Rental Property Evaluation!!!
Hi,
I am very new to investing. I am about to close on my first rental property. It is a 3BR/2BA, 2-Car Ranch Duplex. 1220 square ft on one floor. I am purchasing it with only 4% equity but intend to hold it for a while. The neighborhood is close to a high school, a new shopping complex and two major employers in the town. And it was built in 2001. Fair market rent is $1000.00 and I will be asking for $975.
I know this is not enough detailed info to make a totally accurate assessment but can anyone tell if this deal "feels" right? Are there things I can do to evaluate this deal any closer?
Please feel free to let me know if you need more information to answer my question. Thanks in advance for your help.
JS
How much cash flow will you have at $975 monthly rent?
How much is your mortgage payment (P& I only)?
I am looking at an interest-only mortgage that will make my total payments (Interest, Taxes, Insurance and HOA Dues) about $800 a month.
Thanks.
I would try to get $995 rent in order to get that cashflow a bit coser to $200.
Also, 4% equity is cutting it a little close. What if you have to sell? You don't want to be upside down in your loan. Those closing costs will eat up that 4% and more.
Interest only loans are the only loans I do now.
Is this the first one you've looked at? If so, keep looking. Something better will come along.
Zenith,
If you don't mind me asking, why are interest only loans the only loans you do now?
Just curious.
why don't you use the ProForma-nator under "my tools"...what does that tell you?
I used to be a lender and have looked very closely at the LIBOR Interest Only program that is so hot out there now...
Beware of how long you plan on keeping the property on these interest only programs.
If you are going to keep a property for more than a short time (1-2 years) make sure you then see what the 3-5-10 year histories are on the interest only programs and find out what your average interest-only rate will be.
When I did my analysis, it was actually much cheaper to get a 7 year ARM or even a 30 year fixed than go with an interest-only LIBOR over 5-7-10 years.
Rates are very low now on fixed, and you eat into the pricipal on the fixed programs, so not sure why you would want to "only go with interest-only programs" unless you just keep for a very short time.
My two cents.
Quote:I am looking at an interest-only mortgage that will make my total payments (Interest, Taxes, Insurance and HOA Dues) about $800 a month. smithj2,
Have you considered all your expenses throughout the year? Advertising, legal fees, vacancy, utilities (during the vacant times), maintenance and upkeep, repairs, and replacement reserve all have a cost.
How soon can you raise the rent, and how much will the market bear?
If you consider all these expenses and can manage to get your cash flow to around $200 per month, I would say go for it.
I am uncomfortable with an interest only loan over a long time period simply because you don't know what will happen to rates. Your margins are a little thin to cover a steep rise in interest rates. An amortizing loan for this property would make it a negative cash flow proposition.
Your exit strategy should also play a role in your decision process. If you are in a high appreciation market, then you might expect dramatic increases in property values over a short time (2-4 years). In this case, I would be more inclined to go forward under your approach.
On the other hand, if your market values have plateaued (even worse, peaked) then you will be no better off four years from now than you are today. To prove it yourself, consider how much you will owe to payoff your interest only loan, how much your selling costs will be, and your holding costs (how long does it take to sell a vacant property in your market), for a property that you sell for the same price you buy today (remember your market has peaked or plateaued). Subtract this total from your selling price and then tell us how much you have left over. Subtract your initial down payment and closing costs. Now, how much is your profit? Is there anything left over?
If this property will not increase your net worth over time, then it would be best to pass and find another opportunity.
Thanks everyone, I have gleaned so much information from your posts.
DaveT, I am in the Northern Colorado market and the only reason I even considered this property was because of the high present and expected appreciation rates. I have done a lot of research and everything I've read points to a steady appreciation of at least 4% in the next few years. (Average over the past few years has been as high as 8%).
An add on question would what are your thoughts on the Northern Colorado market? Is it expanding, peaking or has it plateaued?
The interest only programs I am looking at are based on the Libor and have no prepayment penalties. That way, if the rates seem to be going haywire, then I can always refinance into a fixed rate down the line.
Also, I have an investor friend who always says "Just Do It". His philosophy is that gettting the first deal done is the most important thing because if one looks at the numbers only, one will always feel thet the margins are never enough.
Thanks.
Does the LIBOR based loan have an interest rate cap? or an annual limit on the adjustment?
The loans I have seen recently do not have any limits on the adjustment at all and everyone seems to expect the LIBOR rate to rise dramatically during the year.
A 4% appreciation is the same as inflation. If you sell in two years, you will probably spend all of your appreciation on your selling expenses. The question is, will your net worth be higher in four years with this property in your portfolio?
Listen to Dave,
Realestate is either about cash flow or net worth and in time BOTH.
Dont take a big chance because a friend says "just do it"
Count the costs.
[addsig]
Just Do It is okay advice... Just Analyze It before doing it would be better. You don't want to get taken to the cleaners on your first deal. I'm currently in a similar part of my REI career as you... been doing lots of research and learning all that I can, but still looking for that first deal. I want it to be a clear-cut winner... there's too many unknowns and extra costs to just sqeak by on a small cash flow. Give extra credence to what Dave has said, and read as many of his posts as you can. He's already helped me open my eyes to some of the things I might have overlooked.
Interest-only looks appealling due to the better cash flow, but it's also nice to build equity by having your tenant pay down your principle. Keep all your options open.
What was the price of that property? Have you looked at all the possible costs?
975 - 800 = 175 per month
175 - 5% vacancy buffer = 125
125 - repair/maintainance = 75
75 - insurance = 25
25 - taxes = < 0
I'm figuring that the somewaht realistic cash flow is negative without any major/unforeseen expenses.
Is there any way you could charge more for rent? Can you make a quick upgrade and then charge more? Otherwise I'm not sure its worth the risk.
Just my 2 cents.
Quote:975 - 800 = 175 per month
175 - 5% vacancy buffer = 125 cygnus,
For a single unit, a vacancy is one month's rent loss. In this case, if you allow $80 per month vacancy (about $975 divided by 12), your example gets to a negative cash flow even quicker.
I would use a 5% vacancy factor for multi-unit properties, but for a single unit property I use one month's rent.
smithj2,
Do you use Microsoft Excel? If so, let me know and I'll email you a spreadsheet that I've created.
It helps you estimate all the costs of an investment property, including down payment, mortgage, and closing costs and maintenance.
It then calculates your cash flow and rate of return on your money based on the market rents. It also calculates several key ratios that both you and your lender will be interested in.
I have found it invaluable for quickly analyzing properties that come across my desk. I can quickly dismiss a property that will definitely not turn a profit, or take a much closer look a one that looks promising.
My lenders also like it because they can see that I've done my homework, and they can instantly see the strength of the income (value) of the property that will secure the loan!
Let me know...
I agree with DaveT; exit strategy is important.
I have been doing LIBOR interest only loans because I can turn a $167 cashflow into $473. Refinancing several rentals this way is giving me a much needed capital boost, right when I need it most. At the start.
My exit strategy is to sell in two years. and tax defer (1031) the proceeds. This plus the increased cashflow over the period will be used to buy multifamily properties.
Anticipation of capital appreciation is good located in the counties north of Dallas. These counties have seen some of the highest growth rates in the country this past year.
I am not too worried about a large interest rate rise. The Fed is still trying to help the economy. At best it will be a small decrease in cashflow. At worse, I can refinance.
The terms are 3 years @ 5% fixed. Then whatever the LIBOR is every 6 months. Capped at 11%. Includes no pre-payment penalty.
Quote:I am not too worried about a large interest rate rise. The Fed is still trying to help the economy.
LIBOR stands for the London Interbank Offered Rate and is the rate of interest at which banks borrow funds from other banks, in marketable size, in the London interbank market.
Perhaps you can explain how an action by the US Federal Reserve Board of Governors affects the LIBOR index.
zenith191,
Are you doing 100% LTV? I can't seem to get any lenders to give me lower that 9.95% on my second (first at 4.375%). So my blended rate for three years is 5.5% on 100% LTV. I am hoping that this is a god rate for an interest-only loan in the current economic climate.
Like you, My exit strategy is to sell or refinance in 2-3 years after building on the cash flow and projected appreciation. As an aside, where can I acceess projected appreciation or growth rates for particular areas in the US?
Thanks,
JS.
look2thehorizon,
I would like for you to send me a copy of your excel spreadsheet,
if you don't mind. I need some help, as well as other methods to
estimate all the costs of an investment property.
I could use your spreadsheet.
Thanks in Advance.
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