Let’s make a deal… or let’s not
October 26th, 2006 by KenricHere is a new property that I am looking at. The properties are a bunch of 2br 2ba condos out that are clustered in 4 unit buildings. The condo complex has about 16-20 of these 4 unit buildings. The condos are in a nice area which has some appreciation potential. What is for sale are a package of four, 4 unit buildings, or 16 total condos. The 16 condos part of an estate sale. I can look at this in many ways, 16 individual condos, 4 – 4 plexes, or a 16 unit multi. I tend to always break things down into individual units. I’m not sure if that’s correct or not, but I always like to figure per unit costs then multiply them out.
They are listed as a 16 unit property for about $1.2M. This comes out to $75k per condo which is about market price for them.
Is this a good deal? Below are the numbers for just one condo at $75k.
- The rent averages around $615, but can be raised to $675 (where have I heard that before?)
- HOA is $80/mo
- Taxes are $60/mo
- Insurance is $10/mo
- Property management $50/mo
Net operating income is ($615 – $80 – $60 – $10 – $50) $415/mo or $4,980/yr
Cap Rate is $4,980/$75,000 = 6.6%
Considering that I would be borrowing money above 6.6% interest rate, this is not a good deal at asking price. However, I believe that there is room to move because a seller selling 16 condos at the same time is probably expecting the buying to want a significant discount. So, let’s say that best case scenario is $60k/unit but $67.5k is probably more realistic.
A quick call to a mortgage broker and I’ve found that I can get one loan per four condos, which is good since I’ll save on some closing costs. I really just wanted to get a sense of my loan rate and it looks like somewhere in the high 7′s or low 8′s. If I assume that I will be doing a 80% loan that has a rate of 8% with P&I, my payment per condo would be $396/mo.
Cashflow per condo is only $20/mo. Cash on cash return is $240/$13,500 = 1.7%. Boy does that suck!! My problem is that my cap rate is still below my loan rate. Why am I even looking at this property?
Let’s look at the potential. If what the sellers are saying is true and that rents can be increased to $675/mo, I can slowly go in and raise the rents and increase each unit to $95/mo cashflow. Cash on cash becomes 8.4%. Yeah, still sucks. As you can see through this exercise that the only way to really make money by buying at $67,500 is to hope for appreciation. The cashflow is not worth it. I can get better returns loaning out hard money.
What is interesting is that the condos I purchased in 2004 had very similar numbers and yet I found them as a good deal. Why? It’s because the interest rates were so low at the time. If I can get a 6% interest rate on these condos, what would the numbers look like? 8.1% cash on cash return without even raising rents! 13.5% if I raised rents.
I have always wondered if the potential of refinancing to lower rates in the near future should be included in the evaluation of a property. If I thought that rates would drop to 7% next year… does that enter into my decision making process at all?
The only way I can see this working is if I bought at below $60,000/per unit AND got a lower rate than 8%.
Don’t you hate it when you do all the calculations and the deal sucks!
Posted in Real Estate | 8 Comments »
Stumble it!
That’s why you do this in excel! :)
Will you explain a bit about what “Hard Money Lending” is all about?
By Clifford on Oct 27, 2006
If you can get a loan for that much, and can pay the mortgage, it might still be a good investment tool. You will have collected about $15,000 in principal, and your $18000 in cash flow, which is roughly a 13% ROI not including your closing costs.
If you are able to raise the rents, and property values don’t change much, you could be in a good position to sell 1-year from now.
Its not the best deal though, the rents are pretty low. For every 1% increase in property value, you’re looking at a $12,000 gain… so, you could even look into doing some improvements to get the values up.
NG
By NLG on Oct 27, 2006
NLG,
I was told by my realtor that an offer is coming in today. I told him that I would only be interested at $60k/unit and to call me if the incoming offer was below that or comparable.
Clifford,
Hard money lending is basically being the bank. You lend your money out to people who are buying properties. You are lending based on the security of the property, not the borrowers credit. Borrowers have certain situations that makes them unable to get a regular loan such as, bad credit, tight timeframes, odd properties… Because of this, you can charge a higher interest rate than regular banks. So if I can loan out money at 13%, secured by a property, I have to weigh that ability when buying something with a cash on cash return less than 13% to see if it is worth it.
By Ken on Oct 27, 2006
Clifford,
I also wrote about HML here.
http://www.afterreadingrichdadpoordad.com/2006/08/30/hard-money-lending-or-cashflowing-no-appreciation-properties/
By Ken on Oct 27, 2006
I’m not sure what your real rates of return are on the hard money lending, but in your previous article you indicated that the hard money came from other investors. So, you would be paying them a piece of the pie as well (say you charge 13%, and you pay your investors 7%, and thus you net 6%).
So, are you still better off to lend hard money over this investment?
By NLG on Oct 27, 2006
Ken,
If you can purchase at 60k/unit through hard money, then refinance the units with an 80% loan you could significantly increase your CCR. Using your own company to lend you HM would allow you to cut down on closing costs.
Also, I know you were considering leaving your job – so you could manage yourself giving you an additional $800/month in cashflow.
RealOG
By RealOG on Oct 27, 2006
NLG,
What I meant in this case was that if I put my own money down 20% on this property, my cash on cash return would be only 8.4%. I could get a higher interest rate than 8.4% lending out my money to someone.
RealOG,
If I could purchase this at $60k/unit, I would probably go traditional lending with 100% financing (if possible).
I would love to manage these myself, but then I’d have to move to North Carolina!
By Ken on Oct 27, 2006
I’m just starting to scratch the surface of the real estate sector. When I read about people only being able rent for half of the mortgage (see comments here), it makes me wonder if this deal still sucks. In Boston, I know it’s almost impossible to rent your place out for 75% of what you can buy it for now, much less the 110-120% (or whatever) you would need to cover insurance and management.
I was heavily coerced to move to CA making me turn my condo into an investment property or lose money on it. My mortage is about $1900 and the rent I’m getting is $1350. Yet, I feel that there will be a time in the next 10 years that this will turn around and in 5-10 years, my tenant will be buying the equity on my home even. It seems to me that even if you could come out a little ahead in the short term, in the long term, 5-10 years, you would certainly be in a position to rake in some cash flow and possibly pocket the 5-6% appreciation that property typically gets a year (would be significant with the amount of leverage you have).
Again I’m new to this, so maybe I just need to read a lot more because it feels like I’m missing something here.
By Lazy Man and Money on Oct 27, 2006