Does this deal work???

[AIR]

REO Bank Owned, 1800 Sq ft. SFH...asking $164,500 I think they may accept between 117K-135K. I am trying to figure out if this deal will work for me. I will be pulling equity from my first property to cover 20% Down Payment (avoiding PMI, escrow money, etc.) as well as closing costs. I will also be asking for a 3% seller assist. I am roughly looking at about 30K home equity at 7.49% 20yrs $237 month.
If they accept at 125K my mortgage will be at 100K @ 6.5% Monthly payment: 30 Years
Interest rate: 6.500%
Loan amount: $ 100,000.00
$ 632.07 a month

RE Taxes $2247 / 2007 187.25 Monthly

Insurance: $580 (guessing) $48 monthly


Mortgage: 632.07
Equity Loan: 237.00
RE Taxes: 187.25
Insurance: 48.00

Total Monthly Payments: $1104.25

My RE Agent just ran rental comps for me and they range from 950-1500. This house in pretty good condition so I believe it should be able to get atleast $1200 def $1100. I will only need about 1500-2000 to have it ready to rent. This deal is kinda scary since the numbers are so close. The house does require some minimal work but could easily be updated and sold for a profit in the future. The area is really turning around and it is only one town over from where I live. Tell me what you guys think...

[Debbie]

Tell me what you guys think...

If this is for rental property, I'd pass....

[Dan Auito]

Depending on your area, you might factor in articles like this one:


Reuters
House prices seen falling 30 pct
Thursday December 6, 6:41 am ET
By Julie Haviv
NEW YORK (Reuters) - Housing markets from Punta Gorda, Florida, to Stockton, California, will crash and suffer price drops of more than 30 percent before the housing crisis is over, a report from Moody's Economy.com said on Thursday.
ADVERTISEMENT
if(window.yzq_d==null)window.yzq_d=new Object();window.yzq_d['.8iJHkLaX.A-']='&U=13bq13kdk%2fN%3d.8iJHkLaX.A-%2fC%3d619945.11919575.12364541.1414694%2fD%3dLREC %2fB%3d5040530';On a national level, the housing market recession will continue through early 2009, said the report, co-authored by Mark Zandi, chief economist, and Celia Chen, director of housing economics.
The report paints a worsening picture of the hard-hit housing sector, which is in the midst of its worst downturn since World War II.
While activity will stabilize in 2009, it will not be until 2010 before a measurable improvement in sales, construction and pricing will emerge, the report said.
House prices are forecast to fall 13 percent from their peak through early 2009. After accounting for incentives home sellers are offering buyers, effective declines peak-to-trough will total well over 15 percent, the report said.
Punta Gorda, Florida, and Stockton, California, are the hardest hit markets in the U.S., with price declines from peak-to-trough forecast at 35.3 percent and 31.6 percent, respectively.
"This is the most severe housing recession since the post-World War II period," Zandi told Reuters.
These markets have been hard hit due to several reasons, namely the exiting of investors from the areas, a fair amount of subprime mortgage loans causing an increase in foreclosures and overbuilding by home builders, Zandi told Reuters.
Home sales, however, should hit a bottom in early 2008, which will mark a 40 percent drop from peak-to-trough.
"The housing market's most fundamental problem is it is awash in unsold inventory," the report said.
In addition, the housing downturn will take a large toll on the rest of the economy. During the height of the boom in 2004-05, housing contributed nearly a percentage point to annual real gross domestic product, or GDP, growth.
In the current downturn, housing will subtract more than one percentage point from U.S. economic growth this year, and a percentage point and a half in 2008, with the effect on growth seen most pronounced next spring and early summer.
"The intensifying housing recession is expected to weigh on the broader economy, but not break it," the report said.
The Moody's Economy.com's report, titled "Aftershock: Housing in the Wake of the Mortgage Meltdown," said that when house prices hit their nadir, some 80 of the nation's 381 metropolitan areas will experience a double-digit peak-to-trough price decline.
Price declines, however, will vary in degree throughout the nation, with more than a 15 percent peak-to-trough expected around Washington and Detroit.
Significant declines are also expected throughout most of Arizona, California, Florida and Nevada. During the housing market's heyday, speculative activity was rampant in these areas, causing prices to surge much higher than other regions.
The Northeast corridor, and markets such as Boise, Idaho, along with Denver and Salt Lake City, will experience between 5 percent and 15 percent declines. In the rest of the industrial Midwest and parts of the Mountain and Pacific Northwest, prices will fall more modestly.
While some point to rising default rates in the subprime mortgage market, which caters to borrowers with poor credit histories, as the root cause of the problems plaguing the housing market, Moody's Economy.com said an unwieldy supply of unsold homes is the prime factor.
The U.S. Census Bureau said that, as of the third quarter of 2007, there were close to 2.1 million vacant unsold homes for sale, equal to 2.6 percent of the stock of owner-occupied homes.
A well-functioning housing market has a substantial amount of inventory, but in the quarter century between the early 1980s and mid-2000s, the vacancy rate stayed near 1.7 percent.
The difference between the two vacancy rates provides a good estimate of the amount of excess inventory in the market, which currently totals nearly 750,000 homes and is by far the highest level of excess inventory in the post-World War II period, Moody's Economy.com said. Moody's Economy.com, which is based in West Chester, Pennsylvania, is an independent subsidiary of Moody's Corp and provides economic research and consulting services to businesses, governments and other institutions.

[scottish007]

If this is for rental property, I'd pass....

I am curious, why? What made you say "pass"?

[Debbie]

I am curious, why? What made you say "pass"?

Conservatively, numbers are too close for comfort. Since this is located in Philadelphia, I would pass...If it was located in Illinois, I wouldn't pass it up....If it was located in Ohio, I'd pass....If it was located in Nebraska, I'd consider.

In other words, it depends on the location and what's been happening in those locations.

[dealmaker]

I see this as a solid MONEY LOSER. I wouldn't walk across the street to look at a property with those numbers.

You're at "break even" if EVERYTHING GOES RIGHT, and trust me, it doesn't.

I didn't see any allowance for vacancies, marketing, upkeep, etc, etc. You need rent closer to $2K to make money on this, and the only reason to buy a place is to make money.

Run, don't walk.

dealmaker

[scottish007]

I see this as a solid MONEY LOSER. I wouldn't walk across the street to look at a property with those numbers.

You're at "break even" if EVERYTHING GOES RIGHT, and trust me, it doesn't.

I didn't see any allowance for vacancies, marketing, upkeep, etc, etc. You need rent closer to $2K to make money on this, and the only reason to buy a place is to make money.

Run, don't walk.

dealmaker

If I read your post correctly, on a property with outgoings of $1104 you would need $2,000 in rent to make this a good deal in your eyes?

[AIR]

Conservatively, numbers are too close for comfort. Since this is located in Philadelphia, I would pass...If it was located in Illinois, I wouldn't pass it up....If it was located in Ohio, I'd pass....If it was located in Nebraska, I'd consider.

In other words, it depends on the location and what's been happening in those locations.

I agree the numbers are a little close... The property is not in Philadelphia... its located in a suburb about 25 mins from the city.

[dealmaker]

scottish007 wrote; If I read your post correctly, on a property with outgoings of $1104 you would need $2,000 in rent to make this a good deal in your eyes

Yep, pretty close to that. But then I've been doing this for 30 years and I understand the real world risks that exist. I have to get a GOOD RETURN on every investment I make. I don't speculate, I don't gamble and I don't consider RE to be a charity. I do it for the MONEY.

Statistically, expenses for SFHs run close to 45%. So I go by the 2% "rule", not the 1% "rule". Trustee's sales are full of people who thought; This deal is kinda scary since the numbers are so close but I can make it work (italics added).

Anyone who thinks the OP's deal looks good, try figuring what you'd be getting for the money you're putting in, using the following assumptions; house takes a month to rent, tenant moves out after one year and it takes another month to rent, you have to repaint a couple of rooms next year, rents stay flat for a couple of years, prices stay flat for a couple of years, the one month vacancy per year pattern holds for 5 years, water heater and dishwasher need to be replaced in the 5 years and both go at a time that you have to pay a contractor to replace them. Property taxes go up 6%/year, HOI goes up 6%/year. Sometime in that 5 years it'll need recarpeting, entire painting-interior and exterior, and some other systems will fail. I'd also venture that at least once (probably more due to distance) you'll pay a Realtor to get a tenant in, you'll probably have some other major repairs and maybe (probably at that rent roll) a bad tenant.

Then plug in 6% price appreciation for 5 years, I think this is wildly optimistic in most of the country, and 7% selling cost. Sell the house after 5 years and see what you would earn. BTW, I did NOT run these numbers so I don't KNOW the result, but I'm pretty sure I WOULD NOT like it.

I didn't run the numbers on his scenario or mine, I don't need to.

dealmaker

[Debbie]

You practically put words in my keyboard, Frank. Excellent response!:SM086:

[AIR]

what do the margins have to be for this deal to make sense? If I can get this house below 120 I believe it will work.

[scottish007]

I am interested in the answer as well regarding the margins.

In Georgia, a deal with almost those type of income to debt exist, but they are very few and far between (in areas that I would not drive in, never mind invest).

[dealmaker]

Only you can decide if a particular investment meets your criteria. To do so you have to know your investment objective (cash flow vs. quick gain on a flip or???), your desired return on investment and your acceptable level of risk, at minimums.

For myself I no longer have any interest in holding for rentals, I've never seen a good property manager (although they may exist), I like to do a lot of the work myself (I'm retired so have the time, but I'm also pushing 60 so I don't have the energy or desire to work "sun to sun" on a make ready. Therefor I only flip.

I'm not interested in anything that going to earn me less than 12%, I can make 10% in the stock market (actually equity mutual funds, none of us should be holding individual stocks) and I sleep just fine with approximately 65% of my net worth in there. The extra 2% is a "lost sleep premium".

My acceptable level of risk is just about ZERO. Even when I was younger I didn't take much risk and might have taken more but my wife is RE averse. Otherwise I might not have stopped at 16 rentals. I might have gone to 20 but I doubt I would have gone much higher than that.

So let's look at the numbers on the place you're considering.

You proposed purchase price; $125K, although I doubt if the bank will take that, they've got a BOV for $165 already. Some employee is going to have to explain to his boss why a trusted broker is missing his values by 24%. I don't forsee that happening but let's use your number, $125K

Your monthly costs: $1104
Your montly income; $1104, I took the mid-point because the only comps you had for rentals came from an agent with a vested interest in quoting your high on the rents.

Now let's look at the costs that you didn't include. For argument's sake I'll use the ones I used in my 2nd post.

Allowance for vacancy: 8.3%, that's one month per year, which may be optimistic, although I had my own way of improving on that. $1104.

Advertising: $100/year. I don't know what a classified ad costs in your market, or how effective signage and/or craigslist are.

Agent commission: Let's just say that every other year you have to pay an agent to get you a tenant. BTW in my market it's almost impossible to rent or sell anything (other than lower end stuff) without an agent. That would cost you 2 months rent in 5 years, or 40% of a month's rent each year. $442.

Paint: Let's say that you need to repaint the interior totally once and partially once, to cut down on your vacancies you hire it done. Figure $2K (probably low) over the 5 years, $400/year.

Exterior paint: $2K, $400/year.

Carpet: $2500 over 5 years, $500/year.

Other flooring: $1K, $200/year.

Small crappy stuff, dishwasher, oven element, garage door/opener, sagging fence, etc, etc, etc, $200/year. Hiring this stuff done makes the prices skyrocket

HVAC, water heater, roof, major stuff. $5K, $1,000/year. End up with a roof and a central HVAC system and either of those can cost well north of $10K, assuming building codes and having to get contractors on it. Probably the case but I went optimistic on this one too.

If my addition is correct that works out to $4346 per year.

So, if your rent and your PITI are equal you're going to LOSE $4346 per year.

You may get lucky and you have Mr. and Mrs. Clean for then entire 5 years and they stay and take pristine care of the place. OTOH you may entirely flub your selection process (a common mistake with newbies) and rent to the "tenants from h**l". This will mean you lose 3 months rent while evicting (most newbies do this wrong too) thereby raising your costs and lowering your income. But I chose a happy, and conservative mid point scenario.

If your rents stay flat for a couple of years but taxes and insurance increase it'll get worse long before it gets better. And if you think taxes and insurance won't increase it's time to check your medications.

Anyway after losing $4346 a year on a cash flow basis you wake up one day and think; "hey, this getting rich on REI isn't all it's cracked up to be", and decide to sell. Let's say that prices have appreciated 6%/year, way overly optimistic IMO, and you manage to sell it for $167K.

From the $167K you'll have commissions of $10,000 and other selling costs of (local custom varies, but let's assume) $2K. This means you'll net $155K on the sale, minus your cost of $125K for a gain of $30K, of course you also lost $21730 ($4346/year) for a net gain of $9K. Minus the $2K you said you'd need to get it ready to rent.

I've left out all of the costs associated with the loans because I figured this on a cash on cash basis. Even though you're not working that way I've found it simplifies the process to always analyze deals that way.

So, for your $125K invested you've earned $9K over 5 years. Of course a lot of people will tell you that since you only invested $2K of your own money you earned close to 40% compounded.

Others will tell you that if you do this deal with none of your own money your profit is infinite.

I'm telling you that there are thousands of easier ways to make $9K over the coming 5 years than this. I'd say a young, hustle guy (or gal) could easily earn that kind of money in the coming 4 months or less delivering pizzas or any number of other things.

Anyway, my rules of thumb are the purchase price has to be the net of ARV X 70%, minus repairs. So for a flip you'd have to be buying at about $115K minus the repairs/make ready. For rentals I have to be buying at a ratio of pretty close to; monthly rent = 2% of purchase price. If I'm paying $125K I have to be renting it for between $2K-$2500 month. This is one reason I'm no longer renting.

Paraphrasing what was in my second post; I get love at home, exercise on the golf course and ski slopes, I do REI for the money.

Like I said; I didn't need to run any fancy analysis, spread sheet, calculations or anthing else. I based my estimates on the real world and the fact that I've done enough of all of them to know what it costs and how long stuff lasts.

There are plenty of posts with tales of woe from those who thought like you wrote in your original post that; This deal is kinda scary since the numbers are so close. Close numbers means losing money.

Sorry about being so long winded, but those of your who've been here awhile know that's why I tried my original answer first. To quote the famous Bruce Williams; If you tell some people not to touch a stove becuase it's hot, they'll say 'thank you' and go about their business, others have to smell burning flesh". We're trying to save your skin here, AIR.

dealmaker

[JSAUNDERS]

Very informative -dealmaker:praise:

[AIR]

holy smokes! Thanks for your reply dealmaker.

[JSAUNDERS]

Air- what about just flipping the house? purchase 120k+5K fixes =market for 160K+

What is the house worth in the market right now? would help determine Market value
Just my .02--

[AIR]

I believe the house is worth 185K in good condition. Plus the area is in transition. I would rather play it long term, have them pay my mortgage down and sell later.

[JSAUNDERS]

Well do you think of selling it @170K would give you a quick sale? The property would be underpriced to make it move. You could still make a nice profit---- where as dealmaker pointed out there isn't a great margin to be made renting.

Good luck but I would def. listen to those who have been in this game for quite some time.
Joel

[scottish007]

Only you can decide if a particular investment meets your criteria. To do so you have to know your investment objective (cash flow vs. quick gain on a flip or???), your desired return on investment and your acceptable level of risk, at minimums.

For myself I no longer have any interest in holding for rentals, I've never seen a good property manager (although they may exist), I like to do a lot of the work myself (I'm retired so have the time, but I'm also pushing 60 so I don't have the energy or desire to work "sun to sun" on a make ready. Therefor I only flip.

I'm not interested in anything that going to earn me less than 12%, I can make 10% in the stock market (actually equity mutual funds, none of us should be holding individual stocks) and I sleep just fine with approximately 65% of my net worth in there. The extra 2% is a "lost sleep premium".

My acceptable level of risk is just about ZERO. Even when I was younger I didn't take much risk and might have taken more but my wife is RE averse. Otherwise I might not have stopped at 16 rentals. I might have gone to 20 but I doubt I would have gone much higher than that.

So let's look at the numbers on the place you're considering.

You proposed purchase price; $125K, although I doubt if the bank will take that, they've got a BOV for $165 already. Some employee is going to have to explain to his boss why a trusted broker is missing his values by 24%. I don't forsee that happening but let's use your number, $125K

Your monthly costs: $1104
Your montly income; $1104, I took the mid-point because the only comps you had for rentals came from an agent with a vested interest in quoting your high on the rents.

Now let's look at the costs that you didn't include. For argument's sake I'll use the ones I used in my 2nd post.

Allowance for vacancy: 8.3%, that's one month per year, which may be optimistic, although I had my own way of improving on that. $1104.

Advertising: $100/year. I don't know what a classified ad costs in your market, or how effective signage and/or craigslist are.

Agent commission: Let's just say that every other year you have to pay an agent to get you a tenant. BTW in my market it's almost impossible to rent or sell anything (other than lower end stuff) without an agent. That would cost you 2 months rent in 5 years, or 40% of a month's rent each year. $442.

Paint: Let's say that you need to repaint the interior totally once and partially once, to cut down on your vacancies you hire it done. Figure $2K (probably low) over the 5 years, $400/year.

Exterior paint: $2K, $400/year.

Carpet: $2500 over 5 years, $500/year.

Other flooring: $1K, $200/year.

Small crappy stuff, dishwasher, oven element, garage door/opener, sagging fence, etc, etc, etc, $200/year. Hiring this stuff done makes the prices skyrocket

HVAC, water heater, roof, major stuff. $5K, $1,000/year. End up with a roof and a central HVAC system and either of those can cost well north of $10K, assuming building codes and having to get contractors on it. Probably the case but I went optimistic on this one too.

If my addition is correct that works out to $4346 per year.

So, if your rent and your PITI are equal you're going to LOSE $4346 per year.

You may get lucky and you have Mr. and Mrs. Clean for then entire 5 years and they stay and take pristine care of the place. OTOH you may entirely flub your selection process (a common mistake with newbies) and rent to the "tenants from h**l". This will mean you lose 3 months rent while evicting (most newbies do this wrong too) thereby raising your costs and lowering your income. But I chose a happy, and conservative mid point scenario.

If your rents stay flat for a couple of years but taxes and insurance increase it'll get worse long before it gets better. And if you think taxes and insurance won't increase it's time to check your medications.

Anyway after losing $4346 a year on a cash flow basis you wake up one day and think; "hey, this getting rich on REI isn't all it's cracked up to be", and decide to sell. Let's say that prices have appreciated 6%/year, way overly optimistic IMO, and you manage to sell it for $167K.

From the $167K you'll have commissions of $10,000 and other selling costs of (local custom varies, but let's assume) $2K. This means you'll net $155K on the sale, minus your cost of $125K for a gain of $30K, of course you also lost $21730 ($4346/year) for a net gain of $9K. Minus the $2K you said you'd need to get it ready to rent.

I've left out all of the costs associated with the loans because I figured this on a cash on cash basis. Even though you're not working that way I've found it simplifies the process to always analyze deals that way.

So, for your $125K invested you've earned $9K over 5 years. Of course a lot of people will tell you that since you only invested $2K of your own money you earned close to 40% compounded.

Others will tell you that if you do this deal with none of your own money your profit is infinite.

I'm telling you that there are thousands of easier ways to make $9K over the coming 5 years than this. I'd say a young, hustle guy (or gal) could easily earn that kind of money in the coming 4 months or less delivering pizzas or any number of other things.

Anyway, my rules of thumb are the purchase price has to be the net of ARV X 70%, minus repairs. So for a flip you'd have to be buying at about $115K minus the repairs/make ready. For rentals I have to be buying at a ratio of pretty close to; monthly rent = 2% of purchase price. If I'm paying $125K I have to be renting it for between $2K-$2500 month. This is one reason I'm no longer renting.

Paraphrasing what was in my second post; I get love at home, exercise on the golf course and ski slopes, I do REI for the money.

Like I said; I didn't need to run any fancy analysis, spread sheet, calculations or anthing else. I based my estimates on the real world and the fact that I've done enough of all of them to know what it costs and how long stuff lasts.

There are plenty of posts with tales of woe from those who thought like you wrote in your original post that; Close numbers means losing money.

Sorry about being so long winded, but those of your who've been here awhile know that's why I tried my original answer first. To quote the famous Bruce Williams; If you tell some people not to touch a stove becuase it's hot, they'll say 'thank you' and go about their business, others have to smell burning flesh". We're trying to save your skin here, AIR.

dealmaker


dealmaker,

Your responses really got me thinking. Consequently, I completely revised the structure of my next proposed purchase. I arrived at my own thoughts on required return etc. and factored in more contingencies than I orgininally forecast :SM127:

Thank you for taking the time to document your thoughts....

[dealmaker]

I can tell you where the mines are; but you're still going to have to step on them yourself.

Glad to be of some help.

dealmaker