I want to buy my first investment rental property and found a good deal. I already viewed the property and the 20% dp will take just under half of my savings to buy. The property is a huge city lot containing one duplex that has a 2 br and a upstairs 2 br Attic unit. The property also has a separate small single family house and a 50x20 four unit storage garage. All units are rented now even the storage units. The apartments all will soon need updating with new kitchens and bathrooms. The price is 91k and the income from all units totals $1300 a month with tenants paying utilities. The area rental market is good but 2 br rentals only average $400-500 a month. After mortgage, taxes, 10% vacancy, $500 in average yearly repairs it still would leave me with $300 in monthly profit. Does this sound like a good deal and can you offer any advice?
Snapshot:
Price: 91k
Down: 18k
Balance: 73K
Payment: 30yr @ 6% = $437/mo pi
Rent: 1,300/mo
Annualized Income/Expense (based on typical assumptions)
$15,600 Gross Scheduled Income (GSI)
-$1,560 10% Vacancy Factor
$14,040 Gross Effective Income (GEI)
-$6,240 Expenses (EXP) (40% not including vacancy)
$7,800 Net Operating Income (NOI) [Cash flow before debt service]
-$5,244 Debt Service
$2,566 Cash flow
14.2% Cash-on-Cash Return before taxes.
5.83 Gross Rent Multiplier (GRM) (Price divided by GSI)
8.5% CAP RATE: (NOI divided by Price)
NOTE: The overall expenses are about 50% of the total income, including 10% vacancy factor. As long as there’s no work to do with this thing, or you can increase the rents significantly after any work is done, these numbers work.
In my experience, unless there are defects, you absolutely should not undergo upgrades and remodeling whatsoever. This is NOT the time (or the place) to be a pride of ownership owner. Wait until your ready to sell in a couple of decades, then hope the next buyer is a hopeless pride of ownership buyer who is happy with 1% returns. There’s an amateur born everyday…! :anon
Just get the place clean, functional and rented. End of story.
Again, forget about putting in new kitchens and bathrooms and indulging your fantasies that somehow you’re improving the lot for your tenants …or magically increasing your values …and/or getting higher rents. That’s what amateurs think and assume.
That all said, if you just want to own pride of ownership, and it’s going to happen, then just buy pride of ownership units, and expect returns that hover around around 1% annually. :banghead
If you work this place over, at this price, your return will drop to about 1% annually anyway (we can only hope), and then you’ll be the happy owner of an old building with new kitchens and baths …that is still not exactly pride of ownership.
And just to add insult to injury, your rents won’t go up enough to matter, because your property is still in the same murky location it was before you put in new kitchens and baths. :banghead
Buy it, clean it, manage it, and forget it.
:beer
This looks like a good deal on the surface, except if the building is more than 50 years old, and not been heavily updated already, you’ll turn into the owner and manager of the “money pit.”
Termite infestations, dry rot, roof conditions (especially flat roofs), and galvanized plumbing (which automatically demands a huge discount) are the first things I want to inspect and use to beat the seller up with.
Finally, I ask you, “Are other investors in your area buying at 8.5% CAPS? Or 5.8 GRM’s …on the age and condition of the buildings you’re looking at?” If not, maybe you should not. Just saying.
I was more looking at a 15 yr mortgage, so when I’m closer to retirement it would be a small second income. I will do my own management and probably 80% of my own repairs. The duplex is maybe 70 yrs old, the single family is around 40 yrs old and the storage garage is only 10 yrs old and all look very sound. I would think the proprieties would only take at most an average $1000 a yr in repairs. The heating systems are around 10yrs old and the roofs are around 10yrs old and all electric has been updated in the last 20 yrs.
troyrb,
I’m not here to argue over your expenses. I’m telling you what to expect. You can tell me that you’ll only spend 1,000 a year on maintenance, repairs and replacements on your rental, and I’ll tell you that I haven’t been able to achieve that figure on any one house over any 10-year period to date since 1980.
Sure, you may defer maintenance for a year or two, or not see much to do at first, since the seller already plowed a bunch of money into the place to get it sold, but you will have ongoing things to fix, replace, and otherwise maintain.
Without belaboring this point, let me suggest to you that on a newer property we can assume the maintenance and repairs, including replacements and reserves will run 10% annually. That’s not too conservative.
Well, at 10% of the GSI, you can expect to pay a minimum of $1500 annually to keep your product marketable, on average over 10 years.
Please, for the love of gawd don’t assume your expenses are gonna be about $1000/yr. You’ll spend that much just replacing the vinyl in the kitchen after the renter rips it dragging the engine block outside.
I assume $2000/yr in maintenance on any one single family home I own. This is why I don’t like houses with very low rents, regardless, if I could buy them for nothing. The basic maintenance costs can’t be reduced or ignored for long. It just costs $2k a year to keep a house in marketable shape. That’s a house. And that’s a twenty year old house. You’re talking a 70-year old duplex.
The costs of maintaining a house are like ‘rollover minutes’ on a cell phone plan. You may not use all the minutes this month, so they just roll over to the next. After a while you’ve got a load of minutes. Same with maintenance costs. You might not spend more than a $1,000 this year… But that’s just one year. Next year it’ll be $3,450 after a tenant ruins the flooring, the fish tank broke and flooded the living room and bedroom carpeting, and some kids sprayed graffiti on the garage wall, and that was after the front door got knocked in during the fake burglary the tenant staged to cover the fact the ex-boyfriend ‘came back for his stuff.’
In 2013 it’ll be $1,532.23 to pay for the gutter repair, sewer backup, glass replacement, replacing the disposal for the third time in so many years, and 12 other little things. Sure the budget was blown by only $523.23 that year, and it’ll be back to normal soon, right?
You get the point (I hope). Meantime, really, $1,000/yr is a pipe dream.
If this were me, I’d want to be at $65k for this place at these rents, and this age. That’s just me.
Thanks for your help. I decided not to go though with this purchase and look at maybe buying small single family homes instead.
The best advice that I can offer is always be prepared for the worst. In your calculations you stated the yearly repair budget is only $500 but that the apartments would need updating. Based on that information your repair budget is a little low for future updates. Additionally your vacancy rate is a little low as well. What would happen if you have a vacancy for over 6 months, would you be able to cover the cost of the mortgage without completely exhausting your savings. By increasing your repair budget while also increasing your vacancy rate you will decrease some of the risk involved in the investment making this property a solid investment.
Ahhh, numbers, the engineer in me loves numbers.
Sorry, doing some research and learning as I explore getting into the rental market (something I’ve wanted to do for years). Jay, a few follow-up questions if I may?
You appear to use a 20% downpayment, my understanding is any rental properties now require a 25% downpayment. Is that simply an oversight in the example or am I looking in the wrong places. My goal is to maximize leverage given the current interest rates so the less down the better!
Second, 40% expenses… can you provide some insight into that? I’m guessing it’s a historical value you’ve created based on experiences? Does that include 8 or 10% fee for a property management company, etc? Just looking to understand what is rolled into that number. I’ve been playing with my own worksheets and the more I know the better.
Third, I didn’t see any mention of property taxes in your calculations… That would seem to affect your cash on cash return quite a bit thought GRM and CAP rate wouldn’t be affected. I’m guessing you account for the taxes in an area (good or bad) by adjusting those 2 factors for evaluations?
I was also going to ask about an equity calculation but it probably doesn’t matter much for that spreadsheet. Do you typically look for 30 year financing? I’m torn between free money and lower payments (30 years at low interest rates) and building 5% equity a year (15 years). Some numbers I’ve run show the lower interest rates available on 15 year mortgages can save a person upwards of $600/yr compared to paying off a 30 year mortgage in 15 years (higher rate) but with that comes the requirement to pay that extra 40% every month. Any thoughts?
Geesh, I type too fast and ramble, this smiley appears appropriate… :help
I always rune numbers figuring my payment with me putting $0 down. If it takes a down payment to cashflow, then it’s not a good deal.
My spreadsheet is uber- conservative, but it barfed red at me and spit out 50K as an offer price.
Note: I factor Management fee diferently than most. I calculate a 3 unit deal with these numbers as much worse than a 1 unit deal.
I believe 25% and I have even heard for commercial mortgages, sometimes, 30% is required. No longer the days of 20% down on conventional mortgages thru banks.
Some banks won’t even do NOO loans anymore so you need to check around where you are to figure out if you can even get financing at all.
Check out http://www.reiclub.com/forums/index.php/topic,50498.0.html for more detailed discussion on this topic.