Setting up a process that you can trust when embarking on a new campaign is both equally crucial and difficult. You need to not only be able to define every thought process along the path in order to make it repeatable, but you also need to be able to adjust and correct your process as you go through it. That is what we are going to be attempting to do here today, create a repeatable process for performing home value analysis so that you can quickly analyze not only a property but a neighborhood as well for investing.
Identification of Investment Property
The first place to start looking for investment opportunities is dependent on what type of an opportunity you are looking for. For this case study, we were looking for a house to hack within roughly an hour of Philadelphia. Our friend and co-founder Bill is our participant, who is looking for a place that is just about move in ready, that he can live in while renting out the other unit(s). We would be utilizing a 203 Loan and we are limited with available cash on hand. For this exercise, we assumed we could max out our initial up front costs at roughly $15,000.
With this information in mind, we were able to find our first property fairly quickly, by heading over to HomePath and just looking for units that met our needs, as defined by Bill. In our start, we wanted to work from the outskirts of what he was looking for and then gradually work our way back to Philly. In doing so, we stumbled upon 133a and 133b Stevens Avenue, Jamesburg, NJ 08831.
The property specifics were perfect for what we were looking for, a duplex with a 2 bd/1 ba that we could rent out and a 1 bd/1 ba for Bill to live in. The house was almost exactly an hour’s drive to Philly, it was over 2,000 square feet and the population has grown by 50% since 2000. However, only 10% of homes are rented in Monroe township, which is literally the lowest number I have ever seen rented, which means that we could get this property but good luck turning profit off of it. You will need to be damn lucky or very experienced, neither of which I am comfortable enough to say I am. Therefore, I am bailing on this property and will keep looking.
521 Westminster Ave Elizabeth, New Jersey 07208
After leaving Monroe Township, I spent a little bit of time working my way through New Jersey until I stumbled upon Elizabeth, a town a little further away than anticipated, roughly an hour and a half to Philly, but only a half hour to New York. Even though this location is slightly further out than we were hoping for, I figured it wouldn’t hurt to take a closer look as the property looked pretty good.
This property was even better than our last option, as it is a Duplex, but the only difference being that our new property has two units that each have 3 bd/1 ba, there is an attached two car garage, and just under 2,500 square feet of property. The only downside of the property is that it is slightly more expensive than our first property, as it is listed at $209,500. Still, 3.5% of 70% of the listing price is is roughly $5,100 down, and add on an assumed $10,000 more for closing costs and we are still in working range of our $15,000 starting point, albeit $100 over budget 🙁 .
Next thing to look at is the neighborhood details, as I don’t want to run into a similar issue as last property and find something I like but have it be in the worst area possible. So, I used Niche, which gave our town of Elizabeth a grade of a C, which isn’t ideal but it’s not bad either, so I will begrudgingly take it. The average house is right around 3 people and year over year growth is trending down at roughly a 3% clip. All in all, not a great neighborhood to invest in, but also nothing jumps out as necessarily worrisome or negative. It is all just less than ideal.
Finally, let’s check out backbreaker from the last property, renters market.
Housing Metric Score:
Now is the time that my partners and I go the purely subjective route and we grade the property on a scale of 0 to 3. Our scale is defined as such:
- 0 – This property is unlivable, and massive improvements would be needed prior to any person could move in.
- 1 – This property is livable but it still needs a good amount of work. Think properties with really bad kitchens or bathrooms, where everything works but it wouldn’t be something that you would want to have to deal with.
- 2 – This property is move in ready, and while you might want to improve or refresh the kitchen or floors, it is not necessary for any of us to be comfortable moving in and living with it.
- 3 – This property is in fantastic condition and needs no improvements for it to be a place we would WANT to live in.
Based on this scale, our property is valued as a 1. Our reasoning for giving this property a score of a 1?
Flooring and Painting:
Needs new flooring multiple rooms, as is evidenced by that horrific rug. Seriously, did a tractor die on that carpet? What is that? Also, I get trying to match the paint with the carpet, but why did they choose this color brown?
Other rooms didn’t have the gross brown coloring problem (I can’t yet speak to if they also housed the death of various farming equipment, but stay tuned for updates), but they did have the same issues of needing to rip out the carpet and re-paint the room.
For starters, I don’t entirely feel safe looking at this picture, so there is not a chance in hell that I would be climbing into this tub. The tub itself needs to be replaced, as does the caulking, the tiling and the window from the looks of the frame. Also, can we take a second here and ask why people want to put windows right above the bathtub? Who is the genius designer who thought that was a good idea? Sorry for the tangent, it just doesn’t make any sense at all to me.
The kitchen looks to be in desperate need of improvements before it would presentable as a kitchen that any of us would want to live in. As you can see below, the cabinets need to be updated, the appliances look very old, the flooring is coming up, and the counter appears to be caving in. This isn’t even mentioning the massive hole above the stove or the sink that looks like it was around before the women’s suffrage movement.
As you can see, this property is what I would call livable, as there are not any large holes in the floor or exposed wiring/beams. However, I would not want any of my friends or family living in a house like this, so I had to keep this qualified as a 1 property.
The next step in our property analysis is to identify whether or not the property is in a decent part of the town and doesn’t send off any major red flags. Seeing as the largest red flag in my book is safety, our first step was to take a look at how dangerous of a community this is. This was simple enough, as there are tons of sites that provide this general overview for you:
Ok, so not great, the entire map is shaded with a certain red lens that really makes you want to check to ensure your wallet is still in your pocket while reading this. However, silver lining is that where our house is appears to be one of the better areas in this town, as we are avoiding some of the deep reds.
I’m not satisfied though, as that still looks pretty ugly, so let’s take a peek at the street view on Google Maps:
Would you look at that?! Not too shabby, we’re right next to a Spine and Health Care Center which appears to take care of the property and looks nice. Taking a closer look at the street view, this neighborhood doesn’t look too bad either. I actually think the street our house is on looks pretty nice, and there is a school down the road and the rest of the houses on the block appear to be taking care of their properties.
It is by no means Bel Air, but I wouldn’t have any problem moving to this street based solely off of the images we have access to. The next step here would be to drive by the location and get a feel for the area in person, but before we invest that type of time, I would want to check out the comparable properties in the area and see if our property makes sense from the investment standpoint.
Our first step to finding comps is to go to any of your standard rental sites, today I chose Realtor.com, and throw on a couple of filters and then just go hunting for the same skeleton of a house as your property. After a quick scan, I found the following properties:
- 101 Lincoln Avenue
- I picked this property because it was a single family home with nice tiling throughout the property.
- It looks like the kitchen and bathroom are pretty good, just not updated.
- I would rate this property as a 2 on our scale.
- This property is renting for $1,700 per month, with utilities included
- 424-426 Jefferson Ave
- I picked this property because it was the right skeleton with hardwood throughout.
- The kitchen doesn’t need anything but could stand to be updated a bit.
- I would rate this property as a 2 on our scale.
- This property is renting for $1,450 per month, with no utilities
- 560 Walnut St Unit 2
- This is a single family home with 3 bedrooms, so this comparison is not exactly a 1 to 1, however, I thought it would provide some good data to consider.
- The primary reason is that this property is a 1 on our scale, as it looks like a college house, there have been no updates, ugly flooring, dirty, and old.
- Even with all of these flaws, the house was renting $1,500 per month without utilities.
Calculate Your Investment
Now that we have comparables, we can more accurately diagram out what our investment will look like as we now have a way to estimate rental income and property taxes.
Let’s walk through the initial entries though to make sure everything is clear.
Our purchase price is calculated by taking 70% of listing price, so we took 70% of $209,500. That left us with $150,000 after rounding up. We then tacked on $35,000 to include the repair costs, which brought our purchase price to $185,000.
We came to $1,300 per unit rental income based on 101 Lincoln being $1,700 including utilities, we assume $300 for utilities ($100 for Comcast, $100 for electricity, and $50 for water rounded way up to compensate for any additional expense we might be forgetting). This brought this property’s rental income to $1,400.
424 Jefferson is renting for $1,450 while the single family home is renting for $1,500. Therefore, we put our rent slightly lower at $1,300 to take the most conservative approach that we could. Our goal with rent will be to start with the price higher than what are assuming here, and drop down on that rate to our base rental depending on demand, so this $1,300 estimate is to reflect the worst case scenario for us.
With our loan requiring 3.5% down, we know our down payment is $6,475 and we estimate a high closing cost total of $10,000 to account for unforeseen expenses. This is higher than we anticipate, but I wanted to be safe with my estimate. This keeps us fairly close to our initial goal of $15,000 out of pocket.
We know our interest rate is 4.9%, which is based off of the latest APR as it is 3.9%, which we add on a full 1% in order to assume the worst case scenario.
Based on the tax estimated for similar properties in the same location, we are going to also estimate taxes of $7,000, and while I desperately don’t want to have to relive the nightmare of trying to establish a clean comparison for estimating taxes, so instead of walking through every step, let’s just cover the basic steps.
- First step was to figure out what our NJ tax rates are;
- Now the tedious part, which is to establish what our comparison properties are in the tax listings, which is way more difficult than it sounds since New Jersey clearly doesn’t believe in improving their website to be simply readable;
That was about it, but I can’t stress how much more annoying this step was, so please just pretend to be impressed.
With our property taxes included, we now have all of our numbers estimated, so we are able to truly evaluate the property as an investment. What we find out is that this property is generating a positive cash flow rather quickly, yet the cash on cash return is only -0.03%. The problem is that the property is still a little too high to deliver the value we would be looking for.
Move In Philly Home Value
Target Home Value – $155,000
Cash on Cash ROI – 10.5%
Year 1 After Tax Cash Flow – $2,080
Move in Philly Home Value – $120,000