A Broker's Search... Has Ended! (Sort of...)

Posted by Toes

Mon Jul 30th, 2007 02:24 PM

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So I decided to forgo buying a new development condo in Manhattan in favor of buying a townhouse! I finally found it - a gorgeous pre-war two-family townhouse in Bedford-Stuyvesant, Brooklyn. The asking price was $785K but due to a seller that had already picked out a new investment property and a broker who really knew how to make a deal happen, I am in contract for 470 MacDonough Street for less than the asking price. When we close, I will let you know exactly what I paid for the property. Here is why I suspected that the price was negotiable:



4/18/07 - property is listed at $899K
5/19/07 - price reduced to $815K
6/17/07 - price reduced to $799K
6/22/07 - price reduced to $785K

Talk about a serious seller (see Noah's post on "Timing A Low-Ball Offer" where he discusses what to do if a seller reduces multiple times in a short period)! So on 7/12/07 - before I thought there might be another price drop generating new interest in the property, I made an offer below the asking price.

My potential new home/investment property is only a few blocks from the A train at Utica and is only 4 blocks from Bread-Stuy, my favorite coffee shop (they have the best red velvet cake!). The townhouse has gorgeous and very unique looking fireplaces, moldings, stained glass and the original light fixtures.

Even though the sale was broker to broker, which is usually a very easy/smooth transaction because everyone knows what they are doing, I have never bought or sold a townhouse before. So I had no idea what the home inspection would turn up. Based on numbers other agents had quoted me regarding the condition of their properties, and the description of the property being that it needed "mostly cosmetic work," I thought the house would need about $75K of work. Included in this figure was:

1. Window replacements ($500 each) for 15 windows - $7,500
2. Stair rail reinforcements, etc. - $3,500
3. Remove and replace cellar floor slab - $6,500
4. Paint, refinish floors - $10,000
5. Bathrooms, kitchens (basic upgrades, we aren't talking SubZero here!) - $40,000
6. Restoring ceilings, fireplaces, misc other - $10,000

GRAND TOTAL (So I thought!) -------> $77,500

Then I got the home inspection report back (the cost of the inspection was $750). I almost had a heart attack & I thought about pulling out of the purchase. In addition to the renovations I thought were needed, the home inspector dropped a bomb on me with the following expenses that I was not anticipating...

Trade Area Approximate cost

1. Electrical re-wiring / upgrading - $20,000
2. Re-lining of fireplace chimneys (typ.) if desired - $15,000
3. Replace roof hatch - $2,500
4. Replace roof membrane and install proper flashing - $5,500 (property description said that it had a "new roof" so this was a complete surprise)
5. Install insulation at cock-loft - $6,500
6. Correct water damaged surfaces, various - $5,000
7. Check / clean main chimney - $1,000
8. Install fixed ladder to roof - $1,500
9. Replace cellar hatches with steel hatches (each) - $1,500 (x 2)
10. Remove and replace cellar ceiling - $3,500
11. Foundation wall pointing - $5,000

GRAND TOTAL ------------> $78,500 !!! (not including my $77,500 estimate)

On the surface, the home inspection indicated that the house needed DOUBLE the amount of work I thought it needed. I went back and tried to renegotiate the price, but found out that the broker had already significantly cut her commission to make the deal happen (she was more than generous!) and the seller had come down to his absolute rock bottom price. They also had someone coming back for a 2nd showing and an open house scheduled. I quickly took a look at 3 more properties that had come onto the market, which only reaffirmed my decision that I wanted this house.

Then I:

A. Went into a temporary depression because I really love the house but thought that it might not turn out to be the great investment that I thought it would be.
B. Called the home inspector to find out exactly what work HAD to be done right away, and
C. Had a sit-down with my contractor (who fortunately had come to the home inspection) to see what he thought really needed to be done right away, what could wait until later, and how much it would really cost me.

After speaking to the home inspector and my contractor, I learned that the chimney stuff can totally wait, the basement ceiling doesn't need to be redone, its more of a cosmetic thing, (eventually I will want to refinish the basement anyway to increase the value of the property) the ladder can wait, the celler hatches can wait, and if I downgrade my expectations for the kitchens and baths, $100K should cover everything.

My contractor also promised to have the owner's duplex done in 3 months and the one bedroom rental done a month later. I had budgeted 5 months for the property to sit completely vacant during the renovations, so hopefully this will help my bottom line (although I know realistically construction never happens on schedule).

I had also highballed my expenses, (which of course, can fluctuate):

Taxes = $1700
Insurance = $2400
Water - $50/month = $600
Heat - $300/month (installing insulation should help keep this lower) = $3,600/year

And I had lowballed the rents I am expecting:

Owner's duplex $2,300 (I really should be able to get $2,500)
One bedroom rental $1,300 (I really should be able to get $1,400)

So I am hoping the expenses and rents come out in the middle of my projections and don't turn into the "worst case scenarios."

Then I called my mortgage banker and asked how much the extra $25K - $50K (in case it costs more than expected) home equity line would cost.

Basically, before I knew about the extra work needed, I was looking at a break even cash flow the first year, and depending on taxes and expenses and how much they increased, I should have been cash flow positive after year two.

My assumptions were based on a 5/1 interest only ARM at 6.125%. I want to tie up as little cash as possible so I can have my money working for me elsewhere. I also want to have as much cash in reserves possible in case my numbers turn out to be wrong. Based on the additional home equity line I will be needing, I am going to be cash flow negative about $200 a month. After my accountant works her magic depreciating the property, I will be cash flow positive.

When I really think about it, aside from the mortgage payment, everything is pretty much speculation. If I think too much about how many unknowns there are in this investment, I start freaking out a little bit. The good thing is that I own my current apartment on the UES and can always sell it if it looks like I am going into the poorhouse.

I feel strongly that you can't get an amazing return on an investment with your money sitting in an on-line savings account making 5% interest. You have to take risks in life or you won't be rewarded; 'you have to be in it...to win it!'. I'm 30 years old and if I am going to take a chance on something, the time is now, not when I'm 60. In doing my research to select a neighborhood, Bed Stuy is the last place within a 15-20 minute commute to the city where you can buy a two family property with charm for under $785K that doesn't need a complete gut reno.

The streets in and around the Stuyvesant Heights historic district are beautiful and tree-lined and the neighborhood block associations even put out large flower pots on the sidewalks to make them look even nicer. Almost everyone meticulously maintains the landscaping in the front of their homes. The house I am purchasing is one and a half blocks outside of the Stuyvesant Heights historic district and there are talks about expanding the district to include my block (which some people are fighting because of the restrictions that come with owning a landmarked house).

Even if I am slightly negative on the cash flow for the first two years, I will "make" money by depreciating the property for tax purposes. I am betting on the area appreciating in value as people seek out neighborhoods with affordable town homes. My number crunching indicates that I will be cash flow positive in 2 years. Since this is a ten year investment for me, and possibly longer, I am confident that I am making a good investment. I will eventually move into the property and rent out the second unit when I decide that I need more space.

Next up: the Termite Inspection (cost = $150). If it turns out that the entire house is being eaten alive, I can back out of the contract. There is also a clause in the contract that if the tenants don't move out as they are supposed to (the house is supposed to be delivered vacant and broom-swept), in time for a Sept 1st closing, I can back out of the contract. I don't want my 10% deposit sitting around in a non-interest bearing escrow account while the current owner spends six months to a year evicting his tenants.

I will keep you posted on my progress and I look forward to reading your comments! Thanks!
- Toes