Summary: This is a continuation of our series of posts where we evaluate a property that comes across our desks to show you how we evaluate deals. The goal of this series is to help our readers become more comfortable evaluating properties both good (recognizing hidden value) and bad (recognizing red flags).
Redfin recently started covering the Spokane market, which is great news, because we find it to be the most useful app for identifying potential property deals.
For this week’s deal of the week, let’s check out a property I found on Redfin last month. This one ended up being purchased by a friend of ours.
I regularly look at Redfin for deals. When I came across this property, I could immediately see this was a home run.
In fact, it was such a good deal, that by the time I found it and approached our agent about it (only 20 hours after it was listed), one of our good friends had already been out to walk the property, spoken to the selling agent and had submitted an offer on it!
This experience was a good reminder for us (and for you!) to add your search parameters into Redfin and sign up to get alerts based on those filters so that when a good property pops up, you’ll be the first to see it.
Now let’s dig into the deal (which our friend just closed on this week).
Property Description
Location: Kendall Yards area of West Spokane, Washington
Initial Screen
This property consisted of a main house and a separate bungalow. It was listed for $225,000.
On Redfin the main house was described as a “fourplex conversion,” which meant that it started out as a single family home and was converted into four separate living units.
All of the five units, including the bungalow, were noted to be 1-bedroom/1-bathroom.
When I first saw the property, I immediately recognized that it was already above the 1% rule because current rents were reported to be $2,300 ($500/month for each of the units in the main house and $300/month for the bungalow).
But that was with current rents.
Because we own 13 units in Spokane, we have a good sense of property rents in the area. Generally, a 1 bedroom/1 bath in a decent neighborhood will rent somewhere around $650/month, and, if the property is a stand-alone dwelling (i.e. not part of a multifamily), you would likely be able to get more. Therefore, we would expect the bungalow to rent for more than $700 a month. From the property description, it appeared the bungalow was being rented for less than market rent because the person living there was managing the property.
If we didn’t know the market rents from experience, we would confirm them by either calling a property manager or using an online resource like Rentometer. When we plugged this property into Rentometer, we found the median price for a 1-bedroom apartment in this area was $675/month. So we knew we were on the right path.
If you were able to get rents up conservatively to $650 per unit in the main house and $725 for the bungalow, you’d get $3,325 per month compared to the $2,300 it’s currently bringing in.
We also recently learned that there is higher demand for one-bedroom and studio apartments compared to other apartment sizes in Spokane, with rental rates are above 90%. This makes the appeal of a property with five 1-bedroom units even more attractive because vacancy is unlikely to be an issue going forward.
Hidden Value
If you’ve been following our deal of the week series, you know that we love to hunt for hidden value.
Using only the information available in the Redfin listing, I was able to identify several possible sources of hidden value.
- Basement: The listing describes a “full” basement” that is “partially finished.” This suggests that it’s livable space that might be converted into an extra bedroom or perhaps a basement unit.
- Storage: In the “Multi-Unit Information” section of the listing, they note a shared storage space. In this case you might be able to create separate, secure storage units and possibly rent these to the tenants.
- Laundry: This same section also lists shared laundry. It may possible to generate extra income by converting the shared laundry into coin-operated units.
- Appreciation potential: While appreciation is never a primary goal when we purchase rental properties, we pay attention to properties that are in the “path of progress.” If you go to the satellite view on Redfin and zoom out, you can see Kendall Yards, a beautiful planned community. This property is only three blocks away from it. Although the neighborhood surrounding Kendall yards is still rough in certain areas, in a few years, we expect the entire neighborhood to boom.
After walking the property, our friend was also able to recognize at least one other source of hidden value besides those listed above! Moreover, after purchase, she did confirm there was already a coin-operated laundry in the basement bringing in about $40 per month.
Cost of Repairs
There are no pictures of the inside of the house, so it’s difficult to come up with a cost of repair until you fully inspect the property. However, for the purposes of making a decision about putting in an offer or not, we can make some reasonable guesstimates.
Main house: The main house obviously needs a new roof (let’s budget $10,000) and probably at the very least interior paint and flooring. Let’s assume you need to spend $5,000 a unit in upgrades for a total of $30,000 for all four units.
Bungalow unit: The bungalow unit clearly has a good roof on it. Let’s assume another $5,000 in repairs.
Now, let’s look at the property’s cash-on-cash return assuming $35,000 in repairs and $3,325 in after-repair rents.
Calculating the cash-on-cash return after repairs
Let’s fill out the cash-on-cash (COC) return calculator (download this below or by joining our Facebook community) going line by line:
Purchase price: Let’s assume you get the property for the asking price of $225,000.
Down Payment: We will assume that you have to put down 30%, because this property will likely require a commercial loan (anything above four units requires a commercial loan).
Closing costs: Closing costs typically range from 2-5% of the purchase price. Based on previous transactions, we will assume 3% or $5,250.
Repairs/Renovation: As described above, we estimate renovation costs to total $35,000.
Interest Rate/Years/Payments: Let’s assume a 5.3% interest rate, amortized over 25 years with payments made monthly. These figures are based on a recent commercial loan that we obtained.
Number of Units: There are a total of five units. We need the number of units because there are leasing costs associated with each unit. This combined with leasing cost per unit (below) and average occupancy (below) will determine your total annual leasing cost.
Property Taxes/Year: According to the Spokane County website, 2018 taxes are about $2,978. It’s always best to pull the information directly from the County website as opposed to relying on the information in Redfin or Trulia.
Insurance/Year: We estimate insurance of about $1000/year. This is based on our experience, but you should verify this with your insurance agent.
Monthly Gross Rental Income: As above, the gross monthly income after repair is $3,325/month.
Vacancy Rate: Based on our experience, vacancy of 5% is a fair estimate. You should verify this number with your property manager and real estate agent.
Property Management Fee: Our current property management fee is 7%. It is a negotiated rate that we got after we went above 5 total units in the Spokane market.
Leasing Cost per Unit: Our property manager charges us a half month’s rent. Therefore, half of the rent per unit is $332.50, which rounds up to $333.
Average Occupancy: We conservatively estimate one year but this is one that we sometimes increase to two years because in practice, you have some control over vacancy. For example, we generally raise rents every year. If we want to keep a tenant, we may choose to leave the rent the same in order to keep a tenant in for longer than a year.
Maintenance Costs: We typically use 5% as our assumption. We normally fix up our units to our high standard so our actual maintenance costs are typically lower but we like to be conservative in our estimates. This property was built in 1907, so the number may be higher. Then again, by fixing up the units, it may actually be lower too.
Monthly Utilities: Current water expenses are listed at $4,600 and fuel expenses at $1,673. Therefore, we’ll put in a monthly utility figure of $523
After entering in all of the figures above, we get a 9.3% COC return or $10,046 in cashflow per year on a total investment of $107,750. The COC return goes up to 10.1% if we assume our tenants stay two years instead of one.
Conclusion
Based on the COC return of 9.3%, we would definitely put in an offer on this property.
It’s close enough to our target of 10% COC return and there’s enough hidden opportunity (e.g., coin operated laundry, possible storage rent, possible basement unit) to drive the returns even higher.
Also, there’s always opportunity for reducing expenses such as billing back utilities.
Last, we were fairly conservative on the repair costs and as it turns out, we heard from our friend that there’s minimal repairs needed on this one so the actual COC return will be considerably higher (12.9% if we lower repairs from $35,000 to $5,000).
Sounds like this one turned out to be a winner!
