Is this a good deal/Need advice badly! - Posted by Alex Gonta

Posted by Alex on June 11, 2006 at 20:28:58:

Hi Ray,

Much, much thanks for excellent advice. To answer step by step. My gross rent roll calculation also included a $400/month basement tenant, but because he is not a “steady” type of tenant, I wasn’t sure he should or should not be counted. The basement area has a full bathroom and kitchen and is finished, but it is not an apartment that can be rented for much more than $400/month and the tenant seems like a day laborer that is transitional to this area. I logically assume that for such a small rent I can always easily attract a college student to live there, and there are 2 universities nearby.

In terms of financing, my numbers were like this: 5 year ARM on 80% of 460k, or 386k at 7% with 1pt to buy down the interest rate. An additional 10% as a second mortgage, to avoid PMI, or 46k at 8% as a conventional 30yr, and my own 10%, or 46k at prime, currently 7%, but I have a one time option to lock.

My figuring of the math suggests that my own downpayment money, of about $65k as a LOC is 6.5 years at $880/month. So I can take the $400/month of the basement tenant and apply it toward my LOC and take $480/month from my own salary and apply it as well. That way, at $880/month toward the LOC, I in about 7 years have paid off my LOC that got me into the deal in the first place. That means my exit strategy is a minimum of 7 years. I also figure at that point, the property will have appreciated at 4% per year, conservatively, and I will have paid down my initial LOC, if little of the original property itself, since this is essentially a 100% financing deal.

I know I"m probably under-estimating repair/upkeep costs. My goal was to take the $800 per month,the positive cash flow, and apply $400 of it toward my LOC and take the remainging $400 left over to act as a “repair escrow” and bank the money,not touch it. In one year, that will be $4,800, more than enough to act as an emergency repair reserve. In the second year, I was planning to take the $800/month positive cash flow, and apply ALL of it to my LOC, instead of $400 from my paycheck and $400 from the property.

So in other words, my gameplan was to start paying toward principal of the LOC starting the second year of ownership and additionally create an emergency repair/vacancy repair reserve in the first year. My holding period is a min of 7 years, and my goal is to cash out at that point via selling. Is my plan solid or has holes? I’m not starting out with much cash, so I thought this is an option for me.

Input is highly appreciated. (By the way, I can get a 6 family, with smaller rents, but 6 units instead of 4) for roughly the same price. THe deal with the 6 family is that the oil heat makes the landlord pay the heat and not the tenants and it kills the cash flow. The cost of converting to 6 separate boilers and 6 separate water heaters, units and labor and sheetrock work was estimated by a contractor at $30k.

Help appreciated. What’s better choice, this 4 family, with separate heat and so forth, two high tenants at $1250 or so each, and two “$800” tenants, or one big 6 family, with all 6 at $900/month but higher operating expenses, initially. Price very close.

Is this a good deal/Need advice badly! - Posted by Alex Gonta

Posted by Alex Gonta on June 04, 2006 at 08:34:56:

Need advice and not sure what to do. I’m a new investor looking to buy a 4plex in Jersey City, New Jersey. The city is next to Manhattan so great rental market because the city offers many amenities, shopping and local job market and neary by NYC market make this city “New York’s 5th borough”.
I also want to invest “close to home” in order feel comfortable with investment as I get my feet wet.

Looked at properties for 3.5 months with real estate agent. Saw very few with positive cash flow. The relationshp of asking price in this hot market as compared to total rents was not there simply. Saw very few in good condition that didn’t require major work, in terms of plumbing or sewage. Many of the properties had low quality tenants, that have gotten used to living in substandard conditions and got used to living under a “slum landlord”.

Finally found a property in exceptionally good condition near Bayonne NJ. Asking price was originally 505k, and then reduced to 485k. Offered seller
450k, or 90% and was countered at $460k, or 93%.

It’s a 4 plex. It breaks even with 3 out of 4 tenants. Here’s the break down: Taxes=6847, Insurance=1700, water+sewer=800, and repair reserve is $1200, but the property needs absolutely zero work. Here’s the numbers:

Gross rents= $57,336
Mortgage Expense= $34,888.46
Fixed Expenses= $11,732.00
Repair Escrow= $1,200.00
Total Yrly Expenses= $47,820.46
Yearly Cash flow= 9,515.54
Monthly Cash flow= 792.96

Financing first mortgage as a 5 Year ARM and a downpayment mortgage for $10%
My concern is that I need to put down 46,000, or 10% of the downpayment plus
closing costs and points, for a total tune of about $65000, to get only about
$800 bucks a month. I’m borrowing the downpayment money as a Line of credit against my home. So my LOC costs me, interest only, $404/month so my effective cash flow in reality, is only about $400 per month.

Yes, I have tax advantages and long term appreciation as my gain, but
dealing with tenants and so forth is alot of work for only $400 bucks per month and a major risk for taking on an additional mortgage and alot of responsibilites.

Since the return on investment is not a cash on cash return, I figure it will take me at least 5 years to recoup my initial downpayment money. Area is safe area, but not the best in the city, but not high crime. The rents are $1350, $1350, $728 and $900. Getting the two highest income tenants to rent again in this area, if existing tenants leave, if either of the above two leave would be hard to re-rent.

I’ve been thinking about investing and getting out of a job for a long time. I don’t want to be on the fence forever, and want to start investing. The house is in good shape and has good rent roll. Good tenants, seems like. In this hot, overpriced market, it has positive cash flow at least.

What is advice? Do I buy, or do I wait?

Re: Is this a good deal/Need advice badly! - Posted by ray@lcorn

Posted by ray@lcorn on June 06, 2006 at 16:42:45:


I think you need to take another look at the numbers.

First, adding up the rent roll does not add up to the gross rent listed. 1350+1350+900+728 = 4328 x 12 = 51,936. Your numbers show a gross rent of $57,336. That’s quite a discrepancy on a four unit.

The expenses have no maintenance costs, so I assume you are estimating $300 per unit per year and that’s where the reserve figure comes from. In my experience, one move-out can cost that much.

I can’t follow your debt service calculations. What are the terms (e.g. interest rate, amortization period, LTV) on the first mortgage?

Then it sounds like you’re trying to finance the down payment with an interest-only home equity loan, for 100% financing?

That will throw your break-even into the 90%+ range, with no apparent upside, and no exit strategy.

But the thing that worries me the most is your comment that “I don’t want to be on the fence forever, and want to start investing.” I can appreciate your eagerness, but that’s precisely the wrong reason to do a deal. You might get a reality check from this article:

If I’ve misunderstood something let me know.