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No. of Recommendations: 18
Proposed purchase price: 81,200
Expected rents: $10,800
Condition: Good. 4-year old roof, 8 year-old furnace. In an area of mostly single-family homes, with a few duplexes mixed in.
Anticipated capital expenses: exterior painting w/in a few years. I can't even guess what else.
Utility Costs: $490/year for water. Renter pays other utilities
Property Taxes: $1122/year
Proposed financing: 20% down, 20-year amortization, 7.375% interest rate (quoted last Wednesday from a lender)


This price appears high, though not outrageously so. You have a GRM of 7.5, which superficially suggests that you will have a modestly positive cash flow.

Some questions:

First, you refer to "the furnace". Does this mean there is one furnace in the property? Therefore, do you pay the heat? This will substantially affect your calculations.

Second, you call it a duplex. Now, "duplex" is one of those terms which means different things in different parts of the country. Around here, a duplex is a converted house, typically divided into an upstairs and a downstairs apartment. In other areas, a duplex is what we here would call a double; that is, two side by side apartments in a building that was built to be that way and was not converted from a single family residential.

If your duplex is what we would call a duplex here, then the price you are paying is quite high. If it is what we would call a double, then it looks a lot more attractive.

The property taxes and water bills look to be in line.

At your proposed 20% down with a 20 year amortization and 7.375 (look for that to drop in the near term), then your PI is $518.36/mo. Given that your rent is $900/mo we see that your PI is 57.6% of your gross. Add in $100 for taxes and another $50 for insurance, and your PITI is about $668/mo, which is 74% of your gross. As you can see, this deal is starting to look skinny.

Now, we haven't considered a vacancy factor. You have to consider this, even if you intend to rent to a relative you trust. Any month you don't get paid - even if the unit is occupied - you have to consider as a vacant month. So, let us assume 90% occupancy. In this case, your $900 rent becomes $810. Since your PITI is $668, you have a net cash flow before utilities and maintenance of $142. After $41 for water, you have $101 left - or $1212/yr. As a rule of thumb you should budget about $250 per unit per year for maintenance, leaving you an annualized cash return of about $712.

Since you put up $16,240 to purchase, your cash return is about 4.38%. In the first year, you pay down $1,478.84 in principal, for a return of 9.2%. Your depreciation expense will be about $1818, sheltering about $1100 in additional income from tax, (after cash flow is sheltered) which will save you about $300 in tax for a return of another 1.85%. If you get capital appreciation at the rate of inflation, you'll pick up about another $1600 there in non cash gain, for about 9.85%. So your total cash and non cash return on this deal is about 25.28%.

Keep in mind, the non-cash aspects of this are problematic and you might not get them, ultimately. That is the risk.

Who pays trash? Who pays heat?

This deal is skinny. On the average, you won't have much cash flow. That $101 a month can vanish in the blink of an eye with a furnace repair bill or a bad water heater, or a trashed apartment. The 20 year note helps; over the first 10 years, you will pay a total of $21,049.98 on principal, but at the cost of not having cash in your pocket.

If you could obtain a 30 year note, your PITI would become $599/mo totalling 66.5% of your gross which looks better. You would have $169 left after vacancy and water bill, which looks a bit better. However after 10 years you would have paid only $8,734.31 on principal.

I would only go into this deal if I thought I could raise rents fairly quickly, or if I thought there would be substantial capital appreciation. Normally, when I run through the computation I ran through in this post, I want to see a total return of 50% or better. Short of that, the risk can get to be too high.
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