Septics, Appraisals, and Knowing When to Walk

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Real Estate

The Backstory

Last November, we were looking to expand our short term rental portfolio.  More specifically, we were looking for a house located near a ski resort, that also had other year around amenities close by.  In today's market, it's rare that we find investment properties on the MLS that fit our strict buying criteria, however, we found a diamond in the rough.  The house was located in Bryant Pond, Maine, approximately 20 minutes away from the bustling Sunday River Ski Resort.  This house was listed as a 5 bedroom, 4 bathroom house with roughly 2,700 SF of living space.  It was listed for $399,999 and had been on the market for roughly 200 days.

Pre-Offer Due Diligence

Whenever a house sits on the market for more than 45 days in this market, there is usually a reason why.  As investors, we are constantly looking for aspects in a home that may not have been desired by others.  In this case, we looked to learn two things.  1) Why had the house sat for so long without being sold, and 2) As an Airbnb/short term rental, what was the potential revenue that we could make annually.

Finding the answers to each of these questions would allow us to calculate an allowable offer price.

Starting with number 1 - why had this home sat on the market for 5x longer than other homes in the area.  When we began researching, we found that at some point in the last 5 years, the seller had put an addition onto the home and in doing so, built a partition, effectively making this house a duplex.  On one side of the duplex was a long term tenant, on the other side was a seasonal renter that paid a premium to rent the unit out for the ski season.  This ultimately meant that a buyer looking to use this home themselves couldn't do so until all of the leases expired.... AND they would then have to knock down the partition if they wanted this to be converted back to a single family home.  That's a lot of work and a lot of waiting for somebody looking to buy a ski vacation home.

For us as investors, this actually presented an opportunity - the ability to rent out multiple units means multiple revenue streams off of one individual property.

Then for number 2 - what could we expect for revenue?  This is actually pretty simple.  There are a few different tools on the Internet that you can pay for.  These tools pull data from all Airbnb and VRBO listings for a given zipcode (our favorite is!).  These tools will tell you the occupancy rate, average nightly rate, gross annual rate, and occupancy trends for that area over the course of an entire year.  You can hand pick listings that are similar to yours in terms of beds/baths and amenities.  When we ran the numbers, we figured that we could gross roughly $85,000 per year, which would net somewhere around $40,000 annually.  That's some strong cashflow and it certainly justifies that asking price of $399,999!

The Offer

As we do sometimes, we decided to submit 2 different offers.  Often times, you have a higher likelihood of the seller accepting one of your two offers because they have 3 options (either of your offers or just simply saying no), rather than a singular offer, where it's either yes or no....people like options!

I'll also note that we did not see any mortgages listed on the deed, which usully indicates that the seller owns the home outright and sometimes, that presents an oportunity for seller financing.

So, our first offer was for $325,000 with seller financing.  Our second offer was for $375,000 with 10% down. (PRO TIP! You can get a vacation home loan and only put 10% down!).  For those that don't invest, the goal is typically to put as little money down as possible and leverge the banks money (the other 90%) while still recognizing a high cashflow.

Unsurprisingly, the seller rejected both offers, but he did say that he'd go up to $389,000 if we wanted the house at the price....we did.  However, with 10% down, our down payment would be $38,900 plus we'd have approximately $10,000 in closing costs, so our "All In" would be right around $50,000.  We realized that it would be more advantageous for us to counter that by offering $399,999 ($10,000 above his counter ask) and request $10,000 back as a credit towards closing costs.  This means we would have a down payment of $39,999 but NO closing costs and ultimately save us about $10,000 of out of pocket expenses.


Contingencies and Post-Offer Due Diligence

The contingencies that we had as part of the offer were simple - we had an inspection contingency and a financing contingency - both of which we exercised.

The Inspection - For the most part, nothing raised an eyebrow during the inspection of the house.  A few DIY projects that weren't 100% up to code, a few outlets weren't working, and an older but functional roof...nothing that would kill a deal.  We did perform an inspection on the septic.  The tank itself was fine, however it was noted that this house was listed as a 5 bedroom and this septic was only built for 3-4 bedrooms.  It was also noted that the flow system was only built for 3 bedrooms.

So now we have a house that has 4-5 physical bedrooms (depending on if you count the loft), but a septic system that was really only designed for 3 bedrooms.  It told us that when the owner put the addition on the house and transitioned the home to a duplex, the proper steps were not ever taken to expand and/or replace the septic system to accomodate the additional living quarters.

Beyond the septic, we also learned that the town still considered this home to only be 3 bedrooms, mainly because the septic was never updated and the proper permits were not pulled to properly consider this home to be a multi-family home.

....I bet the seller wasn't expecting all of these speed bumps when he decided that he wanted to sell the home....

The Appraisal

The outcome of the inspection was that the seller agreed to fix some of the issues that we pointed out, but unsurpringly, he wasn't very open to installing a new septic system to accomodate the larger home that he now had.  The challenge here is that our "comps" (comparable homes that have sold in the last 6-12 months) all suggested that a 4BR and 5BR home was worth around $400K and a 3BR home was worth around $350K.  The appraiser appropriately considered this home to be a 3BR because that is what the town considered it and with that, they valued the home at $364,000.

The Outcome

In the end, we exercised our financing contingency and stated that because the appraisal come in $35,000 below the list price, that we couldn't get financing at the agreed terms and we decided to walk.  This was the right call.  As an investor, you always need to have multiple exit strategies and think 2-3 steps down the road.  For this property, if short term rentals weren't working as we expected, we'd need to be able to sell the house and still make a profit.  At the very least, we needed to be able to sell the house without inheriting the same challenges that the current seller was facing when trying to sell the house to us.  For us, it was clear that the house met our financial criteria, in that we could appreciate high cashflow in a great market, however, it did not meet our strategic criteria of being able to safely sell the home if we ever need to.

What's Next?

Well... us investors ALWAYS have irons in the fire... We already have another house with an accepted offer about 15 minutes away in Bethel, Maine, still near Sunday River.  We found this house using one of my 4 favorite off-market strategies.  Follow me on instagram @menapace_realestate or check out my Facebook page "Menapace Real Estate" to see photos and details on our next short term rental acquisition!