Case Study: Buying Rental From Landlord

[david156]

My landlord are interested in selling their rental property in a private sale. Can you help with my decision? Please let me know if there's anything I have missed and I'll try to add it as soon as possible.

Story
I had been living in this apartment for 3 years. Our lease runs July 1st - June 30th, but in January 2019 I moved out of the apartment and sublet the unit to my friends. I graduated, started working, and saved as much as I could. It would be a private sale, so the landlords aren't paying a realtor commission. The unit is about 60k out of my borrowing limit, so I would be co-signing the mortgage with my brother with whom I'd split all expenses and future sale revenue.

Life Situation:
I live in Montreal, Quebec. I work full-time and study part-time. I have no dependants or debt and I live with my girlfriend. I am thinking of leaving Montreal next year, or at least, live elsewhere during the 6-month winter.
My brother lives in California, he works as a software engineer and lives in a van. He is happy to split the investment with me if I can prove to him it's a sound idea.

Gross Salary/Wages: $70 000 (me); $100 000 (brother)

Current Cash: $24 000 (me)

Other Ordinary Income: I work a part-time job which nets $5000 a year. Although I’ve asked mortgage brokers, I’m not certain how it will be included in a final mortgage pre-approval

Market Value:
My landlord purchased this property in 2007 for $255 000. The municipal evaluation is now at $359 000. More recently, they had real estate agent come over to the apartment and he appraised it at $395 000.There are units of similar size that are newly renovated (bathroom, kitchen, floors), selling for $409 000.
Their final offer to me was $375 000, so I’m using that as the sell price.

One-time Expenses for Ownership
Welcome Tax: ~$4500
Notary: $1500
Title Insurance: $400
House Inspection: $700

Yearly Cost of Ownership
Property Tax: $3716 (confirmed)
Condo Fees: $2400 (confirmed)
Apartment Insurance: $1000 (assumed)
Maintenance: $1500 (assumed)

Mortgage
Downpayment: 5% for a total $18 750
Interest Rate: I think my first mortgage rate will be fixed 3% for 3 years
Mortgage Insurance: ~$20 000
—> Monthly payment: $1754

Net Operating Loss
With an initial rental income of $1910 a month, we'd have a NOL of $6000 that reduces gradually and becomes NOI after 13 years. On average, our NOL is $3000. We wouldn't see any profit in this investment until we sell.

Comparison to Stock Investment
Assuming 9% compounding return on a comparative stock investment using all of the capital we would’ve invested into this real estate property;
Assuming a 3% appreciation on the property value;
Assuming monthly rental income of $1910 that increases by $40 every year with no vacancy;
Assuming a closing cost of 4% sell price;

If we sold within the first 4 years, stocks are better
At 4 years, we break even with the stock investment
At 12 years, this would would double the stock investment

Motivations for Purchase

• In general, getting started in real estate is scary, so the fact that I know this apartment so well is an important factor and a good opportunity to get started. The apartment is in a student neighbourhood that I've lived in for many years; I know the tenants, and feel confident I can find tenants through friends of friends for at least the next few years
• It's a private sale so, presumably, I'm getting a better deal than if they posted it online
• For the time being, I live across the street, so managing the apartment is convenient
• The apartment is 1200sq ft in a downtown Montreal neighbourhood and competitively big
• I should invest in a rental property while I have income to leverage, so that if I decide to travel or go back to school, I am still significantly exposed to the market and employed as a landlord

Questions:

• Is there something I'm missing here about a co-signed mortgage with my brother? Is this a bad idea?
• I feel an urgency to get exposed to the market while I still have a salaried income to leverage, and I think real estate will be a reliable way to continue being employed while traveling. Is this motivation misguided?
• Are my assumptions realistic?
• What do you think about lease-to-purchase?
• Am I getting a better deal because it's a private sale, does this make it a rarer opportunity, or does it not matter?

Help on Negotiation:
My landlord first offered me $387 000. I offered $345 000, and they responded with $375 000 as a final offer.
I told them I saw similar-sized units around the neighbourhood that were totally renovated. They replied that the kitchen was renovated in 2006, and my bathroom was renovated in 2016 before I moved in. I haven't had an inspection but I suspect there will be some work to be done in the bathroom. They also mentioned that if they didn’t sell to me now, they may move back into the apartment next summer. I wasn’t sure how to interpret that.

[erutio]

From a pure numbers perspective, this is a horrible investment. 

[Archipelago]

You'd definitely want to pass on this one.

[SwordGuy]

Run like hell unless you get your jollies losing money.


This is a horrible investment at that price.


Go to the sticky thread in this sub-forum that lists books to read.   Read them.  THEN start to invest.

[Papa bear]

Bad rental regardless of anything else going on in your situation.  This place is way off on rents to market value. 


Sent from my iPhone using Tapatalk

[BicycleB]

Most landlords in this forum seek properties that are cash flow positive. Accepting a NOL on purpose is not commonly thought to be wise, at least among this forum's circles.

I am only a small landlord myself: one house. When I bought it long ago from my then-landlord, it was very cash flow positive. Now it breaks even and I consider selling it.

If you could predict the future, you would know which option is better, stock or this deal. Then again, if you could predict the future, there would probably be better opportunities around somewhere.

I've read that a rule of thumb for flips is to buy properties at 70% of market. You're not flipping, I understand that, but the comparison suggests that a savings of 3% or 4% on purchase is nowhere near enough to turn a bad deal into a good deal.

Your landlord may move in, but that doesn't mean you should buy.

I can't predict Quebec real estate. My guess is that if you can, there are probably better deals somewhere. Do you know enough about Quebec real estate to know where the best deals are? If not, the stock path allows you to educate yourself until you are a more knowledgeable buyer.

[david156]

Thank you for your replies, and the recommended reading. I appreciate that you took the time to read my situation and shared your thoughts. I’m worried because many of you have seen strong red flags.

Is 2x after twelve years in comparison to an index fund bad performance for real estate? Or are the red flags specifically running a loss, the rent-to-market-value ratio, and a co-signed mortgage?

Would you be willing to explain in more detail the red flags that you see?

[BicycleB]

Or are the red flags specifically running a loss, the rent-to-market-value ratio, and a co-signed mortgage?

Would you be willing to explain in more detail the red flags that you see?

1. Running a loss - yes, red flag.
2. Rent to market value ratio - yes, red flag
3. Co-signed mortgage - yes, red flag

1. If you're not getting positive cash flow, you're highly vulnerable to problems and may never harvest any of the profits you think will eventually materialize. A hiccup in your other income (think layoff) could make you lose your investment.
2. Nowhere near 1% rule of thumb. Here's an example of discussion on 1% rule. Calculate the ratio you have and compare.
https://forum.mrmoneymustache.com/real-estate-and-landlording/1-rule-1-of-what/
3. I wouldn't cosign something with someone where I thought I'd have negative cash flow, let alone something that might actually lose money. Relationships are valuable and I wouldn't risk it.

Your assumptions for the stock vs real estate scenario appear highly speculative to me. I don't count them as a solid basis for comparison and wouldn't take risks like that without a better proposition.

All just my opinion, course. FIREd; made a few good deals, passed up some bad ones and some good ones. Best investment ever was in real estate, but I wouldn't do this deal.

[clarkfan1979]

The probably of your old landlord having the best deal for you is really low. I would run some comparisons from the MLS. You might pay more for a property and have the rental numbers turn out better. Maybe higher rent, lower taxes, lower HOA?

If you are already rich, you don't need to be cash flow positive from day 1. It's ok to run negative as long as you have a plan for long term appreciation. However, based on the average joe, they typically want instant cash flow because they don't have the bank roll to run a negative.

My first rental was a 4 bedroom house near a University when I was in grad school. My parents co-signed because I was a grad student making $15000/year. However, I had 50K to invest, so I bought a house near campus. I had 3 roommates that paid the mortgage. The mortgage was $950/month and I collected about $1000/month in rent from 3 roommates. It was a foreclosure that I purchased for 182K. I put 10K of material and 6 months of sweat equity into it. After rehab, it was worth 210K to 220K. Now 12 years later the rent is $2500/month and it's worth 400K.

[malacca]

It sounds like the whole idea was one of convenience. You were living in the unit and are familiar with it. That isn't a reason to buy.

Lower end properties are always a better investment - as the renters can't buy. People on the upper end will simply buy if the calculation of rent vs buy isn't in their favor.

Winnipeg properties will get you a solid 8% net. Same in the southern USA. For $375,000 you can get 8 or 10.

[Dicey]

I like the quality of advice you have received thus far. I'm going to bat signal @waltworks anyway, because he always has great feedback and I love his no-bullshit answers.