Experts help with due diligence on first rental property!

I think that I may have found my first rental property. The seller is a guy who wanted to get started in rentals, but he and his wife are moving to Arizona and he is selling the only property that he ever purchased. He seems like a very honest guy because he is telling me about the incessant headaches he constantly was dealing with because he didn’t screen his tenants properly and they stuck him for rent because he was too friendly (he studied Carlton Sheets and claims that it was going great until he swayed from the system). It is a residence that was converted into a duplex with private entrances. Each unit is a 2/1, but the downstairs unit has access to a large basement and patio. Both units are currently vacant since August and he has past leases that show 725 for the 1st floor and 600 for the 2nd floor. This is just about market value, possibly a bit under for the second floor unit. The asking price is $60k but records indicate that he paid $44.5k in 2004. I also considered asking him to give me a delayed settlement contingent to my finding at least one tenant. What do you think?

What should I expect my outgoings to be? How much should I offer and what should my maximum allowable offer be (I’m thinking no more than 50k with a goal of 45?)? What kind of due diligence do I need to do? What things do I need to know? Help me with my first deal pros!

He isn’t very motivated if he is trying to get 60K from it after paying 44.5 in what was still and appreciating market in 2004. Offer 40K and see where that takes you. At 40K and with the potential rent roll, and if it is in decent rentable condition it should cash flow for you.

The market determines rent, not his past leases (which could state $2000/mo for all they’re currently worth). This is especially true for a vacant property with little/dubious track record. You must do a rent survey of comparable apartments in the area to determine value and marketability.

I suggest you use care in buying a conversion. Make sure the property is fully permitted, code compliant, and built on a lot zoned for a duplex. Call the building department about this specific property. If not, selling it could be a disaster. Or worse, the building department could make you bring it up to code or revert it back to a single.

Thanks. Equity, I was only stating his past rents as an indication of the past, nothing else. I know the market rents in the area fairly well, but I will of course look up more comps before I buy this property. Thanks for the help. I hadn’t thought about checking to make sure it was legally subdivided.

When you purchase a rental property, you are not really buying the property, you are buying the cash flow. Until you do a cash flow analysis, you have no way of setting your maximum purchase price.

As a general rule, expect 50% of your rent to cover your overhead costs. The other 50% pays your debt service and whatever is left over is your pre-tax cash flow.

If you have checked the market and believe $1300 is a fair estimate of rental income for this property, then you have $650 in net operating income per month to cover your debt service and cash flow under the 50% rule. You also need to confirm that $1300 is at or below the mid-point of the market rent range. If the mid-point is lower, then set your rental expectations lower. In many areas of the country, the rental market is so soft that potential tenants are asking for and getting rent reductions. If the landlord is asking $800 per month, the tenants are offering to pay $750. Landlords are accepting just to end a long vacancy period.

Multi-units such as this property tend to be harder to rent, tend to have annual turnover, and rents don’t increase as fast as your overhead expenses. So, for this property, let’s require $200 monthly cash flow. This leaves just $450 per month to cover your debt service.

If your financing rate is 6% fixed for 30 years, then $450 will support a
$75K loan. So, based upon this rough estimate, it would appear that you could afford to pay full asking price for this property and still cash flow.

You will need to nail down the numbers for your overhead expenses and confirm that the property is a legal duplex. If the owner is so tired of being a landlord, he may be willing to just break even and walk away. If you decide this property will work for you, suggest you start your negotiations at $44K and work your way up to $47K.

Don’t become a motivated buyer. Be prepared to walk away if you can’t agree on a price. After the owner makes another mortgage payment, he may just call you and accept your offer.

Your contingency of delayed settlement until you can find at least one tenant is akin to people making offers on houses contingent upon selling their own house first. These contingencies can string along a seller for quite some time. If he has another offer come in without such contingencies, that will make your offer look much weaker. If you don’t have the ability to carry the property for a couple months of being vacant, this is probably something you should really consider before doing the deal. Since this is all new to you, I strongly suggest you call around to banks to see where they stand on Non-Owner Occupied (NOO) financing. You will likely run into different rules and terms than if you were looking to purchase a house for yourself. 30 yrs may not be available. What if you find you can only get 5 yrs fixed at 7% amortized over 10, 12, or 15 years? Would you still be able and willing to complete the deal at that point?
If you have questions about the condition of the property, get it checked out. How good is the roof? Are there any floor or foundation issues? What about plumbing, electrical, HVAC? Are the taxes current on the property? Get title insurance.