Analyzing Condos For REI
Hello all!
I am looking at trying to learn the basics of analyzing properties for REI purposes, and I want to learn enough to avoid this "analysis paralysis" virus I keep reading about. I will describe my process and ideas, and then anyone can tell me if I seem to be on the right track.
I want to look in the western suburbs of Chicago (I'm buying a TH in Lombard on Wednesday... not for REI, but for principle residence... got about 5K in equity at closing, and we're going to finish the basement for 5K adding a family room, 3rd bedroom, and a full bath, and lots of storage!). I am looking for 1BR and 2BR condos in and around that area (Lombard, Downers Grove, Lisle, etc.) for REI purposes. Judging by the advertised rental rates I've seen in these areas, some of the condos on the market could be break-even or small cash-flow properties. Is this even on the right track?
The way I look at it, if I can bring in a little cash from a condo every month, that's a plus. Here's an example of my math: If I buy a 125K 2BR condo with 5% down ($6250), I will finance 80/15/5. My 1st payment will be $570 (30yr@5.5%), with my 2nd payment of $110 (interest only 7.0%). With prop. taxes of $1500, that is $125/mo. This is about $800 a month, plus assessments, which I am estimating from $75-125 a month, for a grand total of about $900 a month. The going rate for 2BR rentals is probably between $850-1150 a month, depending on many factors.
This is how I look at it... even if I am breaking even every month, I am paying down $1350 of the 1st principle in the 1st year, and I get a $6800 write-off for interest and $1500 for prop. taxes that year. Even at a 25% tax rate, this is another $2000. Am I way off here? I know the math is right, but should I even be thinking about this? If I got a $100 a month cash-flow, that 's another $1200. Improvements over time would be cheap labor... I have many skilled tradesmen in my family, and I'm learning more and more all the time. Not to mention the added benefits of depreciation deductions and having my own small business to do the REI.
My goal for 2004 is to aquire one quality property... small goal, so easy to achieve). With mortgage rates so low, it's a great time to be a REInvestor, right? Once they go up, rental properties will be better for young people who can't afford to buy. Unfortunately, I'm finding that the Chicago area is a hard market to crack. It's tough to find the good deals out there. I foreclosure market is very competitive.
I'm sure I'm missing out on something big. I'm trying to learn to make the numbers work. Obviously, having extended vacancies would ruin this plan. I also will try to find properties with already cheap prices, and properties on the market for a while. I'm getting in close with several realtors to help me find the good deals when they first come up. If anyone has some advice or comment, good or bad, please feel free to voice your opinion. I'd rather be called a fool than do something stupid and look like one. It would be a very expensive lesson to learn. Thank you very much.
Jeff
What happens to your cash flow if you have one month of vacancy,
you have to repair or replace an appliance (water heater, for example),
you have to paint the unit after the tenant vacates,
your association increases the monthly fees,
your landlord insurance premium is $400 per year,
your tenant's pet destroys your carpets and your security deposit is insufficient to cover the replacement cost,
your property taxes go up and your mortgage escrow payment is now larger,
your interest only second mortgage note has a balloon payment due in two years?
why not go under "my TCI" then "my tools" and then "ProForma-nator"...what does that tell you?
If you do that make sure you are buying condos where the appreciation factor is going to be strong. No sense getting a dog because expenses will go up and you will have vacancy rates.
Q
Listen to Dave!
I think, he has given you some great advice. If you are going to go the rental route, you need to have cash reserves to cover the payment if the tenants don't pay the rent, it is vacant etc....
I think you are on the right track, however
I personally would stay away from 1 bedroom condos unless I absolutely stole the property.
I would recommend you go on with your
plan, however do not pay over 80% of
market value. If you have the owner carry a second, have it be long-term just like
your first. I personally would try to cash-flow at least $200 a mos unless it was
in a high appreciating area. I also don't
like condo's unless they are on golf courses due to the high turnover rate.
Best Riches,
Jeffrey Adam
P.S.- Read the article titled "Driving For Dollars."
_________________
"The only place success comes before work
is in the dictionary."
[ Edited by JeffreyAdam on Date 01/25/2004 ][ Edited by JeffreyAdam on Date 01/25/2004 ]
Thanks to all of you for your quick and informative responses, especially Dave and JeffreyAdam. I have taken some of those factors into consideration, but a few were areas I knew about, but haven't explored.
My goal for 2004 is to find one property to buy for investment, and by no means will I dive in headfirst without putting on my scuba gear and checking out what's under the water, doing chemical tests on the water, and making sure to warmup and stretch. You've all helped me realize that I still have a lot to learn and look at. That's why I'm here of course.
I'm finding that the Chicago area is a very hard area to find deals in... the foreclosure market is dominated by a few big boys, and the ones they don't want... they don't want for a good reason. Not to mention the high appreciation the area has had over the last 5 years... it's going to be a tough process.
I haven't been that crazy about the Pro-formanator just yet... some values it won't let me change.
JeffreyAdam,
Do you recommend staying away from 1BRs for resale purposes, or cashflow purposes? Or both?
Thanks,
Jeff
Way to define your goals. They seem attainable and rational but most important...you have them.
Refer to Dave's post. You did eventually mention vacancy which should be added as an expense but there are others. How about a planned monthly maintenance expense. I've personally found that the numbers work for condos until I add the condo associate fees. Ouch! I didn't see that cost in your initial numbers. Further, if your positive cash flow is that lean you have less a chance of weathering a storm without going into your pocket. Basically, you should have some accomodation for the 'what-ifs.'
Hey cygnus,
Thanks for the encouragement and advice. I didn't have the association fees in there, as the listings I pulled up on the internet didn't have them there, just the taxes. I've been estimating aggressively higher so far based on what I've seen in my own home search (only two days till closing... woohoo! )
You're right, Dave did have some excellent points. I luckily have a contractor for a father, and have learned a lot in my 26 years so far. My fiance's uncle also does every trade there is, so I imagine that upkeep and improvements will come at low cost by comparison.
Things such as vacancies and pets can be wild cards, however, and I do understand that. Also, I would carefully check the age and order of the various appliances.
One area I am still unfamiliar with is landlord insurance premiums... would it be typically much higher to insure a condo that I was renting out versus living in? I only ask because my HO6 policy will only be about $10/month for $50K of coverage on my townhome.
Thanks all again,
Jeff
Because the property is a condo, you should expect that the building structure is covered by the association master policy. What may not be covered is everything inside the unit.
Imagine for a moment, that you can pick up the condo unit and hold it upside down. Everything that falls out is not covered by your association policy -- washer, dryer, refrigerator, even wall to wall carpet if not the original carpet. Built-ins such as stove and dishwasher are usually considered covered under the condo master policy unless they have been replaced.
Whatever falls out is your personal property. Your landlord policy needs to provide personal property coverage (at least to replace your property if stolen).
Additionally, your landlord policy should have a liability rider. If your tenant sustains an injury on your property, the tenant might decide to hook up with a personal injury attorney and sue. Your insurance company may defend you and pay any judgement up to the limits of your coverage.
I usually go with about $5K in personal property coverage and $1MM in liability coverage. For a condo, my annual premium had been under $100, but this past year my rates have been 50% to 200% higher at renewal for the same coverage. Additionally, the insurance companies have added a mold exclusion rider to my policies.
Homeowners insurance is not the same as a landlord insurance policy. The insurance risk is a little higher for a tenant occupied property and the probability of a claim is also higher. What helps keep your rates down is the low limits of coverage.
Thanks Dave, that answers quite a few of my insurance questions. Not to mention all your other posts I've been reading on other topics... thanks for sharing your wealth of knowledge.
Is there coverage out there for landlords for things such as you mentioned in your previous post: tenants damaging appliances, pets destroying carpets, etc?
There may not be a carrier out there that covers tenant abuse to your property. You make it a provision of your lease that damage to property due to tenant abuse is charged to the tenant.
You also make it a provision in your lease that the tenant must carry renter's insurance. Hopefully, you can file a claim against the tenant's insurance policy for major repair or replacement costs incurred as a result of tenant abuse.
Most of the time, I just eat the cost and move on. It is a cost of doing business.
Jeff,
I would stay away from one bedroom condos period, unless of course I could steal them at 60% or below! That is California standards of course.
Good Luck,
Jeff
[addsig]
I appreciate the advice JeffreyAdam... unfortunately, the only way to get a condo at that deal is in the foreclosure market. There's always the possibility of a serious don't-wanter, but the Chicago market is tough. Thanks for the help though. I'll find my deal somewhere... I still have 11 months for that goal.