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Saturday, July 7, 2018

Roofstock Property Purchase: A Note on Appraisals

The appraisal does not necessarily reflect actual value, it just reflects current condition of the property and what the surrounding similar properties are going for. If an area is about to get really hot, it will require buyers going above appraisal to get into that market, which in turn raises the appraisals, and the cycle continues. It is not necessarily the best idea to be the first person to cross that line and "overpay", although it may be worth it if you think that the potential appreciation far outweighs the amount you are overpaying.

Another thing I did not know before this process was that the appraisal limits the amount of the asset that the bank will cover.  In my case, that means that now the loan will only be for a max of $89k, regardless of whether or not the closing price drops from the original $115k or not.  

Pros

  • A lower total price, duh!
  • The seller may realize that the evaluation will not change in the near term and knows that the same thing could happen with the next potential buyer or the buyer after that. 
  • The drop in price also results in a reduction in principal and interest, which raises the profit margin and monthly income

Cons

  • May not be able to use my loan to leverage as much as I would have before, resulting in more initial investment
  • The appraisal coming in so much lower than the original asking price decreases the odds that the seller will agree to the lower price. 

I am now calculating a maximum closing cost that I would be willing to accept taking this new loan amount into account. It's simply a numbers game with an optimal point at which there is a minimal initial investment and maximum monthly profit.

On a personal note, it is really hard to even consider withdrawing the offer given all of the time and money I've already put towards getting this far, but it is important to never force a deal just because you have gotten through most of the closing process. It is imperative to take a step back and look at the deal objectively or you will just be signing up your valuable time for mediocre returns. You cannot lower your standards!

On a financial note, I have at most $945 to lose and will most likely be able to recoup $545 of that, so all in all losing $400 is much better than getting into a bad investment! 

A few lessons from this: 
  • Limit the amount of loses should the deal not close and make sure you have proper contingencies in place so that if a deal goes south, you can get out of it
  • Even if you have an appraisal/inspection contingency, if you believe that the appraisal will come in much lower than the asking price, it may not be worth going into the investment as it is probably unlikely that the seller will want to reduce the price enough. Make sure you think it is worth the possible loss of some funds to see if the seller will be willing to take the bait!

Roofstock Property Purchase Day 38: Waiting for Seller Response

It is now a month after entering the contract and three days since I proposed my counter offer. I have not heard back from the seller, even though a response is legally due at this point per the PSA. I contacted Alexis at Roofstock and asked her what was going on. She responded that they have not heard back from the seller and asked if I wanted to amend the PSA to extend the response time. If I did not, the contract would be null and the sale cancelled. It is a holiday week (Fourth of July!) and of course I don't want to lose the deal before getting a response on the new price. Alexis quickly put together the amendment for me to Docusign. I am impressed how quickly Roofstock was able to move through this whole process. 

Image result for ticking time

With the contract amended, I have an additional week to hear back from the seller...

Roofstock Property Purchase Day 21: The Appraisal and Inspection

Three weeks into contract, the bank sent me requests for a non-refundable $400 earnest deposit as well as $845 for the appraisal bill. In regard to the inspection, Roofstock covered the cost through one of their certified inspectors. 

The $400 earnest is all that I would be on the hook for should the property not close (i.e. they'll cover the $445 remaining on the appraisal should it fall through).  If the property does close, then the $400 will go directly to the closing costs.  

At this point my expenses are as follows:

Roofstock fee-$575.00
Escrow Money
-$1,500.00
Appraisal
-$825.00
Application Fee
-$400.00


However, only $975 would be non-refundable should the deal not close. I'm also guessing that Roofstock will waive their earnest fee since this is my first property purchase and first time using their site. It would certainly leave a bad taste in my mouth should they not give me that back. Hopefully we don't have to find out! 

On the fourth week into the process, the appraisal came through, valuing the duplex at $89k, approximately $26k below the asking price! This was somewhat expected. As I mentioned in an earlier post, several other sources matched this price. I then sent a rebuttal offer of the appraised price to the seller ($89k). 

The inspection came in from Roofstock on the same day.  The report had tons of photos in it as well as estimates on immediate and at-turn costs. There were a number of small items that need to get fixed, but nothing that was unreasonable or that required the seller to take care of before closing. In total, there was around $7k worth of repairs that will need to be done in the next couple of years. This is in the ballpark to what I was already factoring in for my capital expenses using the 2% of purchase price rule. The big ticket items are still rated to have 5+ years left, which is what I was mainly concerned with. Overall, I think that the expenses have come in a bit higher than initially budgeted, but the drop in price will easily cover the delta.

I also had my property manager and a friend who has construction experience take a look at the inspection report to make sure that I wasn't missing anything big. Both came back saying that overall things look reasonable.

Roofstock Property Purchase Day 14: Getting Loan Disclosures

After about two weeks into contract, I took a look at the numbers again and realized that the they were not looking good after plugging in the actual quotes that I was receiving. 

I contacted Roofstock with my new findings in order to let them know that this didn't seem like it would be a good fit anymore. I wanted to give them early notice so that we could save everyone time and money.  They arranged a call to discuss and figure out exactly what was going on before taking any action.  During that call, I was happy to find that I made a dumb accounting error in my calculation (was double counting an expense). Now all of the sudden the numbers were looking good again!


But wait!...the next day I received my first loan disclosure.  After reading through it I was a bit surprised.


My rate was 5.75% and my closing costs totaled up to be around $9k! This was a huge surprise to me and totally threw off my numbers for this property.  The property was now once again looking mediocre.  Talk about a roller coaster.  




Why was this happening? With such a low purchase price and down payment, anything that effects the initial investment has a huge impact on Cash on Cash returns.  Reducing closing costs or expenses has a much bigger impact on Cash on Cash return than proportionally reducing the actual price of the property (due to leverage). 


You need to be careful there, though, because many closing costs can be tax deductible (see this article), so sometimes it is not worth trading closing cost for total cost.

Next, I contacted my loan officer to get clarification.  During this call, I learned a lot:

  • The bank conservatively takes into account all possible closing expenses 
  • They add in much of costs that I had already taken into account (for example first 6 months of insurance, taxes for 6 months, etc). In other words, these were being double counted in my calculations
  • There was a sales tax that was several thousand dollars, but I found out that the seller was actually covering that cost (as is traditional, or at least most of it)
  • The rate of 5.75% is higher than I expected because the property is a duplex and not a SFH. This is a national rate that this bank has little flexibility on. I could have shopped around to find more aggressive banks, but the difference here did not seem worth the time for me.
After clarifying what would or would not be in the actual closing cost, I was able to see that the actual closing cost was going to be closer to $3,500. I plugged that into my spreadsheet and boom, we're back in business!



At this point, my cost structure was as follows:


I'm looking at a healthy 10% CoC with $270/month in passive income.  A few more of these and I'll be on my way towards a nice chunk of change in my pocket passively. 

One thing to note here is the Recovery Point.  This is the time it would take me to get my initial investment out and be able to put it back to work elsewhere.  That's the true way to scale and grow an investment quickly.  Ideally I could have something that returns in 5 years. This does not take into account the fact that: 
  1. That money will be accruing monthly, not all at the end 
  2. I will be leveraging that money elsewhere for growth (whether that's in stocks or another property; we can go through that math at another time) 
  3. There will be appreciation involved that will hopefully allow me to refinance and pull the additional needed cash out that way  
With all of those combined I expect that I'll be able to have my total investment back within a 5-7 year time frame.  

Roofstock Property Purchase Day 6: Insurance, PM, and Expenses

6 days into the contract period, I signed an agreement with my PM and provided that info to Roofstock. 

Insurance was next.  Roofstock provides a list for all things needed, so they make the process easy in that sense.  Alexis (from Roofstock) recommended several insurance providers.  My loan bank also provided me with some options.  After comparing everything, the bank provided the best option.  I was able to get the following coverage for about $900/month on my duplex:



At this point I was able to fill in my own spreadsheet to lock in actual numbers.  I started a spreadsheet that had the following items:


  • Expenses
    • Property Management
    • Taxes
    • Insurance
    • Repair and Maintenance (CapEx) - estimated at 2% of total cost of property
    • Principle + Interest
  • Income
    • Rent with a 5% vacancy
  • Closing
    • Down payment
    • Appraisal cost
    • Escrow
    • Closing costs




Roofstock Property Purchase Day 5: Getting a Property Manager

Roofstock has several recommendations for Property Managers that cover the area for my property.  They list these for each property:



They also provide a more detailed breakdown on their rates at the bottom of the property page:

One thing to note is that Roofstock's expense estimate for property management does not seem to take into account the numbers they provide for their listed PM's.  I'm guessing they have some average that they apply since each property could have different coverage, but I made sure to add in proper expenses for property management.  Also, because my property is a duplex, I'd have 2 units worth of expenses. 

I interviewed each of the PM's and researched their reviews on on the web.  Marketplace Homes had the best prices, and during my call with Mike Tamulevich, it was clear that they knew what they were doing and would provide an affordable but professional service.  Mike had good answers to all of my questions, and also provided insights that I had not known before.  




Their costs:
  • $70/month per unit
  • 1 month rent leasing fee per unit
  • ~$2480/year, $1680 for any year afterwards that tenants simply renew their lease
I also found out that Marketplace Homes:
  • generally places tenants within 10-20 days in the area of purchase
  • takes a much more sophisticated approach to selling/showing the property.  They use professional photography and digitally furnish the apartment so that potential tenants can see it how it will look furnished, which helps a ton in terms of getting viewings.  
  • were willing to give me a discounted rate since I have a duplex
  • have an eviction coverage for any tenant that they place at no cost to me.  
  • have an insanely high ~98% retention rate, so they are good at choosing tenants.  
  • also covers most of the eastern side of the US, so that I can use them in other states and be able to get economies of scale working with them.
Mike has been awesome. In addition to helping me out with this property, he has also been a sounding board for other properties, giving me the low down on the areas and rent reports. I will try to use Marketplace on any future purchases (many Roofstock purchases are within their domain).

Roofstock Property Purchase Day 3: Getting the PSA

Within 4 days of the accepted offer, I received the PSA.  This is an electronic document that is signed through Docusign.  I read through the entire thing and there was a bit of confusion regarding the contingencies.  I have clarified with Roofstock that these are all taken care of through an amendment at the end of the agreement. This is my biggest concern since I haven't seen the property yet at this point other than a few outside photos.

I checked zoning and mining hazards (as this is a thing in PA).  I also checked to make sure there were no red flags in terms of the type of sewage, wiring, or plumbing as those can be big expenses to replace. I also made sure that I received an updated ledger that consisted of redacted bank statements so that I could see what the actual rent/vacancy was for the property.  This was not properly included in the PSA, so I had to get that sorted out.  One of the units is currently vacant, and the other unit just resigned for another year at $800/month rent.

Once I ensured that I had those ducks in a row, I went through and signed the PSA within the 2 day window. I was then required to put down a $1500 escrow that would be maintained during the closing period (fully refundable should any contingency kick in and if we close it goes towards the payment).

Roofstock Property Purchase Day 1: Offer Accepted

I went with Roofstock's recommended lender, Northpointe Bank.  Corbin Radabaugh is my loan officer, and he has been great through this process.  I highly recommend him!  The pre-qual process was super easy.  I needed to provide him with:
  • Copy of 2016 & 2017 W2’s
  • 30 days of most current paystubs
  • Copy of rent/lease agreement 
  • 2 months current bank statements for bank accounts and investments, all pages
  • Copy of Driver License or photo I.D.
After getting pre-qualified for $250k (to be safe since at that point I hadn't chosen a property), I went ahead and made an offer for $100k.  This is very easy to do on Roofstock.com.  The seller countered with $118k.  I then responded with $115k, which was accepted.

NOTE: One downside to this process is that Roofstock is the middle man in all of this, so there is no way to personally negotiate with the seller. 

Jason Pabon, Roofstock Business Associate, has been helping me through the selection and purchase process.  He has been providing me with some leads on properties and making sure I know how to use the site properly.  He is also a Roofstock investor and has a property of his own. We have been in contact almost daily until I entered contract.

Then, somewhat surprisingly, my interaction with him almost disappeared and I was now mainly dealing with Alexis Duarte, a Transaction Coordinator.  Although I realized that the roles are different (he is focused on helping customers get to contract, while she works on managing the closing), it felt a bit abrupt.  Don't get me wrong, Alexis and Jason are both great, and Jason is still available should I have questions, but I just think the process could be better with one person following you through the entire process.  I'm guessing this is less efficient for Roofstock which is why they go with the approach that they do.  Big picture, not a big deal.

One thing that was not clear to me at the beginning is that Roofstock is not the buyer's broker. In fact, they mainly represent the seller.  I didn't fully realize this until now, after entering into contract.  It definitely makes me more wary about what I confide in my Roofstock associates.  Although I doubt they are using my information to tip negotiations to favor the seller, I'd hate to expose crucial information such as my negotiation strategy to the seller through conversation with a Roofstock associate. It would be nice if they had someone that clearly represented the buyer as well.

On that note, it also makes me a bit uncomfortable with how they are totally the middle men throughout this entire process and receive a portion of the closing cost.  This feels like there could be conflict of interest going on as the buyer has no direct contact with the seller.  I've noticed in practice this is not the case, but still something that may make some investors uncomfortable.

Alexis contacted me after entering contract and said she'd have a PSA for me within a few days time. I need to provide her with my pre-qualification letter as well as the contact info for the bank.

Roofstock Property Purchase: Finding My First Property on Roofstock

Now that I am familiar with the site, I can get started searching for appropriate properties.  There were several properties that were great deals when I was first exploring Roofstock, but I was unable to move fast enough to make a move on them.  I recommend getting pre-qualified for a loan as quickly as possible if you are serious about getting a property so that you can move quickly on good deals.  

In general, I've found that very few of the properties reach my standards for a solid investment.  What is my criteria?
  • Under $150k
  • Cash on cash return of 10%+
  • 2-3-star neighborhoods (would have to be really good to get into a 2)
  • Buy and Hold
  • Refinance/capture my initial investment within 5 years so that I can repeat the process
Roofstock likes to list the 5 year yield and IRR, which can make the properties seem like  better opportunities than they really are. This criteria revolves mainly around appreciation, which I don't like to count on since it is so dependent on the current state of the economy. I want my investment to make sense without appreciation, and then enjoy the additional benefits of it when it occurs.  

With that in mind, I have found a property that looks like a good opprotunity in a growing area, Pittsburgh, PA:




It is a duplex in an average neighborhood listed at $120k, with total market rent at $1600.  

Notes on this property:
  • Not obvious that it is a duplex as there is only 1 address listed
  • Unclear whether Roofstock's valuation of the property is for one or both of the units
  • Unclear whether or not both units are vacant

UPDATE: I was able to quickly clarify these items through my Roofstock advisor via email/phone. Here are my initial numbers after some research:


This is a little below my desired cash on cash (CoC) rate, but is in a good area so I am willing to take a slightly lower CoC for that.  I did more research on the area and the investment, and it's looking like a good property.  Based on valuations from Zillow, Trulia, and Roofstock itself, I figure that the appraisal and actual valuation will come in $10k+ lower than the list price, and with inspection and appraisal contingencies on this property I feel okay about going into it at a higher initial offer price since the numbers are still working out at the offer price.  I figure worse case, I'll just get an even better investment! We'll see if this is a good strategy or if the seller will be very fixed to the offer price.

There are a few factors that have helped me jump on this property before anyone else:
  1. The list price is higher than most valuations
  2. It is an Inspection Contingency property, meaning not Roofstock certified and rent is not guaranteed
  3. There is unclear documentation on Roofstock.com as to the single or duplex valuation and/or vacancy
  4. Duplexes generally require 25% down payment compared to the normal 20% down on SFH investments (I didn't realize this until I got into closing)