a conservative estimate here?

It seems kind of silly how easy it is to manipulate that number... for instance, increasing the rent on each unit by $5/month increases my return by an entire percent. Or if I only need 10% of gross rent for repairs instead of 15% the return goes up to almost 12%.

Any thoughts, questions or suggestions?

Finances_With_Purpose

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Re: Help on Evaluating Investment Property
« Reply #20 on: June 15, 2019, 04:42:41 AM »
How much is the balloon payment?  Are you sure the amortization is 30 years, if there's a balloon payment.  I'm a little unsure what the financing arrangement is, but it sounds questionable. 

netloc

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Re: Help on Evaluating Investment Property
« Reply #21 on: June 16, 2019, 06:40:34 AM »
How much is the balloon payment?  Are you sure the amortization is 30 years, if there's a balloon payment.  I'm a little unsure what the financing arrangement is, but it sounds questionable.

The balloon payment (for my hypothetical offer) would be $130k. Basically, amortized over 30 years to determine my monthly payment amount. However, after 8 years I would have to pay the remaining principal and refinance with a bank.

But, I still decided against it. I think it could have worked out, but at this point there is just too much I don't know (about the property, the market, know-how for fixing minor issues) to feel comfortable jumping into it.