Hey everyone! Its been a while since my last update so here is the current opportunity that has come up.
My SO asked me to not buy any more real estate for the rest of 2022 after we closed the two duplexes and apartments but it is now 2023 is a new year and new opportunities exciting. Currently we are working on the purchase of a commercial property with a partner that is chewing up all of my cash available for down payments that we are set to close within the month.
Wouldn't you know it my parents come along in the middle of all that and informed me they are considering getting out of the their rental properties as they are in/near retirement. Currently they own 5 with gross rents of ~$106k per year. Of the five properties 3 of them are 100 year old homes. Typically I tend to shy away from these unless they have abnormally good returns and stick to 1970's or newer construction.
They indicated they are hoping to sell them for $900k which at a 7% cap rate is a great deal. The issue is I don't really use cap rates and use ROE typically. For those of you who measure cap rates the worst year they have had on them places net income at $69.4k/.07 = $991.4k which I think is an ok deal in that sense. Two of the homes are in excellent shape and are a steal at $180k each but the other three are very mediocre at best at $180k each and being older homes if I was purchasing from a stranger I wouldn't probably consider them despite the potential for higher returns.
Those of you plugged in before know I think cap rate is a less than ideal measure when comparing new opportunities so the year one ROE I am estimating at 25% down, 5.5% interest rate and financing the DP at 8% interest only is the following: $69.4k - (225k *.08) - 36.3k (yr 1 Int) = 15.1 /225k= 6.7% using their worst years numbers. Now this is nothing to get excited over on its own but considering I would be putting $0 money down it makes me pause to consider it.
The fallacy in my ROE calculation is that I would be borrowing the DP from my parents and then paying it back when I refi the properties between years 7-10 so technically I would be increasing my net income using none of my own funds as a 100% leveraged deal so ROE is also not a good measure in a deal like this. This feels like a good opportunity but it does carry a fair amount of risk.
Pro's:
- Helps parents with retirement income as they would get $1500/mo in interest payments from me until I refi and lumpsum pay them back
- $0 money down to increase my portfolio a fair size
- Two of the homes I am very interested in owning and fit the style of rentals I prefer
- properties have been owned in family over 10+ years and maintenance and issues in all but one home are under control
- three of the properties are multifamily
- City currently is offering a grant (80% to max $15k) to update grandfathered nonconforming multiunit homes to meet bylaw this affects 2 of the older homes
- known homes and long term tenants as I help my dad manage them today already
- 4 of the houses are in great neighbourhoods
- less than 3% historical vacancy rate
Cons
- Lower returns than I normally expect out of older homes
- will not take very much maintenance/renovation costs to eat up my $15k annual profits in first 5 years
- Interest payments on $225k for potentially 10 years
- a relative lives in one of the units and pays 40% below market rent and I suspect it would not go over well at thanksgiving if I raised rent or kicked them out. They do not maintain their space well.
- outside my 25% debt to equity rule for new purchases
- If I renovate the update the units to become conforming it will take ~one month each and I'd have to either find temporary accommodations for the tenants or evict them to take advantage of the grant
- 3 of the homes are outside my ideal type of rental property
- 100% leverage
I feel pretty indecisive on this one which is a tad odd for me so I am more than welcoming any holes to be poked in this chain of thought or opinions for or against!
Thanks for the read. I look forward to the discussion!