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Doing your due diligence

I currently have an offer on a property and I want to talk you through the due diligence I am doing on it.

The property is a 4 bedroom house on 500m2 in Otahuhu. This is a relatively small block for the area and the house is in fairly bad shape hence the purchase price of $280000.
The idea behind the house is that I will buy it, renovate it and rent it out to hold.
Currently the house is rented to friends of the owners for $330pw and they have not looked after it.  I got a new rental appraisal and based upon a 4 bedroom house close to Otahuhu college and the train line the market rent would be $450 – 470pw.

I then got in a valuer. He valued the house at $284000 which means  I am paying the market value for the property. I went through with a renovation project manager and we talked about every thing we would change/ do to the house.

The immediate problem with the property is that the bathroom floor has completely rotted out and needs replacing, this gives us a chance to rebuild the bathroom. The property also has a separate toilet right next to the bath room which is exceptionally large and would easily fit a shower and vanity in it, and so we can turn that into an ensuite for the bedroom that backs onto it.

The kitchen needs minor work done to it, including opening up the laundry which comes off the kitchen. If we could compact the laundry into the corner we would create an additional 4 square meters of useable space. The kitchen would get new lino and we would move the stove from its current position. The carpet in the house is in pretty good condition. As we are keeping it as a rental there is no need to remove it, just give it a good commercial clean. It is also possible to dye the carpet if we wanted to. I would paint inside and out and do some minor fixes on things like windows and a few boards outside.

The valuer did his home work and told me that the property would be worth around $350000 all done up. I also got in a building inspector and he told me the property had a few issues; the property was relocated to its current site and it wasn’t tied down to its piles, it has some dodgy wiring which wasn’t done by a registered electrician, and the rotten floor has spread from the bathroom to the separate toilet next door. This gives me grounds to go back and renegotiate the deal for a better price or to get these things fixed.

The total renovation cost comes to around $28000.

The numbers:
Based on a new valuation of $350000 and a 85% LVR, I can refinance to (350000 x 85%) $297500
This means I will receive in cash my deposit and my renovation costs back in my pocket.

With a rental appraisal of $450pw I have an annual income of $23400.
I will have interest costs at 6% (Interest only locked in for 5 years)$ 18000
Rates – 1200
Maintenance -1000
Insurance -800
Management at 7.5% – 1755

Incoming  23400
Outgoing  22755

Difference 645

The property will make $645 per year without me having any money at all in the deal. If I wanted to increase my cash flow I could get a better interest rate: I.e. 4.99% for 2 years, I could also look at managing it myself. These are not recommended by professionals, however if it means that you can hold a cash flow positive property with no money in the deal then I think it is an option to look at, at least until the rent rises enough to cover those other costs.