Sunday, November 05, 2006
To Become Wealthy: To Bid or Not To Bid
I have learned to break down the numbers to evaluate any given property from two books by the same author, Frank Gallinelli. The first one is called “What Every Real Estate Investor Needs to Know about Cash Flow.” This is the main one that I am using this week to decided to bid or not to bid on a quad-plex in Dallas, TX.
These are the numbers that are given on the MLS listing:
Asking price $174,900
Gross Rent $1975/mo or $23,700/yr
Taxes $2717
Insurance:$2200
Owner pays Water/Sewer/Trash:$175/mo or $2100/yr
These are estimates of other expenses that we will have:
Property Management: $1896/yr
Repairs and Maintenance: $1200/yr
This gives me a Net Operating Income of $13587.
I have not added in a vacancy rate because I have been told that all tenants are long term tenants. Of course I will verify this once I get the opportunity to see the leases.
So far the numbers look pretty good to me, until I calculate the mortgage costs. My knowledge of mortgages comes solely from the purchase of my primary residence last year.
First I looked at a 30yr fixed at 7.5% with 10% down payment and no PMI. (I am assuming that we can do an 80:10:10 piggy back loan.) In this case, my mortgage payment for the year would be $13.207.56.
This will only leave me with $380 pretax cash flow for the entire year. This is a whopping 2% return on our initial investment of the down payment.
Then I thought about an interest only loan at the same rate for the same amount. Then the payments for the year would be $11805.72.
This leaves me with $1781 pretax cash flow.
Now, I have done a lot more numbers with the mortgages, since that is the biggest expense by far for the whole property. If we put down 20% instead of 10% then we increase our yearly cash flow to $1847 and that increases our cash on cash return to 5%. This is the bare minimum cash-on-cash return that we want for our money. However, we do not want to put that much money into any one property unless it has a lot more units in it.
Our best bet will be to take shorter terms for a much lower rate. If we could get an ARM with a 6% rate. With only 10% down, the yearly payments would be $11,325, leaving us with a positive cash flow of $2262. A 13% cash on cash return would result. If you add in an estimated $10,000 other up front costs (lawyer, etc), the return on investment is 8%.
So, is this property worth my while? I still need to evaluate the taxes and depreciation, and then do another analysis to figure out how low I should bid.
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4 comments:
I guess you should answer this question when considering any property:
"Will this property help me become wealthy?"
In this case, even if you can manage $2000 of cash flow per year. That's peanuts. What if your tenants do damage inside the house that you must take care of? If one year they leave and your house is vacant for even one month, you've lost all cash flow for the year. Two months and you're heading negative.
My properties generate $10,000+ cash flow per year. I like this because it allows three things:
1) Enough money to cover incidental costs (new storm door, new railing, any painting, etc.)
2) Cash flow to save for future investments (eventually I should have enough properties so that the rental business generates the income for the next investment)
3) Some cash to cover vacancies.
NG
Yes, the more numbers I calculated, the less interesting the property looked to me as well. In the price range that we are looking in, there are mostly duplexes available, so I was excited when I saw a quadplex.
However I wonder if there is a way to make this property work. (Making low offers, creative financing, creative lease agreements) I am open to any and all ideas for any properties.
I am a believer of "slow and steady wins the race". I was not expecting to retire on the first property that I bought. Party because I have yet to find one that is that good. But I continue to look and evaluate. I am going to ask my realtor to send me listings for more expensive properties with more units to see if those properties will produce more income.
Thanks again for taking the time to read my blog and comment!!
TBW -
Thanks for reading my books. Here are some thoughts regarding the property:
Take a second look at my discussion of estimating value by applying a cap rate to the NOI. I don't know what the prevailing cap rate for quad-plexes in Dallas is, but I suspect whatever it is, it will suggest a value under 174,900.
If the property can be purchased at a price that is more realistic given it's current income, then consider if the current rents are below market and if you can bring them up. If it has long-term tenants, the answer may well be "yes" but you'll also have to factor in vacancy loss while you bring the rents up to market.
Finally, take a look at my article about managing for value to get some other ideas as to how you might improve both the cash flow and the value of the property once you own it: http://realdata.com/ls/manofvalue.shtml
Good look with your investing.
FG
This is an excellent article. Thank you for suggesting it. http://realdata.com/ls/manofvalue.shtml
I have decided against this property in Dallas, although I have found another one that I will post about tomorrow.
I am constantly using the Cash Flow book as a reference tool. I will definately take a second look at estimating value by applying the Cap Rate to the NOI.
Thank You!
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