Author Topic: Critique this potential investment property  (Read 4416 times)

Posthumane

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Critique this potential investment property
« on: August 27, 2013, 03:18:03 PM »
My DF (dear fiancee) has family who live in a nearby village, and when one of their neighbours passed away they immediately put in an offer to purchase the property. They then passed it off to DF, she agreed to it (somewhat blindly, IMO), so the offer went in in her name. Now, we are having a bit of a time securing a mortgage due to her lack of credit history, and because of the age of the property. Here are some details:

Current Price: $69k
This is very low for the area, and well below the property tax assessment. The property is actually two adjacent 150'x100' lots, one with an older mobile and one vacant but levelled. The mobile is in tact and "liveable" but would need some updates. However, lenders are very hesitant to finance older mobiles (this one is from 1976), which is part of the issue.

Gross rents: $700
This is my estimate based on some kijiji listings which come up once in a while, but there are usually very few to go on since it's a small village of a few hundred people. The only reason for people to live there is because it's close to a military base. Most people commute to the base from the next nearest town (40km, pop 6k) or city (50km, pop 70k). The rents in the closer town/city would be closer to $1k for a house, or $600-800 for an apartment.

Expenses:
Taxes are low here, about $650/year. Tenant would pay utilities. Insurance would be on the order of $800/year. The somewhat unknown cost would be repairs/maintenance. We have a somewhat guaranteed tenant for at least a couple of years - DF's step brother who currently lives with her parents and is looking to move out but stay in that village as he works at the base.

Other factors:
DF's parents live literally next door to this property, and were considering buying it themselves. They are still interested in buying the vacant lot which can be severed from the title once the property is purchased. Her dad is recently retired, fairly handy, and is willing to help out with much of the repair/maintenance side of things. The disadvantage of having her parents there and renting out to a family member is we lose a lot of control regarding what gets done to the property.

So, first off, if we can get a traditional mortgage at 3.44% (what we were quoted if it goes through with me cosigning), is this a good deal? My calcs show that it is, but I may have missed something. This would be for a 5 year term, 25y amortization as is common in Canada.

Secondly, if we can't get the mortgage, what are some other options? It's possible that if her parents cover 20-25k for the emtpy lot that they want, we can scrape together enough to cover the rest between the two of us. However, this would require me to either cash out most of my TFSA investments (which are at a low point right now) or take a significant sum out of my line of credit at 6.5%. If we went this second route, both our names would be on the title as opposed to just her name in the first case.

Either option would deplete her current liquid savings, whereas the first option would leave me rather uninvolved apart from being a guarantor for a loan for one year. I know some people are opposed to buying real estate jointly when you aren't married but I'm not too worried about it, so no need to comment on that.
« Last Edit: August 27, 2013, 03:21:27 PM by Posthumane »

JohnGalt

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Re: Critique this potential investment property
« Reply #1 on: August 27, 2013, 03:56:14 PM »
Can you walk away from the property??

The numbers probably only start to make sense if you can get the rent you listed and get the $25,000 back from selling the vacant lot. 

There doesn't seem to be enough figured out to warrant going forward if you have an easy way out at this point.  If the parents really want it, let them buy it but if you and your DF don't already have a plan laid out, neither of you should be purchasing it. 

daverobev

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Re: Critique this potential investment property
« Reply #2 on: August 27, 2013, 04:14:41 PM »
Go for it. $700 on $69k is pretty good (NOT amazing but pretty good), and you know you have options with the land. AND know you have a tenant for 2 years!

3.5% mortgage is fine. You're unlikely to get lower than that now, I think. Doing it on the LOC less good. See if you can get them to come down on that (they might). Also see if you can get an MBNA Platinum Plus card - 12 months interest free, with a 1% balance transfer, BUT if you go through GCR you can get some of that back (PM me if you want more info).

What province are you in? If Ontario it's less good.

Any chance of the base disappearing in the next 10 years?

Posthumane

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Re: Critique this potential investment property
« Reply #3 on: August 27, 2013, 04:26:46 PM »
Can you walk away from the property??
That's an interesting question, and one which I myself have also pondered. Legally speaking, I'm not sure that we can since they put an offer in without conditions of financing and it was accepted. That kind of made me do a double take since an offer without conditions seemed a bit foolish to me, but that's what they did. Initially I was uninvolved in this since when this started we weren't engaged, and they wanted to keep the whole thing "in the family" so to speak. Her parents basically arranged everything and then said to her "oh, actually we're not sure if we can actually afford this right now, so you buy it."

Anyway, can you tell me how you ran through the numbers? I'd like to know more. This is what I did initially:
Purchase price: $69k
Downpayment: $14k
Principal: $55k
Monthly mortgage payment (based on 25y, 3.5%): $276
Gross rent: $700
Taxes: $55
Insurance: $70

This leaves a margin of $299/mo for vacancy/mgmt/maintenance before we get down to zero cash flow (but still ~10% equity gain on purchase price). This alone isn't a huge margin for an older house, but when combined with the fact that it's assessed at over $100k for property tax it starts to look not too terrible. Other properties in the area are listed between $115k and $170k, and a couple vacant lots nearby are listed at $40k for a comparable sized lot to $25k for one half the size. I live in a mobile home in a nearby town and my land is 1/4 the size, and it's valued at $200k, although it's quite a bit newer than this one so not really a great comparison.

daverobev: I think the chance of the base disappearing in the next 10 years is pretty low. I work there and have some visibility on what's going on, and while there have been significant cuts, this is an area that has to stick around for the time being for a number of reasons.
We are in Alberta, which has tenancy laws that strongly favour the landlord if that's the reason you were asking.

unpolloloco

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Re: Critique this potential investment property
« Reply #4 on: August 29, 2013, 01:46:10 PM »
Can you get a mortgage for the land only?

JohnGalt

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Re: Critique this potential investment property
« Reply #5 on: August 29, 2013, 03:23:52 PM »


Anyway, can you tell me how you ran through the numbers? I'd like to know more. This is what I did initially:
Purchase price: $69k
Downpayment: $14k
Principal: $55k
Monthly mortgage payment (based on 25y, 3.5%): $276
Gross rent: $700
Taxes: $55
Insurance: $70

This leaves a margin of $299/mo for vacancy/mgmt/maintenance before we get down to zero cash flow (but still ~10% equity gain on purchase price). This alone isn't a huge margin for an older house, but when combined with the fact that it's assessed at over $100k for property tax it starts to look not too terrible. Other properties in the area are listed between $115k and $170k, and a couple vacant lots nearby are listed at $40k for a comparable sized lot to $25k for one half the size. I live in a mobile home in a nearby town and my land is 1/4 the size, and it's valued at $200k, although it's quite a bit newer than this one so not really a great comparison.

daverobev: I think the chance of the base disappearing in the next 10 years is pretty low. I work there and have some visibility on what's going on, and while there have been significant cuts, this is an area that has to stick around for the time being for a number of reasons.
We are in Alberta, which has tenancy laws that strongly favour the landlord if that's the reason you were asking.

I didn't really run through any numbers - just used some of the general rules of thumb that get thrown around. 

It's a manufactured home and you're only expecting to be able to rent it for 1% of the purchase price.  That tends to be a low end investors look for with brick and mortars - I'd imagine the expectation would be higher for manufactured.

If the property is really worth the $100,000 property tax assessment (doubt it) then, by all means buy it for $70,000.  Then you'd probably want to just flip it and take your $30,000 in profit rather than rent a $100,000 property for $700/mo. 

All that said... the main reason I asked if you could walk away was not the numbers it was more about the haphazard nature by which you've found yourself considering it.  If you have thought it through more than the original post indicated and the numbers work for you, go for it. 


Posthumane

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Re: Critique this potential investment property
« Reply #6 on: September 02, 2013, 10:32:06 PM »
Can you get a mortgage for the land only?
No, unfortunately. I asked about that, and apparently the only way we could get a mortgage on land only is if we demolished the current house and intended to build on it within the next year (essentially it would be a builder's mortgage). They won't do land mortgages in residential areas here otherwise. If it was a farm, it would be a different story.

I didn't really run through any numbers - just used some of the general rules of thumb that get thrown around. 

It's a manufactured home and you're only expecting to be able to rent it for 1% of the purchase price.  That tends to be a low end investors look for with brick and mortars - I'd imagine the expectation would be higher for manufactured.

If the property is really worth the $100,000 property tax assessment (doubt it) then, by all means buy it for $70,000.  Then you'd probably want to just flip it and take your $30,000 in profit rather than rent a $100,000 property for $700/mo. 

All that said... the main reason I asked if you could walk away was not the numbers it was more about the haphazard nature by which you've found yourself considering it.  If you have thought it through more than the original post indicated and the numbers work for you, go for it. 

I have been running the numbers and looking at comparable properties even when I wasn't involved in the purchase, so I have had a bit of time to consider the options, but I didn't really count on not being able to mortgage the property. I just kind of assumed that a mortgage was a given.

While I don't have 100% confidence in the tax assessment, I don't think it's too far off. I know I said "vacant" in my original post, but the land isn't completely vacant as it does have a small outbuilding on it (basically a small garage), and the lot that has the house on it has another small garage, and carport attached to the house. The place has had a number of improvements/additions over the years to the original house that was placed there.

Interesting thought about flipping it versus renting it out. I wonder if getting a ~30k one time payout would be better than the rent revenue in the long term. Although the "value" of the property may be 100k, the cap rate is still calculated on purchase price, isn't it?

Hamster

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Re: Critique this potential investment property
« Reply #7 on: September 03, 2013, 01:20:07 AM »
If you really could purchase for $69k an sell it immediately for $30k profit (minus transaction costs), then of course that is a great deal - >40% return in a matter of weeks.

As for assessing its worth as a rental... I am not a believer in the 1% rule, other than as a very rough starting point. But, then again I'm not building wealth or turning profits as quickly as some people are in RE (looking at you, arebelspy). If you have low taxes, low interest rate, no HOA fees, low anticipated maintenance/upkeep costs, tenant pays all utilities, and are in an area of low vacancy, then 0.7% could be much better than a property that meets the 1% rule with high taxes, high interest mortgage, high maintenance costs, high vacancy, landlord carrying utility costs, and expensive property management fees.

Do the full math, and make sure you cash flow after accounting for vacancy and all of the above expenses including maintenance under less than ideal circumstances. Then consider how it fits with your goals and what your return is based on your upfront costs under various scenarios. Every few years, think about current sale value of the property (or your current equity), and recalculate your return, considering what you would walk away with if you sold it for, minus transaction costs.

arebelspy

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Re: Critique this potential investment property
« Reply #8 on: September 03, 2013, 07:51:53 AM »
If you really could purchase for $69k an sell it immediately for $30k profit (minus transaction costs), then of course that is a great deal - >40% return in a matter of weeks.

As for assessing its worth as a rental... I am not a believer in the 1% rule, other than as a very rough starting point. But, then again I'm not building wealth or turning profits as quickly as some people are in RE (looking at you, arebelspy). If you have low taxes, low interest rate, no HOA fees, low anticipated maintenance/upkeep costs, tenant pays all utilities, and are in an area of low vacancy, then 0.7% could be much better than a property that meets the 1% rule with high taxes, high interest mortgage, high maintenance costs, high vacancy, landlord carrying utility costs, and expensive property management fees.

Do the full math, and make sure you cash flow after accounting for vacancy and all of the above expenses including maintenance under less than ideal circumstances. Then consider how it fits with your goals and what your return is based on your upfront costs under various scenarios. Every few years, think about current sale value of the property (or your current equity), and recalculate your return, considering what you would walk away with if you sold it for, minus transaction costs.

I absolutely agree with you on doing the full math and only using the 1-2% rule as a rough guide to start, but saying that one should accept a lower rate of return since they aren't looking to build wealth as fast is just silly.

One should still wait for a good investment.

That's like saying "I keep my risk-free money under my mattress, instead of a CD, but that's okay, I'm not looking to build wealth as quickly."

Or "Yeah, I'm invested in this index fund with XYZ company that has 1.2% fees, when I could get the exact same index fund with another company at 0.2% fees, but that's okay, I'm not looking to build wealth as quickly."

...what?

You don't have to be looking to build all your wealth through real estate to decide to make solid investment decisions in it.  Even someone who makes a one-off purchase is much better buying a property that grosses 1.5% of the purchase price in rent than one that grosses 0.5% (i.e. a house that rents for 1000 that costs 67k rather than one that rents for the same 1000 but costs 200,000).
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Hamster

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Re: Critique this potential investment property
« Reply #9 on: September 03, 2013, 08:01:55 AM »
Hey Rebel, I think we have our cause/effect wires crossed. I was saying that maybe the reason I'm not building wealth as fast is because I don't follow those rules strictly. Not saying that I don't follow those rules because I don't want to build wealth quickly.

arebelspy

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Re: Critique this potential investment property
« Reply #10 on: September 03, 2013, 08:07:48 AM »
Hey Rebel, I think we have our cause/effect wires crossed. I was saying that maybe the reason I'm not building wealth as fast is because I don't follow those rules strictly. Not saying that I don't follow those rules because I don't want to build wealth quickly.

Ah, I totally misread that*, my bad.  Thanks for the clarification.  :)

*Probably because I've heard the same arguments from so many other people "Oh, I'll just invest in my area and buy a $500,000 house that rents for $2000**" (it's a trap!) and then says a similar comment like "well I'm not looking to build wealth that quickly, it's a slow long term play."  And I have to use a similar argument that cash over a CD or a subpar equities investment isn't a slower long term play, it's just an inferior one.  I should have realized someone like yourself wouldn't fall into that silly line of defense/thinking.

**Waiting for honobob to ask how much appreciation that 500,000 house has.  ;)
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Posthumane

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Re: Critique this potential investment property
« Reply #11 on: September 03, 2013, 05:29:19 PM »
No doubt that a 2% property would generally be better than a 1% property, which in turn is better than 0.5%. The question is how much risk/hassle one is willing to accept for better returns. In my case, almost nothing in my town approaches 1%, and in the nearby city the only properties that do are 100 years old and in a flood plain. In fact, a lot of them went up for sale after the recent floods all over south Alberta. The only way for me to get better RE returns right now is to look well outside of my own area, but I don't think that long distance land-lording is something I want to take on at this time. With this property I think lower returns are more acceptable for me because a family member would be living there, and they would be helping to renovate the property (along with DF's father).

Could we buy it and then turn around and sell it for $100k? I think it could sell for that, but due to the size of the market I wouldn't expect it to sell fast. However, the initial reason for this place being bought at all is for DF's stepbrother to have a place to live, even though he can't buy the place on his own at the moment. It's possible that in a couple of years he will be in a position to buy a house, and the house that he had been living in might happen to go up for sale around that time.

JohnGalt

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Re: Critique this potential investment property
« Reply #12 on: September 04, 2013, 09:08:15 AM »
That's a decent amount of new information... if the goal is to help a family member and you are comfortable with the numbers go for it.

Getting $700/mo gross rent on property worth $100,000 does not sound like a great investment to me (sure you're only paying $69,000 for it and you can look at it that way if you want, but if the property is worth more, there is an opportunity cost to keeping it as a rental).  Your max return (excluding any additional appreciation) is going to be 700*12/100000 = 8.4%.  That's before any maintenance, property taxes, insurance, vacancies.  I have to believe there are better places to invest $100,000 if you're looking at it purely as an investment.