Do I Pay More Than FMV If It Cash Flows???

I have an offer to purchase a rental property that is currently rented annual lease until 09-04. After searching I have found that the value of the property is probably more like 77,000 and my deal (no money down) calls for 90K with a 7% credit at settlement and seller carryback of a 2nd for 24 months. The 1st mortgage needs 80 LTV and all things considered, it still cash flows about $250- $300 per month.

Is it worth it? This is my first "landlord" property. Thanks all!

Comments(14)

  • maw14th April, 2004

    This is a tough call. Are you looking to keep it long term? If so go for it if not let it go

  • tmpringle30114th April, 2004

    Yes I'm not looking to flip it I'm looking to buy and hold for monthly cash flow. It does meet my investment profile, but I'm concerned about the 1) bank appraisal for comps and 2) just the general principal of overpaying a bit to get a no-money-down deal. The actual "cost" (less seller assist) is 83.7K and the approx value is 77K. Also - I did some research and the area I'm looking to vuy is written up in S&P Profile as having potential to increase 68.7% by the year 2010. My gut says go but I need someone experienced to help me weigh options.

  • joefromphilly14th April, 2004

    For a rental property, the value is more in the eye of the cash flow than some arbitrary number. If you are paying $6,000 more than what your research says you are, but you are still getting a nice cash flow, then the true value of the property is not $77,000, but possibly even more than you are paying for it. If you are not worried about paying more than the comps for refi purposes, but instead want the property for cash flow and future appreciation, then go for it.

  • curtbixel14th April, 2004

    How did you calculate the cash flow?

  • SmileyFace14th April, 2004

    If you are right about the FMV, you will have a problem getting a loan. The purchase price will be greater than the appraisal value. You know what that means. Loan amount is based on lower of purchase price or the appraisal value.

    If you plan to keep this property for a short period of time, why do you even care about cashflow from rental income. If you pay $20,000 over the actual FMV, you probably will be having hard time selling the property for what you paid for and more.

  • beacon14th April, 2004

    The proven rent will support the purchase price.

    The positive cashflow will make it a worthwhile investment.

    If your FMV is less than your purchase price you may run into a problem if you decide to sell sooner than 2010.

    I would look at historic gains in property value and extrapolate from there to get a yearly average. Apply that % gain to the fmv of the house over the next several years (be conservative).

    If you can stomach the numbers having to sell at any point on that list, then go for it.

    Unfortunately, none of those numbers are set in stone. It's all a gamble. Try to hedge your bet though.

    Good luck.

  • myfrogger14th April, 2004

    Just something I was reading at the same time I am reading this post:

    Market Approach
    The first approach is to find properties that are comparable to the subject property and that have recently sold. Local conditions peculiar to the subject property are then considered. In order to adjust for local conditions, the Assessor also uses sales ratio studies to determine the general level of assessment in a community. This method is generally referred to as the MARKET APPROACH and is usually considered the most important in determining the value of residential property.

    Cost Approach
    The second approach to value is the COST APPROACH, which is an estimate of how many dollars at current labor and material prices it would take to replace a property with one similar to it. In the event the improvement is not new, appropriate amounts of depreciation and obsolescence are deducted from replacement value. Value of the land is added to arrive at an estimate of total property value.

    Income Approach
    The INCOME APROACH is the third method used if the property produces income. If the property is an income producing property, it could be valued according to its ability to produce income under prudent management; in other words, what another investor would give for a property in order to gain its income. The income approach is the most complex of the three approaches because of the research, information and analysis necessary for an accurate estimate of value. This method requires thorough knowledge of local and national financial conditions, as well as any developmental trends in the area of the subject property being appraised since errors or inaccurate information can seriously affect the final estimate of value.


    My opinion is that you should go for a more effective seller financing solution. If this was the owner's primary residence before maybe you can offer him more at 0% interest as then he would not have any interest to pay tax on. You could raise it so that you are effectively paying 3% or somthing.

    The primary way IMHO to value rental properties income approach. It seems that your casflow is pretty decent and it is a no money down deal. Is it better to take something for nothing or nothing at all?

  • tmpringle30114th April, 2004

    Thanks all - very good advice as I would have expected from this site!

    Basically the rental "boasts" approx an 8.5% cap rate. Based on the rental, the fiar market value of the property is very close to, if not more than, I am paying.

    I agree however, obtaining financing is going to be difficult as it is a SFR and although it has a good rental history, the comps being used will be resident owner occupied comps.

    I like the deal overall, and if it flies I'll probably walk away from the table with a little $. (By the way - I calculated cash flow VERY conservatively - using a management company, etc... as I would be an out-of-state owner)

    I believe in the market value of the area but may need to get more advise from all of you if financing becomes difficult - of course everything in the deal is "subject to" just about everything under the sun.

    Thanks again - I think I'm gonna jump in on this one. Can't win if ya don't play!

  • jam20014th April, 2004

    Just a thought here... What if you had a drastic life change in the next couple of years, what then? Say you lost your job, SO got sick, you the things that life throws at you sometimes. Getting stuck with something you can't afford, and can't sell would be a REALLY bad thing. Not saying not to do the deal, just throwing a thought out. Good luck with whatever you decide...

  • mykle15th April, 2004

    Something doesn't smell right about it to me. Such a situation just doesn't occur without there being something more to the story. If the area has that strong of a rental market prices would reflect it. If you can buy at over market value and make that kind of cash flow then you can buy at market and make even more. Seems investors would be all over it and a market correction would occur almost immediately.

    Has there been a major economic change to the area recently that maybe isn't being completely reflected yet? Did a business close down and housing prices crashed leaving some stuck in expensive leases that won't be duplicated in the future? Did a business just open and housing prices are on the rise, but comps aren't available reflecting the change yet?

    Is there something about the clientel in this area that causes a lack of demand from those who purchase rentals? IE an area with military renters has a higher turnover rate and more damage than a typical area and the pricing of investment properties would reflect that.

    Mykle

  • Lufos15th April, 2004

    Gentlemen and you too Ladies,

    I assume you are all reading the newspapers and listening to the many many Pundits sounding off on the reasons for this big spike in Real Estate Values that has occured.

    In my area which I admit does suffer from many forms of unstructured thinking. There have been in the past several things that you could more or less rely on.

    For example if you own some houses or duplexes or triplexes you look around the area, arrive at what kind of income the average household has and then you take about one quarter of that and you figure that is your correct rental rate in that area. Ok so you are a Democrat you go to 30%. But that is it. You stop.

    Have you seen what has happen'd to single Single Family Houses out here in the suburbs (middle class) of LaLa land. Through the roof.. The average family now has to kick in about one half to get a semi decent house. I saw a little 3 br 2 ba the other day for which they were asking $2,400.

    the point of this posting. In view of the present time situation, you may think you are making a very conservative buy and based on present rental it probably is. But consider if you experience a vacancy and you put out the sign go on Craigs List, or one of the strange Rental agencies that charge you nothing just let them put out a sign and make a small charge to everybody who calls in on the sign. well you are in for a shock. The rents are flying up and fast. So check around you may have the buy of the year.

    Next point of consideration. As the spike in real estate prices begins its wavering in the next eight months, will the price to rent also drop? Or will it stay high and maybe do a decend at a slower rate?

    Give it some thought. I am.

    Lucius 8-) 8-) 8-)

  • tmpringle30115th April, 2004

    If my gut as well as my background don't fail me on this one - I think I am in good shape. The rental market in the area is good now - but with an increase in home values or a decrease - either way this property cash flows. Plus - if I put zero down and end up getting cash back at settlement, my ROI is unmeasurable because it's infinite.

    If the market does stabilize and I am guessing it will during and after the election, my guess is it might bring the interest rates up a bit, and as such, fewer people qualifying for decent homes and up goes the rental market.

    Just my two cents.

    Thanks!

  • tmpringle30116th April, 2004

    UPDATE AND LESSON TO BE LEARNED:

    I lost the property becasue I didn't act. I sat with my thumb firmly planted where the sun don't shine, waiting on my "partner" (husband) to give his final ok and I didn't write the contract. The deal was made for more than I was going to pay, so if I had locked it up, I would have had a very good investment.

    Hesitation - the key to failure.

  • davmille17th April, 2004

    I'm sorry you missed your deal, but you probably could have gotten some better advice if you had simply answered Curtbixel's question above. Sellers usually overstate income potential and understate expenses. You may have simply missed out on a multi year nightmare instead of the great investment you were hoping for. However, you didn't give enough information to get a complete answer to your question.

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