Condo Offer: $42m for $60m appraised - Posted by Doug Pelton

Posted by Ronald * Starr on October 06, 2001 at 19:06:25:

I received this response via e-mail. Seeing no problem with privacy, I answer here.

--**-------**–THE E-MAIL------*-

Date: Sat, 6 Oct 2001 11:58:17 -0700 (PDT)
From: “Doug Pelton” | Block
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Subject: Condo : $40 for $60k appraised

Ron, thanks so much for offering your thorough

This condo is probably in one of the
oldest/nicest-kept associations in our area. I vistied
the assessors office and, yes, did look up prices for
units selling in that 50-unit complex; no 1 bd. sold
recently, but found a couple of 2 bedrooms in that
complex: 1080 sq ft/$61,5k…and $60k. In 1994, two 1
bd in that complex sold for 55k/803 sq ft and 45k/
668 sq ft----this was the peak of our market. Yes, she
did buy ‘high’ at peak.

A ‘lower end’ condo complex sold 1 bed. last year for
$39.5k / 620 sq ft and $51k / 690 sq ft !!

Seems the 1 bd have a higher cost-per-sq foot ratio,
for sure.

I’m wondering if a lease-option would give me some
room to decide if it rentable. Maybe $1000 for two
months and, during that time, she vacates and we try
to rent it.

Am studying your letter as I’'m a ‘newbie’ (have one
free-clear rental with good positive!) and trying to
understand the scenario about the creative finance
otions----for example, I could, say, offfer her $40k
with her taking $5k in a second at a high interst?

Thanks again for your time, Ron

Doug Pelton


Doug Pelton-------------

Well, I still don’t have much of a feel for the value, as you did not indicate the square feet in the unit. However, if a “lower end” condo sold for more than you can get this one, that sounds pretty good to me.

I am still unclear on how much she owes on the loans and the terms of the loans. Taking subject to the existing liens might make sense, but without knowing the amounts and the terms, I can’t say for sure.

I like that you would be buying so that the monthly rent is about 1%-1.1% of the purchase price. At that rate you probably will be ok, especially if you got a new fully-amortizing mortgage at about 7-8% interest rate. You might be ok with the existing financing. See previous paragraph about this.

I’m not real excited by a $1,000 option consideration for just two months. Typically, people get options for about 1-4% of the property value, and that is for longer term, say 6 mo.s, 1 yr, or even 2 yr. Being she is living in the property and is elderly, it might not be good for her to have her move out without a firm sale. IF you don’t buy, what does she do now?

Could you get some idea how hard it is to rent without her having to move out? Possibilities: you have an option or a contract with a slow close, to give you time to find a renter and her to get ready to move out. Meantime, you show it while she is there.

You look up the ownership records for the complex, find all rental properties and contact the owners to find out the rents they are getting and how hard it was to get a renter in.

Contact some real estate agents in the area to attempt to get two pieces of information: possible market value, possible rental amount and ease of renting.

Go to the library and read local newspapers for past few months looking at condo rental ads. Maybe even call some of the numbers and talk with the people about rental amounts and ease of getting rentals.

Yes, I think if you can get in for a comfortably small down payment and get 9-12% cashflow on the property, it might make a good investment. However, if I thought that the appreciation would be negative or zero, I would probably not go for it myself. I figure that with cash for a downpayment, it might be better to find some other deal with better returns projected.

Your last paragaph confuses me. I thought that you had been suggesting to her about $42K? And when you said that, it sounded like you could put down $2,500 and buy it. That suggests that she owes $39,5K? Now you are suggesting $45K and her carrying $5K. Now neither deal sounds bad, if you have positive cashflow. But they don’t sound like the same deal.

I think key here is to put little cash out. Thus, if it turns out to be a bad deal, you don’t have much to lose. You might be well able to sell it for more than you paid for it. If she will carry, that sounds good to me. I would suggest that if she does not seem to understand or like an option idea that you not push that. Introduce it and see how she reacts. Then back off if she is negative.

Now, you mention having a free and clear rental. That is ok if you are into your retirement years and are not planning to acquire more properties. However, if you are thinking of expanding your holdings, you might well want to refinance that rental property to provide cash for buying more properties. There are a couple of good ways to go: just standard low-interest long-term self-amortizing loan; a bank line of credit loan. The later you would pay down whenever you had some extra cash. You would then be able to borrow out more money whenever a good deal popped up. You would only pay interest on the amount of loan money you were actually using. The interest rate, however, is usually somewhat higher than for a standard long-term loan.

Good Investing*****************Ron Starr****************

Condo Offer: $42m for $60m appraised - Posted by Doug Pelton

Posted by Doug Pelton on October 05, 2001 at 08:36:11:

Seller, a 79 yr old widow, listed ‘owner to sell’ for a 1 bedroom
condo. Asking $54m. Appraisal service did a ‘limited survey’ at $60m for a second she took out earlier this year—‘limited’ because difficult to bracket a group of like units.

Very nice unit includes washer/dryer, new stove, dishw and g.dispsl in a good, well kept-up area.

It is on the taxrolls for $40,600…she bought it 8 yrs ago for $45, she says. I told her as an investment it would rent @ $400-450, and would only leave me @ $60 mon cashflow.

She called me later that evening and wanted to know what I would offer. I said IF I were to offer, I would consider the taxroll figure of $40.6 plus 5% or $42m. My cashflow would be a bit better…and if I could only put up $2500 cash, my return could be 9 to 12%.

I may have to go a couple of months at worst to rent it in this market, but we have a large 65-plus age market here and would be attractive.

Does this sound too thin of a deal?

Doug Pelton

Re: Condo Offer: $42m for $60m appraised - Posted by Ronald * Starr

Posted by Ronald * Starr on October 05, 2001 at 20:50:04:

Doug Pelton-------

There are three economic benefits of owning rental real estate: Cash flow, Appreciation, Tax reduction = CAT. You add the three together to project your total return. Divide this by your investment to estimate return on investment.

You have roughly given us some suggestion of what the cash flow might be like. Go ahead and get a firm idea of what it will be.

By telling us what she paid and might sell it for, you are telling us that past appreciation has been negative. Do you have any way to project what it might be in the future? A good appreciation can make up for a lack of cash flow.

What about tax benefits? Condos are usually good in this regard because you don’t have to deduct land value, or at least not much, before depreciating the purchase price. If you are in a high tax bracket, this can make up for some weakness in cash flow.

I would suggest that you have to do a better appraisal job on this property. Try to work with selling prices of other units in the complex, even if not 1-bedroom units. Go back for a few years and compare 1 vs 2 bed units sold in the same time period. What ratio do you get? Apply that to the other units to estimate the 1 bedroom. Similiar for studio units, if there are some.

Try to find some other condo complexes which you can use as comparables, even if you have to do some adjusting. Try looking at past sales prices for the properties in the subject project and compare to past sales prices for units in the other complexes at the same time. Get a ratio. Look at recent sales in the other complexes and use the ratio to estimate the value of the subject property.

It is possible that she paid more than market value when she bought. Do you know this?

You do not mention what she owes on the property, except to say she has a second. Maybe you could just take the property subject to the existing financing after paying her $10? Maybe you could get her to pay part or all of the second and sell you the property for the first and a zero added or for the first and part of the second that you pay?

Naturally, you need to check how the homeowners association operators and how the property is managed. Possible special assessments coming up? Inceased monthly dues planned or likely to come up? Are they escrowing major future expenses month by month? Have they calculated out these escrow expenses realistically? You see, you have very little control over the these expenses, so you have to at least estimate them pretty well.

Now, all you investigations can be done after you have a signed purchase agreement. That way, if it turns out to look good, you don’t have to worry that Jim (FL) snuck in and bought it before you finished your analysis. If it does not look good after an investigation, you can drop the deal or possibly drop the price.

My rough rule of thumb is that I want to get $2 in e quity for every $1 of cash I have to pull out of my protesting wallet.

Good Investing*************Ron Starr**************

Re: Condo Offer - Posted by Dave T

Posted by Dave T on October 05, 2001 at 10:21:05:

“…as an investment it would rent @ $400-450, and would only leave me @ $60 mon cashflow.”

Well which is it – $400 or $450? At $400 is your cash flow only $10 per month? Way too thin for me. What if the condo fee goes up next year? How much of an increase would it take to put you in a negative cash flow situation?

What about a minor repair such as an appliance breakdown? Will the money to repair/replace an appliance have to come out of pocket?

Why aren’t there comparable sales numbers for 1BR units? Does this suggest that there is no sales market for these units, and therefore, if you need to sell you will need to discount your price (just as your seller is having to do now)? If your seller really paid $45K eight years ago, and will consider selling for $42K now, why do you expect to profit later?

This deal does not cash flow well for a rental investment property, and the after market sales numbers tend to discourage a resale strategy. I don’t think there is a profitable deal here.

Just my opinion.

Re: Condo Offer: $42m for $60m appraised - Posted by Steve (N.Ga)

Posted by Steve (N.Ga) on October 05, 2001 at 09:29:51:

A couple of things. Never use an appraisal that was obtained for re-finance. These are always (at least in my opinion) going to reflect a higher value. Not sayng that this Condo would not sell for this price, but I would be leary to put much confindence in this report. Also, you are basing your offer on the value within the taxrolls. Again, this does not always reflect a true value for property. In order to determine what to offer, you must first determine what the ‘true’ market value would be. This value is not determined by the current mortgage (very important info, though), by tax rolls(probably the least important to me, albeit somewhat useful), or what the seller orignally bought it for. The true market value of this condo is what it could be sold for in a retail environment.

It would be good if you could get some recent sale figures for these units (preferably in the last 3-6 months; the more recent the better). Never mind what they are listed for; you can take the listing price, fifty cents and go buy a coke. You are more concerned with what they are selling for. This should give you a better indication of the true market value of this unit.

You do need to develop a well thought out plan with an exit strategy. You need to have an idea what you want to do with this this property; whether it is rent long term, or sell (or something in the middle). The exit plan I speak of should be your most important plan in this project (again, this is just my opinion) because it is what will minimze your risk. Your exit plan determines what you will do if you need to unload this urgently. If you do, are you protected, will you get your investment back if you sold tomorrow, etc.

As to you asking whether it is too thin, without knowing the true value of this condo, it is hard to tell. If you could sell this condo for 65k, it might work. If you could only sell for 45k it does look very thin. Whenever, I buy a property, I know what my profit (at least within a comfortable range) when I buy. I calculate what I want to make on any deal into my purchase price, along with the other charges. Now unexpected issues do arrise (unexpected repairs, extended vacancies, additional holding costs, etc), but if you buy correctly, these costs go from losses in the deal to just costs of doing business.

One last thing becasue I am running out of time (maybe other can reflect on additional issues). You lingo is a little off. In the subject line, you state 42m and 60m. I am assuming you mean thousand (k) and not million (m). A little bit of a difference.

Take care