Deal Analysis for 2br condo

Hello everyone,

I am a first-time homebuyer and have come across what appears to be a good deal. You guys are the experts so maybe you can help.

I’m looking at a 2br, 1.5 bath condo located in central NJ, within walking distance/bike ride to the beach.

Here’s the breakdown, assuming 4% interest rate:

$200,000 Sell price
$40,000 down payment (20%)
$1800 property tax
$150 HOA fee per month
$700 home owners insurance (rough estimate, not sure how much this is)

Total monthly payment: $1122.20

A real estate agent said typical rent for a 2br in the area would be between 1500-1600/mo.
It’s been updated, hardwood floors, new kitchen. There’s a laundry facility on site so no washer/dryer in unit.
Very rare that a 2br becomes available in this complex (lots of 1br units for sale between 165-190k)
Most units have balconies, this one does not. This is also the only bi-level unit in the complex.
Square footage was not available online, so I’m assuming 800-900 sq ft.

At first glance what do you think? There should be minimal maintenance required (or so I would think?) so I’m assuming I would not hire a management company. My main concern is having the unit be vacant or having to deal with delinquent tenants. I’ve never owned property before, much less been a landlord.

Any suggestions or advise on this?

To me if I can clear $400 month in passive income that sounds like a good investment. The taxes are surprisingly low for NJ, compared to nicer condos closer to the beach or single family homes. In the 2-3 years I’ve been looking, there have been numerous 1br’s listed from this complex. I believe I’ve only seen a 2br listed once, aside from this one.

Any thoughts?

Can you break down the numbers for us? What is included in the $1120 monthly payment?

Is the $700 insurance the condo associations assessment to you, monthly/quarterly/annually? How much will your contents coverage and liability insurance policy run you every year?

You don’t mention a vacancy allowance. Have you considered the cost of a vacant unit, even for one month, when you have tenant turnover?

$150 monthly association fee is low unless the association master insurance policy is not included.

What utilities are included in your association dues (water, cable TV, etc.)?

If you are an expert on landlord-tenant law, and know your way around the courthouse eviction process, you don’t need a property manager. If you have a rolodex with all the building trades contractors telephone numbers handy, you don’t need a property manager. If you are OK with the 2:00 am emergency call that the water heater sprung a leak, or the HVAC died, you don’t need a property manager. If you know how to do tenant screening and can run credit/criminal background checks, you don’t need a property manager. If you are familiar with issuing a 1099-MISC to each independent contractor that you paid more than $600 for work done in your unit during the year, you don’t need a property manager.

If I were to break down the 1122 monthly payment it would be:
$763.86 principal and interest
$150 property tax
$150 HOA fee
$58.33 (estimated home owners insurance)

I used $700/yr as home owners insurance as an estimate. Based on searches online for NJ, it should be less.

I agree the $150 HOA fee is low. I don’t believe any utilities are included in the association dues. On the MLS listing it says Fee Includes: Common A, Snow removal, exterior maintenance. Not sure what ‘common A’ stands for. Everything is electric (heat, water heater, hvac).

Property managers usually charge 10-15% of monthly rent, correct?

I have considered the cost of the vacant unit, which would be $1120 I’d be responsible for. That’s one of my main concerns. I’d like to see rental history or at least get an idea of rental demand in the area. At this time it would be very difficult for me to commute to my job from this condo, if I had to move into the empty unit.

Suggest you do a more detailed cash flow analysis.

Cash Flow Analysis is a spreadsheet that can be downloaded from this site which will give you a little better appreciation for the cash flow you might really realize from this property.

If your rental income just covers your monthly loan payment and HOA fees, you will be in a negative cash flow situation. Use this spreadsheet, plug in actual costs wherever you can, and when you have to estimate a cost err on the high side.

I always use one month vacancy (unless the market is soft) and expect turnover every year. Management fees in my rental areas run from 8%-15%. The higher the fee, the more it includes. The low fee property managers will pass through costs for advertising, a leasing fee, and a lease renewal fee, maybe even mailing. Some have a supervisory fee (maybe a 10% surcharge) for the repairs and renovations they order for you.

Don’t forget that whenever you have a vacancy, you also have all the utility costs as well.

Common A usually means “common area”. Common areas are those parts of the building and grounds that are shared by everyone – parking lots, outdoor lighting, swimming pool, landscaping, etc. The cost to maintain the common areas and a contribution to the replacement reserve is included in your monthly fee. For that low a condo fee, I suspect that the association master insurance policy premium is billed to the unit owners each year as a special assessment. When doing your cash flow analysis, add the amount of the association insurance assessment for last year (ask the association manager or your real estate agent) to the cost of your own contents and liability insurance policy. Ask your insurance agent to quote you the cost of an HO-6 policy.

When you say you are a first time homebuyer, are you looking to purchase your primary residence rather than an investment rental property? If you intend to purchase for rental use, expect the loan interest rate to be around one-half point higher than you might get for an owner occupied home. Some lenders also add an eighth to quarter point to the interest rate if the property is a condo. It is loan fraud to use owner-occupant financing (for the lower interest rate) when your intent is to use the property as a rental.

Using your figures and knowing that you are looking at this from an investment standpoint, here are my conclusions:

$1,550 Rent

  • 10% Vacancy
    $1,395 Gross Monthly Income

$ 58 Property Insurance
$ 150 Property Taxes
$ 150 HOA
$ 0 Property Management (owner can manage, typical rate 10%)
$ 78 5% Repairs/Maintenance
$ 0 Utilities (Tenant pays)
$ 78 5% Capital Reserves
$ 513 Total Operating Expenses

$763.86 Mortgage at 20% down, 4% interest, 30 years

$ 118 NOI before taxes

This is do-able but not exceptionally profitable. Your expenses (not including mortgage) are at 33%. Investors figure profitability by allocating 50% expenses. If this is the case you would have a negative cash flow of over $1,700 per year.

You are looking at a cap rate of only 5.3% and a ROI on your investment of only 3.5%. I bet you could find a better deal out there.

I don’t see the cap rate that high.

Cap Rate is defined as annual Net Operating Income (NOI) divided by Value. In this instance, using your example, the monthly NOI is the Gross Monthly Income minus Total Operating Expenses. Monthly Gross Income (from your numbers) is $631 ($1395 - $764), giving us an annual NOI of $7572. Dividing this amount by the purchase price of $200K, gives a cap rate of 3.8%.

First-time homebuyer and first time investor are two different things.

As i suggested in an earlier response, this will not ba a positive cash flow property over the long term. There are too many costs of ownership and rental operation that you are overlooking.

Here are a couple of metrics that I have used for the past 30+ years.

  1. Debt coverage ratio = NOI / Debt Service.

Debt service is the principal and interest you pay for your financing. It does not include any amounts escrowed for taxes and insurance, since the NOI calculation already includes your monthly allocation for taxes and insurance.

If the Debt coverage ratio is 1.3 or higher, then the property will probably generate sufficient cash flow to support itself. A ratio of 1.3 or higher usually ensures that there is sufficient cash flow to cover the emergency repairs and unplanned vacancies that always crop of.

  1. Return on Investment (ROI) is your annual cash flow divided by your initial out-of-pocket investment. Your initial investment is downpayment, out-of-pocket closing costs, and any rehab costs you incurred to make the property rent ready. The ROI should be better than you might get from other investment vehicles you have available to you considering the risk of the investment. For example, campbellsimon’s example has your ROI at 3.5%. There are stock and bond investments that may be considered safer than a rental property yet have a higher yield with none of the landlord headaches of a rental property. If you are going to commit this much capital and assume a certain amount of personal liability risk, would a 3.5% return on your investment be a sufficient reward?

Dave & Simon,
Thank you very much for the feedback, it’s much appreciated. To drain my savings/stocks for a 3.5% return would definitely not be worth it.

Is ROI the same as the Computed Internal Rate of Return? On the Cash Flow Analysis form, what % of an increase do you estimate the net sale price from the purchase price? Internal rate of return came to 9.5%, Cap rate 5.6%, and debt ration 1.2% (below the ideal 1.3%).

Some of the numbers have changed slightly since my first post (higher HOA fee of 228, lower mortgage rate of 3.7%). I’ll play with the numbers before I shut this down. Maybe if I put 25% down and get the seller down to 180k.

All in all, I don’t want to beat a dead horse. If I’m under 7-8% I can do better in the stock market. I just know how expensive beach property is, and I thought this was a good opportunity to get started.

Is this a property that can be used as a weekly vacation rental?

No, just monthly/yearly rentals.

I finally got a grasp on these calculations. NOI is now $72/mo, ROI just under 2%. Closer to 4% ROI if I took out 5% capital reserves

I relayed doubt to my mortgage guy. He said ROI is not great but said “rates are low, great opportunity to get in, unit will appreciate and ROI will increase when you sell”. He also said I’m forgetting about money I’ll get back each year from deductions (which I wouldn’t rely on).

My only hope would be for appreciation, since it’s a horrible return compared to what I’d get in the stock market. I can either buy this and hope it appreciates (or eventually move out of my apartment I’m renting and live there), or as was suggested here, look elsewhere for a better deal. My problem is I want to concentrate on beach towns. Not too many options here in NJ with 45-50k.

You haven’t lost yet. Work backwards from A ROI that you need and make an offer.

Returns are usually terrible in beach towns.

Returns are usually terrible in beach towns.
Is that because they carry higher expenses than other areas (higher taxes, flood insurance, etc)? I would think appreciation adds to the return, since property value at the beach typically stays strong.

I see appreciation as gambling. I count on 0% appreciation. It’s a gamble that we all take but I hope to be pleasantly surprised by counting on zero and seeing some.

Typically purchase prices don’t support annual rentals. Only short term. Last time I was in San Diego on Mission beach I looked at property there. They started at $700k and went up to 1M for a basic place. Rent was something like $3k/week. IIRC, the owner was a real estate agent and told me his break even point was 28 weeks. He owned 7 properties at the time.

I looked in Panama City Florida last month and annual rentals wern’t high enough to support an investment there either. I’d sooner buy a vacation rental there than Mission beach but I’m still happy to pay them to rent the place for a week.

No, the biggest problem is that you are trying to buy an investment using an analysis based on the investment retrns, but it’s a different measurement of value than most of the people competing with you for the property. You can’t pay actual value and make any money, and why would the seller sell to you unless you are offering as much as other people?

If you’re stuck on that area I would focus on a place that can be modified to add value, like an old large house that can be subdivided.

Interesting take on the beach house rentals. When I see weekly rentals that high, I always assumed the owners were paying their mortgages off in two or three months.

Your point was dead on, I can’t pay face value and expect to make money using this analysis. I’d be banking on appreciation, and I agree you can’t count on that either. Back to the drawing board it looks like.

Expenses are a lot higher on a weekly rental. You need to include utilities, higher management costs (20%, IIRC?), furniture, and plan on keeping it in better condition. Marketing is a big expense too.

That’s why it takes so much longer to break even. The exciting thing is that you can lower your price at the beginning and get virtually 100% occupancy. As you get started and get better at marketing and find repeat customers you can gradually raise your price back to market rates. You also get paid up front.

I should mention that in your area you can never hit 100% occupancy. Nobody will pay much to rent there in the winter. Same around here.

If I do it I’ll buy in south Florida. Rent over the winter to snow birds, spring to college kids, summer to families, and the only slow season is the fall.

I agree with no counting on appreciation - if it happens, great, if not it’s not the end of the world since you didn’t bank on it.

While the cost of a short-term rental can be way higher than a long-term rental unit, it can also be significantly more profitable if you know your market and target audience.

For example, where I live we have 9 weekends in the year where hotels are sold out six or more months in advance, so huge opportunity there if you have the right house and the right price. There are also 6 additional weekends where hotels may sell out up to two months in advance, so opportunity is there too, just closer to date of event. When I price our short-term rental, I price it to pay for all expenses within those first 9 weekends, with the additional 6 as back-up weekends just in case we don’t book all nine weekends where we get premium pricing. That’s a high-end rental though, with a less expensive one, we’d need lower nightly rates and I’d need to calculate out what it takes to recoup expenses all year.

Right now I’m currently looking at a package deal on three houses, same street, that are getting miserable rental rates for the seller since he hasn’t raised rents in five years, even though tenants have come and gone. His mistake, my opportunity. He paid $20,5000 back in 1998 for each one, so he’s making a profit on the sale too, I’m not snowing him, based on what I am offering him now.

I’ll layout one of them - a SF 2/1 on an R-2 lot. Same size homes built in the same year are selling in the area and on that street for $90,000-$110,000. He’s getting $400 a month for rent where other houses in the area are getting $650-900 (depending on upgrades previously done). The house was updated in 2010 - new roof, HVAC and electrical & plumbing upgrades, hardwoods refinished and gut remodel on kitchen and bath. The house is in great shape, but he’s just not getting the rent because he hasn’t raised it.

I’ve offered $40,000, 25% down ($10,000) and he carries the note 3-year balloon at 6%, with payment of $179.87/month, no pre-payment penalty, no principle pay-down penalty as long as I don’t do either first six months of the loan.

The house will easily get $500 per weekend (2 night minimum at $250/night) in the 9 weeks and likely book 4 of the six other weekends we’d like full occupancy at $500 a weekend for those too, so that’s $6,500 in short-term rental income and will pay the entire year’s note, utilities, advertising, turn cleaning and maintenance. With 37 additional weekends, at $125 a night, booking at least 20 nights total (10 more weekends), would be another $2,500 for the year, potential profit = 25% ROI on my $10,000.

All three of the houses are almost identical, two are next door to each other, the other is a block down the street…makes for easy turning and keeping up with when they’re not vacant. The smallest, above, I plan to use as my office when not rented out for weekends and it will only be available on weekends so I have it available during the weekdays for my use, with my office going into locked closet storage on weekends.

A ROI less than 4% is horrible. Inflation last year was 1.7%. Typically the rate hovers around 3%. If you cannot get a return that exceeds inflation then why bother? You might as well stuff your mattress with your money - you will sleep better.

You said, “I relayed doubt to my mortgage guy. He said ROI is not great but said “rates are low, great opportunity to get in, unit will appreciate and ROI will increase when you sell”. He also said I’m forgetting about money I’ll get back each year from deductions (which I wouldn’t rely on).”

"A great opportunity to get in"to what? Real estate? If so, you can no doubt find a more profitable property to get into. Buying real estate so you can take a tax deduction is like buying three pairs of shoes to get one free. If you are in a 30% tax bracket then you will only earn back 30% of what you spend.

Now, buying real estate in order to capitalize on price appreciation can be a motivating factor here. There is more risk because it is based on future potential but if property values dropped to an all time low like many markets, then the only place to go is up. This price appreciation could motivate you to buy on a short term holding period until prices return to “normal.”