Buying REO properties, please advice!

Hello everyone!

I’m currently looking for REO investment property in Sacramento area. My target is multi-family units (fourplexes). I have RE agent who is helping me, but unfortunately no luck so far… I want to know your professional opinion on how to win a bidding war without increasing bid? My price-range is around 200K.

What I have right now:

  • high credit (760-780)
  • very strong pre-approved letters from few banks and mortgage broker;
  • prove of funds for downpayment. Willing to pay up to 50% down;
  • ??? What else should I have to increase my chance to win?

Example. I found fourplex listed for 200K.

  • what bid would be appropriate to start with? 180K, 190K…??? or lower if go through conventional loan?
  • what if I pay “all cash” - how much can be my bid? 150K, 160K???

Please share with me your strategy.

Appreciate your advice.


Click on the search button at the top of your page and search for “50% rule.” It’s an often discussed method of property valuation. We can’t give you any idea of what to offer based just solely from the seller’s asking price. An income property is valued based off the income it produces. If the units in that 4-plex only rented for $100 each, it would be worth peanuts. I’d also contact those banks again and make sure their pre-approval offer still stands among the mess we’re in now.

Your realtor can help you out a lot more than I think they are. Using the tax records feature on MLS the realtor should be able to assist you in determining if the properties are worth going after, if at all.

Using that feature they can see when the owner purchased it, how much it was purchased for and the amount of the mortgages. In this case, you’re looking to see how much the bank foreclosed on them for.

The realtor should also provide you with a list of similar properties that have sold in the area within 1/2 mile and within the past 6 months (helps to determine value). Using this information, you’ll quickly be able to see if the owners have enough equity available from which to create a deal. You’ll make offers on with the ones that do and where the equity makes sense.

Don’t let the realtor or seller try to convince you that the value of the property is what it will cost to replace it. The value of an investment property is based on the value of the cash flows; most people like to use a 1% rule of thumb. That being the case, if the combined monthly rent of a quad is $3,000, then the estimated value should be around $300,000. So you’ll need to get it for less than that. (also use an apprasial to confirm)

TO make an offer on any property, take the estimated value and multiply it by 70% and subtract the cost of any repairs; this is the most you’re allowed to pay for it. Then take that amount and multiply it by 85%; from there you start negotiating.

for example

Quad monthly rents total 3k est value 300k
70% = 210k
repairs 10k
Max offer 200k
times 85% = 170k start offering from here, going up by 3k til you get to where you want to be.

Seeing as to how you’ll be dealing with bank owned properties, you need to treat them as if they are all free and clear. Don’t worry about offending the bank with your low offers. Also since you have the ability to put down a large amount of cash and have the ability to qualify for a loan, you should be able to name your price. Make your offers and stay engaged witht the bank and you’ll get what you want.

Thank you All for the reply!

Since we are talking about one to four unit investment properties, isn’t the value determined by comparable sales? The buyer will be getting a consumer mortgage loan, so the bank will not use income rules to qualify the loan for this property – they will use an appraisal most likely based on comparable sales.

The 1% rule popularized by Carleton Sheets essentially said that a property should break even cash flow or better as a rental if the monthly rent approximates 1% of the purchase price. For my market, the 1% rule seems to work for low cost properties that I purchase with 80% financing, but breaks down for properties more expensive than $75K.

The consensus rule of thumb these days is Mike Rossi’s 2% rule. This rule says that a property needs to rent for 2% of the purchase price or better to cash flow with 100% financing. The rule does not establish the value of the property, just the maximum price a rental property investor can afford to pay and still cash flow.

Dave T is correct. Though you are buying it for investment, a fourplex is valued as residential not investment (i.e. commercial) property. Thus, market value will be determined by local comps, not cash flow. Five or more units is commercial property and will be valued by cash flow. If you want to buy a fourplex, your realtor should provide you with sales of similar properties that have recently sold within the area of the one you are considering.

During normal times, fourplexes are generally easier to buy because they can be purchased with conventional (i…e. residential) financing thru Fannie Mae and the like. Five units on up require commercial loans. With easier financing, there is generally greater demand for four or fewer units so the prices per unit are higher than for commercial. A bank will not normally finance a commercial property without sufficient cash flow. Fannie Mae doesn’t care so it’s easy to overpay on a fourplex, and many do. You’ll find in California that many people buy expecting to make money on appreciation, so negative cash-flow deals, especially on residential properties, are very common. You might consider some small commercial deals, say five or six units, instead. While the market ultimately determines the value of a property, this is your investment and you’ll want to determine its value to you by the numbers.

Asking a vague question like what should I pay for property that the bank is asking $200k for, will get you into trouble. How are we to know? One, two, fifty, and seventy percent rules are just that – rules of thumb. They are good for screening and indicate whether a deal is in the ballpark and should be considered. Period. Whether residential or commercial, you should evaluate any investment property with the numbers for that specific property (rent, taxes, repairs, utilities, etc.) using well defined investment criteria. You do have investment criteria, don’t you?

No matter what direction you go, lending in this environment has dramatically tightened. I have found that all cash offers with absolutely no contingencies and a ten day close get the banks attention. They just want the non-performing assets off the books and don’t want the delays and hassles of dealing with your financing. Obviously, there are risks with this approach and your offers should reflect that.

Thank you Equity! You are absolutely right - with relatively easy to finance trough conventional loan, I can’t win bidding war on fourplexes without increasing my bid and this is not my strategy. My goal is to build RE portfolio with positive cash flow, not to buy with negative cash flow and pray for appreciation. Appreciation for me is only a nice bonus on top of the cash flow.

I just received a call from my RE agent with bad news - bank has accepted another offer. There were 5 or 6 other offers on the table…
Property was listed for 199K, my offer was 190K. Comps in the area are in range 220K-250K. Rent per unit (conservative number) is $750-800, TLC appx 5K per unit ($20K total). CAP rate with 20% down should be around 8%.

Next time I want to try another strategy (let me know what you think):

  • offer “all cash” (80-85% from asking price) and do refinancing later.
  • write deposit check for more then they asking (say 15K instead of 7K) to show that I’m serious.
  • promise to close deal in 10 days.

And definitely I will start looking for 5+ units to reduce competition.

Cap rate = NOI/Price Where in this equation is the down payment?

CAP rates are yet another rule of thumb you can use to compare commercial properties against one another. You determine the prevailing cap rate in an area for different classes of commercial properties and compare yours to see if it’s reasonably priced or not. Since fourplexes are not valued by income (included in NOI), there is no such thing as a prevailing CAP rate to compare to. You are mixing apples and oranges. With due respect, I’ll take another shot here and guess that you really don’t have an investment criteria, do you? How will you know if you have a good deal? When the bank accepts your offer? Sorry.

You offered $190K + $20K in rehab costs = $210K for a $220k min ARV property. With variations in rehab costs, construction insurance, and associated risks, this is essentially a full price offer!! Why don’t you just buy one in rent ready condition off the MLS and save yourself the aggravation?

On the other hand, there is less competition buying fourplexes that need major rehab. Here, deals abound if you can control your rehab costs. You can truly lowball the banks on these.

I do not base my offers on a % of asking price. As competition heats up, the banks will increase their asking price. Where will that leave you? I work backward from the ROI that I expect.

The banks are lazy, inefficient, and just want out - quickly. Anything you can do to speed and uncomplicate the deal puts you at an advantage:

  • All cash cuts out the wait and complications for a loan to close - speed. (Understand that in this lending environment, refinancing might take a long while.)
  • Offering with no contingencies whatsoever results in the fastest transaction and minimizes the possibility that you’ll back out – speed. (Just make sure you do your inspections up front and include room in your offer for surprises.)
  • Offering to close within 10 days shows your intent to deal quickly - speed. (Few banks can actually do this, but who cares)

A large deposit check is helpful but doesn’t speed the transaction.

Make it easy and quick for them, The banks realize that the highest offer is not always the best.

Thanks you again for the reply!

I’m still thinking that it was not a bad deal…but could be much better if I was able to buy it “all cash” for 170K.
Here is how I’m analyzing each property. Let me know if something wrong with my calculation ( besides you will probably suggest put aside 50% of adjusted gross income):

Purchase price: 190,000
Initial repairs: 20,000
Closing cost (3%) 4,560
Down payment (20%) 38,000
Rental income: 3,000 (750 x4)
Projected annual
payments (6.5%) 11,532

Gross scheduled income: 36,000
Vacancy loss: (10%) 3,600

Adjusted Gross income: 32,400

Insurance: 1,380
Property Management (9%) 2,916
Property tax (1.25%) 2,376
HOA (covers WSG + lands) 3,960
Reserve (20%) 6,480

Operating expenses: 17,112

NOI 15,288
CAP 7.6% (I used very conservative rent of 750/unit), the real rent in the range of 800 - 825)

Using your numbers, your return on invested capital is only 6% at best. The return goes down if your repairs, maintenance, cleaning, legal fees, advertising, and major systems replacements average more than you are depositing in your 20% reserve.

I can buy 10 year bank CDs right now that have a 5% coupon rate, will pay me the interest every month, won’t decline in value so I can redeem them in ten years and get all my investment back, and I don’t have any of the property management headaches that come from rental property ownership. I won’t have to buy extra liability insurance because my CDs aren’t going to sue me, and, my investment is insured against loss by the bank that issued the CDs.

For the extra risk you will be assuming with a rental property investment, I would certainly want more than a 1% premium over the no-risk safety of a bank CD.

Suggest you add “return on invested capital” to your investment criteria and set a rate of return that reflects a fair value for the risk.

Unless you have so much money sitting around that ‘parking’ $170k isn’t an issue, you shouldn’t write that check to buy it cash. The reason why is because once you commit, your money will be locked up until you are able to resale it.

Refinancing the property, if it truly is worth 220k, in today’s market would probably give you back only about 75% of the ARV or 165k; out of which you would still have to pay closing costs. That transaction in my mind, would be a net loss.

If you are going to pay all cash for any investment property you should get it for a price where your return on investment is at least 200%; even if it is to be a positive income vehicle. That being the case $110k is the most you should pay cash. That way if something happens in your personal life (and it will) that forces you to sell, you’ll have plenty of room in equity to get rid of the place and make a profit.

One last thing, never, ever, ever buy an investment property counting on appreciation as part of your profits. Always buy with the profit that you want already factored in. Why? Because we are not in the speculation business, we’re in the business of making money.