First Offer Details

July 9, 2008 · 0 comments

After getting feedback from some other knowledgeable RE folks, I’m not sure that my potential first deal is the right one to start with. While I’ll go into my hesitations on the deal (and the specific feedback I’ve gotten) in more detail in a subsequent post, I wanted to lay out my rationale for considering this deal, and discuss the potential exit strategies I would consider for this one.

First, here are a few details about the property:

  • Single Family Home, built in 1964
  • All brick
  • .5 acres lot size
  • 1250 sq ft main level
  • 3 bedroom, 1.75 bathrooms (stand-up shower in master bath)
  • Unfinished basement (almost the same size as main level)
  • Most houses in the neighborhood are very similar in design/size/layout, and most still have unfinished basements
  • The neighborhood is lower middle-class out past the suburbs, in the “path of progress”

The property is an REO, on the bank’s books for several months now. Just the other day, the bank dropped the price from $127K to $70,500 (no idea why so much at one time).

Potential Exit Strategies

In this area/neighborhood/market, houses aren’t selling. Unless you have by-far the nicest house for sale in the neighborhood at by-far the cheapest price, you can expect it to sit for many months. That said, if I were to buy this house, I would have one of three exit strategies:

Option #1: Buy, Rehab, Sell
If I did this, I’d likely need to sell well-below market to ensure a reasonably quick sale. A couple things I’d have going for me are that if I finished the basement, the house would be a 5/3, somewhat unique in this area; additionally, the area has a relatively large Hispanic community, where more bedrooms tend to be appealing to buyers.

Option #2: Buy, Rehab (including finishing the basement), Rent
Doing this would create a somewhat unique rental property in this neighborhood. The property would be newly renovated, and would appeal to larger families that didn’t have many other options for rentals (everything else is smaller). Additional benefit is that the basement investment would be worthwhile when I sold; additional downside is that the basement would no-longer be new when I sold.

Option #3: Buy, rehab (without finishing the basement), Rent
This option would allow me to put in the least amount of capital to finish the remodel, but also has the downside of commanding lower rent and having to compete with many similar houses in the neighborhood for renters. The nice thing about this option (vs. #2 above) is that I could decide *later* whether I wanted to finish the basement before selling or not. This option would obviously save some time as well.

Those are my options. Here’s the financial data that goes along with each:

Rehab Costs

1. This would be the most expensive option, with costs between $35-40K

2. This option would be somewhat cheaper, as I’d hold off on some of the cosmetic work that I would do when I sold (have stumps removed from yard, improve tool shed, re-finish the deck, put in cheaper fixtures, etc). The cost to renovate would be about $30-35K

3. This would be the cheapest option, and would likely cost about $18-20K to rehab

So, assuming I could negotiate the purchase price down to $65K (I believe I can), the all-in costs for the three scenarios are: 1. $105K, 2. $100K, 3. $85K

Sales/Rental Comps

The comps I’ve found for each of the scenarios above are as follows:

1. There have been very few sales in this neighborhood in the past 12 months (and few for sale currently), so finding comps is difficult. The best numbers I have indicate that the houses with unfinished basements are selling for $125-135K, but I have no comps for those with finished basements. And I have no idea if the lack transaction velocity around that area is more a function of lack of buyers or lack of sellers.

2. Because there are few of these houses in the neighborhood, I don’t have good rent comps. The houses with unfinished basements (the 3/2 layout) are comping out at about $925/month, so I’m going to just make a guess that a 5/3 layout could fetch about $1100/month. One anomaly is that a house up the street is 2 years old, a 4/2 with a finished basement, and the guy is asking $1600. Going to see if he actually rents it or not.

3. As noted above, I believe the rent comps are about $925/month.

Analysis of Options

Now, using that data, here’s what I figure my returns could be in each scenario:

1. To sell quickly, I’m going to assume (though I could be wrong) that I’d have to list this 5/3 for the same price as the 3/2 houses, or perhaps a tad bit higher (I will consult with a RE agent to get their opinion on this as well, as I could be way off). Based on that assumption, my profit in this scenario would be about $25-40K (I’m paying all cash, so there aren’t many holding costs to account for). This doesn’t include agent fees.

2. Assuming I refi 80% of my costs back out, I’m left with an $80K loan, and rental income of about $1100/month. Using the 50% rule (which I will discuss later in the week), my cash flow would be about $750/year, plus another $1000/year if I property managed myself.

3. Assuming I refi 80% of my costs back out, I’m left with an $68K loan, and rental income of about $925/month. Using the 50% rule, my cash flow would be about $600/year, plus another $800/year if I property managed myself.

Keep in mind that while neither option #2 or #3 are that exciting in terms of cash flow (my COC for each is less than 5%), the goal here would be to sell the house at what I believe is market value when the credit crunch loosens and people start buying again. That said, I don’t know when that will be, or exactly how much I could sell for.

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