The Money Mustache Community

Learning, Sharing, and Teaching => Real Estate and Landlording => Topic started by: little stache on September 02, 2013, 11:00:14 PM

Title: Critique this potential investment property (2)
Post by: little stache on September 02, 2013, 11:00:14 PM
Looking at buying a property with long-term stable tenants that will likely remain in the home until, well, they die. The house is very nicely kept on a small lake that could be a second/vacation home. I would buy the house for 190,000, putting 20% down. It is valued at 224,000. The tenants take care of the house, utilities, landscaping, and the interior of the house. The rent on the house covers mortgage, property taxes, insurance with a small positive cash flow of @$300/month. House physical plant is in really good shape. No mechanical replacements needing replacement identified.

As part of the sale, I would be committed to keeping the tenants until they leave and having set small increases in rent similar to a rent controlled apartment. Tenants have never missed a payment, ever.

Property values in the area are stable and have risen slightly over the past few years. At first blush, I have small positive cash flow and really stable tenants. Purchase price is a bit below market so sale in future should bring some additional equity, but perhaps the positive cash flow is to small to warrant potential risk of replacing a garage door or fixing a major mechanical.

What do the experts think?
Title: Re: Critique this potential investment property (2)
Post by: Hamster on September 03, 2013, 01:52:17 AM
The experts will likely say no.

It's better than spending money on cars and cable TV, but at first blush, I'm not convinced the numbers will work well for you, and I'm more willing to give real estate investments the benefit of the doubt than a lot of people here.

You don't have to answer these questions out loud, but my initial thoughts - why do you have the opportunity to buy this property below market value? How do you know the tenant situation is as rosy as it sounds? Is this a family situation (to me, family considerations can certainly trump financial ones, but they can also be problematic)? Why is the seller getting rid of it if they are cashflowing and the property is likely to appreciate?

As for raw numbers, you are looking at about $40k cash up front investment. Cash flow is $3600 per year based on what you've said. If we pretend no maintenance, no utilities, no chance of vacancy, no management costs, no depreciation of property, no time/money to manage the rental then it sounds like 9% return on initial investment which is pretty good, especially if this is a "good neighborhood/good market". That of course doesn't include equity growth, depreciation, or tax benefits, which may work further in your favor. There are also opportunity costs of tying u your money and losing out on better investments.

And there are costs which will eventually come due (many people assume 50% of your monthly rent will go to expenses. This is crude, but something to consider). Add in maintenance (assume 1% per year conservatively is $2000) and you are down to $1600 cash flow per year or 4% return on initial investment (not counting inflation). Eventually, there will be vacancies to account for. Would you pay any utilities?  I assume no HOA. What are the odds of missed rent payments based on the tenants' financial situation/future? Is income for the tenants guaranteed? Could they become insolvent if one of them gets ill and needs nursing home care? In America, the only way many people get that covered is by impoverishing themselves until they qualify for Medicaid, meaning they may not be able to pay rent. Would you throw out an elderly tenant with a spouse in a nursing home? Anyway, I'm not saying no outright, though I wouldn't disagree with anyone who said that the return isn't worth it. But, I think there are many other parts of the story to consider before you could convince me to entertain a yes.
Title: Re: Critique this potential investment property (2)
Post by: arebelspy on September 03, 2013, 07:54:02 AM
Why is the owner selling?

This sounds like a (potentially) good opportunity for owner financing.
Title: Re: Critique this potential investment property (2)
Post by: little stache on September 03, 2013, 08:01:18 PM
Was trying not to give up the details...but ya it is a family affair. Owner needs to take their equity out of the house to meet range of expenses. Another goal is to not have anyone "loose" to much on keeping the current situation stable. The below market price was an attempt to balance out very low rate of return and the unknown time-frame for when the house could be sold or rented on open market. It is a nice area, a little bit out in horse country, but the bright lights of sprawl can be seen from afar. Zillow has most houses running from 150 to 350 for sale in the immediate area (not the "z" estimate).

Yes, income levels are stable and can cover the operating costs of the house and provide small positive cash flow beyond the costs I would be assuming but there is not much wiggle room before it goes negative if the rough 50% "oh shoot" costs materialize.

All my income is from wages and I paid off the mortgage recently (whoot whoot). The down payment on this house would be about one year of savings that go into my liquid accounts (the pre-tax retirement accounts are maxed). There might be tax benefits of owning a rental but I have not worked out how that might impact my tax burden (28%). Wanted to gut check if the small positive cash flow and initial built in equity by under market sale price made any sense at all before trying to game out tax benefits.....

Title: Re: Critique this potential investment property (2)
Post by: Hamster on September 03, 2013, 09:48:26 PM
I certainly think there is value in doing something that is beneficial for family--for many, many reasons, even if it isn't the best financial decision. Anyone who has children has made exactly that decision--spending a bunch of money to raise kids without expectation of financial return.

We are considering tying up a decent sum of money for the sake of helping family members be closer to us and be more secure in old age. It's not a "good" financial decision if looking at return on investment, but I think it may be the right decision for us -  a couple of years down the road.

My personal advice would be to look at the personal/familial return on the investment as well as the financial, and only you can value that. As for the financial side of it, it certainly doesn't look like it will be a money loser - or at least not a big one :-).  Without knowing all details, it sounds pretty safe, and you are in what sounds like a pretty secure personal financial situation.

Could you get more in real estate? Absolutely. Could you get more and still provide the same benefits to the family members involved? Which is more important? Those are different questions entirely.