Summary: This is the first of a series of posts where we do a deep-dive on a property that comes across our desks to show you how we evaluate deals. The goal of this series is to help our readers learn how to analyze properties both good (recognizing hidden value) and bad (recognizing red flags).
Even in this tough market, we have a regular flow of deals coming to us because we’ve built relationships with agents in numerous out-of-state markets. We also supplement that with our own searches for deals using various property search apps.
For this week’s deal, we are going to highlight a property that we found about a month ago on Trulia (this was before Redfin was available in Spokane) and immediately recognized as a “good deal.” As it turns out, it was so good that it immediately went pending after only a few days on market (sadly, right before we found it). Even though this is a deal we missed out on, we want to highlight the things that immediately caught our eye and show you the detailed analysis we performed using our cash-on-cash return calculator (you can download this calculator for free by scrolling to the bottom of the article).
Property Address
3324 E Fairview Ave, Spokane, WA 99217
Initial Screen
This is a single family home with 3 bedrooms and 2 baths listed for $175,000. We own a couple of single family homes in Spokane, so we know that homes with these specifications in decent neighborhoods normally rent for about $1,300 to $1,400 per month.
Assuming this house would rent at $1,350, this property is at 0.77%, so it’s well below the 1% rule we use for screening deals. Normally we would move on from this house because, at the current price, it is below the 1% rule (and since it was only the market a couple of days, you can expect that the price is fairly fixed). However, in this case, we recognized considerable hidden value, so we dug a little deeper on this property.
Hidden value
In total, we found five sources of hidden value in this property . There may be more but these are the ones that jumped out at us immediately, so even in our initial screen, we knew this had potential.
- Extra land: The first and most obvious is the fact that this property sits on a “large double lot.” Many of the lots we see in Spokane are a little over 6,000 square feet. This one was more than double in size at over 14,000 square feet. Oversized lots are valuable because it gives you the potential opportunity to subdivide the lot and sell it off or subdivide and build on it.
- Extra unit: This property has what is described as a “guest house/in-law apartment.” Essentially this is another unit that will generate extra income on top of what you’ll get for the single family home. This wasn’t factored in during the initial screen.
- Basement unit: Based on the description and pictures, there is also a partially finished basement. It is described as one bedroom and a half bath. Looking at the county website, the basement is about 900 square feet (60 feet less than upstairs). It’s hard to tell for sure, but it seems like this could be made into a separate rentable unit. Alternatively, you could add another bedroom or two in the basement for extra rent.
- Attic space: It’s unclear from the pictures or description what could be made of the attic, but perhaps you can get an extra bedroom up there too. Extra bedrooms means more rent. If you can make this into a four bedroom house, you can probably charge an extra $150-200 a month.
- Detached garage: We love detached garages. And the set-up of this garage looks right because it has alley access. This is important because if you are going to rent this garage to someone who doesn’t live on the property, they’ll need to be able to access the garage without disturbing the other tenants. Note you want to rent a detached garage to a different renter than the house because this allows you to charge more rent.
Cost of Repairs
So let’s assume that you tap into three of the five sources of value above and you fix up the guest house, finish out the basement and get the detached garage ready as a rental. Below are our estimates for each, totaling $18,000.
Guest house: Based on the description, the guest house has separate electrical. This is huge because you don’t have to pay to separate the electrical. The unit has one bedroom and one bath, so let’s assume the bathroom and kitchen require some light remodeling and the bedroom is in good condition. Assuming $3,000 in the bathroom and $5,000 in the kitchen, total renovation cost: $8,000.
Basement unit: The basement is described as one bedroom and half bath. According to the Spokane County website, the space is 900 square feet. Judging from the pictures, it appears the basement unit will need at least one egress window in the bedroom. We’ve done egress windows for $2,500 each. Let’s assume you don’t want to go through the extra work and expense to make this basement into another unit (you would need to add a kitchen and kitchens are more expensive). In that case, let’s just add another bedroom downstairs and fix up the basement a little bit. Total renovation cost: $5,000
Detached garage: Because you are renting this out separately, it’s best to pay for separate electrical to the garage. That way, the person renting this unit will pay for whatever electric he/she uses, and you can keep the bill separate from the single family home. We’ve done this with one of our units in Spokane, and it cost us approximately $3,000. We will also assume you have to put in another $2,000 to refurbish the garage, including paint and also securing the doors and windows. Total renovation cost: $5,000.
Total potential rent
After making the above repairs, we estimate your total potential rent will be: $2,450/month. This is based on a rent of $1,500 for the single family home (it’s now a 4 bedroom/2 bath), $800 for the guest house, and $150 for the detached garage.
Calculating the cash-on-cash return after repairs
Let’s fill out the cash-on-cash return calculator (download by scrolling to the bottom of this post or by joining our Semi-Retired MD Facebook community):
Purchase price: Let’s assume you get the property for asking price of $175,000.
Down Payment: We will assume that you have to put down 25% because this is the standard down payment for an investment property using traditional residential financing
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 $18,000.
Interest Rate/Years/Payments: Let’s assume a 5.25% interest rate, amortized over 30 years with payments made monthly.
Number of Units: There will be a total of three units: the main house, the guest house and the detached garage. 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 $2,040. 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 $800/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 $2,450/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 property management fee is 7%. It is a negotiated rate that we got after we went above five total units in the Spokane market. You should start building a relationship with a property manager even before you start searching for properties so you know the cost of property management ahead of time.
Leasing Cost per Unit: Our property manager charges us a half month’s rent. Therefore, in this case, we would take half of the monthly gross rental income of $2,450 to come up with $1,225.
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. Note, if we put two years into the calculator, our cash-on-cash goes up from 10.3% to 13.1%.
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. If the property is in rougher condition, you should assume a higher number.
Monthly Utilities: As described above, electric is metered separately, so there wouldn’t be any electrical costs unless there is common area lighting (which this property does not appear to have). It’s unclear if there is gas at this property, but this is often separately metered as well or it’s just as easy to install an electric stove/oven or an electric water heater. It’s typical for properties in Spokane to have only one water meter. Therefore, the owners are responsible for water. Sewer and garbage accompany the water bill so this is also owner responsibility. The cost of water/sewer/gas for a property like this is around $100/month per unit so, in this case, we’ll put in $200 (the garage owner will not use any water). Note, that if we decided to pay to separately meter the guest house and make everyone pay their own water/sewer/garbage ($0), our cash-on-cash goes up to 13.9%, so it may be worth putting in the time and money to do this down the road.
After entering in all of the figures above, we get a 10.3% cash-on-cash return or $6,931 in cashflow per year on a total investment of $67,000.
Conclusion
Based on the cash-on-cash return of 10.3%, we would without a doubt put in an offer on this property. It not only meets our cash-on-cash return criteria, it has numerous additional sources of value that we haven’t even tapped (the extra land, the potential for a basement unit, the attic) as well as some clear ways to increase our cash-on-cash in the future (separately metering the water to cut out utility costs and decreasing turnover to keep tenants longer than one year).
Remember, just because we put an offer in on the property doesn’t mean we are going to buy it.
If our offer is accepted, we would do a thorough inspection, which includes having our contractor verify the $18,000 renovation budget (and explore the cost/value ratio of adding a separate basement unit) and having our property manager verify the rents. Moreover, after the inspection, we often go back to the owner and negotiate additional reductions based on inspection findings and, potentially, make the numbers look even better.
Making an offer and getting it accepted is just the first step in turning this good deal into a great one.
