Edward Alexander a Harvard graduate is looking to invest in a small income producing apartment building in the Back Bay-Beacon Hill area of Boston, Mass. He currently has $80,000 dollars saved up to purchase this property. He began his search for the perfect property checking current listings and prices using, www.bankrate.com and www.realestate.boston.com. Due to many of his friends living in the area he gained access to eNeighborhoods a program that allowed him to enter addresses and it would show the previous 25 properties sold. Most properties observed sold for $700,000 and higher and required an initial equity investment of $150,000. Since he only has $80,000 in equity he plans to take out a mortgage to cover this cost. He found that the listings he came across were rundown and in bad condition. Such as one property on Myrtle St. This property showed a 20% return on cash investment, but did not account for repairs, vacancies, or management expenses. With these included the cash return would be only 3%. The values of many buildings on Beacon Hill had doubled or tripled in the past ten years due to a large amount of wealthy professionals anxious to own real estate. Alexander therefore believed that an apartment building in the Beacon Hill area would be a safe investment due to little chance of depreciation for functional or economic causes.
After many failed attempts to find a suitable property Alexander learned of a 4-unit apartment house located on the “back slope” of Beacon Hill. While prices in some neighborhoods had declined prices on the “back slope” continued to increase. The property was only partially developed with three 2- bedroom apartments and one 1- bedroom apartment. The asking price was $350,000 and it would cost approximately $165,000 to complete the renovations. He is planning to rent the three 2-bedroom apartments for $2,000 per month and the one 1-bedroom apartment for $1,600 per month. Rentals total $91,200 per annum, estimated real estate taxes total $7,800, an insurance policy for the building would cost $2,600 per year, and maintenance on the building would cost $1,800. Alexander projected a cash flow before financing of $61,510. In order to save money on his contracted costs he planned to renovate, and remodel the building until it cost him $15,000.
Alexander is considering two possible mortgages. The first loan from Geraldine Smith, a loan officer at a savings bank, is offered as an 80% mortgage on the $500,000 property, or $400,000. The bank would waive principal payments on the mortgage for six months during construction, but interest of $16,000 as well as real estate taxes of $3,900 must be paid. In addition, he had to pay $1,300 for six months insurance and $1,500 for utilities; these costs totaled to $22,700. There was also a $1,300 tax escrow that would eventually be refunded to him. There is an existing mortgage taken by the past architect that Alexander can assume. This bank will not grant Alexander a $450,000 loan, even when considering his plan to live in the building, manage, and do some renovations personally. If the income from rents increased after renovation, the banks would reconsider his request for a $450,000 mortgage.
Alexander’s second attempt at acquiring a mortgage comes from Sarah Harris, a loan officer at a local savings bank, and seemed more willing to negotiate the terms of the mortgage with Alexander. Alexander showed her the income and expense projections, the costs, and explained his future plans for the property. Due to the bank’s 80% policy restriction, Harris was reluctant to grant the $450,000 loan before the bank appraised the property, or she saw the property personally. The property would have to be worth $562,500 in order to meet the %80 guideline. The bank used the income approach method to calculate the appraised value and derived a value of $564,200. Therefore, Harris was able to...