Does this deal work?

 

I have one of those aftermarket, Bluetooth- equipped, Kenwood stereos in my truck. Since I got it, everyone in the car is privy to my phone conversations.

 

As I drove to Cartersville with my 18-year-old helper, I got a call from an investor looking to sell his two rental properties. Consequently, Lucas got to listen in on the call.

 

The investor had two properties, which he had been renting out for 13 years. They were located on the same street, and he said the current tenants had lived there for five years paying $1000 per month. He thought that they could be rehabbed and sold for $140,000 a piece and that he was only looking to get $120,000 each.

 

During the conversation, I asked him questions like why he was selling his rentals 13 years into the mortgages and what his mortgage payments were.

 

He told me he was only making $100 a month on each property and that it was more advantageous for him to sell now that his income level was such that he could take advantage of all the losses he had accrued during the time he’d owned them. He also informed me that the mortgage payment on each rental was $900 a month.

 

I thanked the investor and told him I would get back to him.

 

After I hung up the phone, I turned to Lucas and asked him what he thought — was this a deal, or not?
He said, “Maybe. The houses make $100 a month if you rent them. But if you buy and resell them, there is about $20,000 in profit per house. Right?”

 

Lucas had come to this conclusion by listening to the investor, who said he had two mortgage payments of $900 a month and that the houses rented for $1,000 each per month. Subtracting the former from the latter yields $100 a month in supposed profit per house.

 

Next, if we purchased the property for $120,000, and could resell it for $140,000 we’d end up with a difference of $20,000.

 

Lucas did a great job at coming up with these figures. However, evaluating a property to rent or resell takes a little more figuring than just running the numbers we’ve listed.

I told Lucas that when you buy a property, you have to begin with the end in mind. That means we either base our purchase price off the after repair value (ARV) if we’re going to flip the house, or base it off market rents if we’re going to keep it.

 

On a flip, you can count on paying out about 11 percent of the sales price to cover closing costs and realtor commissions. If the house sells for $140,000, subtracting 11 percent from the sales price only leaves $124,600. Recall that the investor in this scenario wants $120,000 for each of his houses. That means we only have $4,600 per house to rehab and make a profit.

 

Lucas said, “That doesn’t work.” I agreed.

 

Next we talked about the rental side. If the house payment is $900, and it rents for $1000, that doesn’t mean you make $100 a month. There are other costs, aside from the mortgage payment, associated with owning a rental property. We call this the expense factor, which includes insurance, property taxes, repairs and vacancies. Taxes and insurance are included in the mortgage payment on this one, but vacancy and repairs will be more than $100 a month.

 

Lucas said, “Looking at it that way, this deal doesn’t work.”

 

 

Lucas was right. I call this strategy “pocket math.” This is just a starting point, but it’s an effective way to quickly see if you need to spend any more time evaluating a potential property. Using this method as we drove down the road, we quickly determined we’re going to pass on these two.

 

 

 

Joe and Ashley English buy houses and mobile homes in Northwest Georgia. For more information or to ask a question, go to www.cashflowwithjoe.com or call Joe at 678-986-6813.

 

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