When First Jumping Into Rental Real Estate -- Be Very Careful
Dear Monty: I want to buy my first rental property with my husband. We plan on purchasing with cash and buying cash flow of $1,500 a month. We found a property with three units and a monthly rent of $1,500. The only red flag is that it is reasonably priced and has been on the market for 100-plus days. I looked into the purchase history and saw that the most recent purchase was only one year ago. Could this mean something? Suppose the buyer intended it to be an investment. Is there any reason the last purchaser could've listed it so soon?
Monty's Answer: Three potential reasons stand out.
No. 1: Something happened in their life. Life-changing events can interfere with or cause people to change directions: debilitating accidents, disabling diseases, relationship changes such as a divorce, etc. Knowing if the real reason for the sale falls into one of these categories is good but not a green light to go ahead. You still need to complete the due diligence as would any sharp investor.
No. 2: They must fix something with the building, the tenants or the location. When an investor makes a mistake, which can happen to both experienced investors and rookies, they will unload it. When they unload it, sharing the reason is not in their best interest, so they may hope no one ever asks or try to conceal the reason. They may use one of the excuses listed above.
No. 3: It is a flipper. Realize there are different kinds of flippers. Some flippers do a great job of adding actual value. They make solid improvements, upgrade tenants, have strong lease agreements and more. The other kind of flipper does a great job of putting lipstick on a pig. They install the cheapest off-brand fixtures, used furnaces and HVAC units and take a chance on the tenants. It would help if you learned to know the difference. Here is a selling to a flipper column on Dear Monty that you will likely find helpful.
THE PROPERTY HISTORY
You mentioned you looked into the purchase history. What did it sell for a year ago? What did the seller that sold a year ago pay? The improvements may show on the MLS data sheet that added value. There is additional information besides the sales history you should understand. Standard due diligence requirements are easy to find. Here are a few Dear Monty nonstandard due diligence tasks where you will learn much more.
MORE DUE DILIGENCE
It is unclear how you define "cash flowing." If the total rents are $1,500, the cash flow will be a different and lower number. If your net operating income (NOI) is $1,500, that is cash flow. You state you will pay cash, which is typically not a good idea in investment real estate. Still, even then, you will have a variety of other expenses that reduce the $1,500. Items include real estate taxes, state and federal income taxes, accountant fees, maintenance expenses and property management. If you are doing property management, you should be paying yourself for the time you invest managing the property.
Here is a small sample of other questions: Are values in the neighborhood rising or falling? How about the risk of flooding? You have more work to do.
Richard Montgomery is the author of "House Money: An Insider's Secrets to Saving Thousands When You Buy or Sell a Home." He advocates industry reform and offers readers unbiased real estate advice. Follow him on Twitter at @dearmonty, or at DearMonty.com.
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