Breaking into the rental market with Inheritance property

[Anthony Pollachioli]

I have been reading about the costs to build a duplex and begin renting, but thought my situation was a bit unique and so I decided to make my own post.

A few years ago we inherited a house and land in town close to a local graduate school for physical therapy, occupational therapy, physicians assistant, etc. 

Being in the field of physical therapy myself, I know that these students come from all over the U.S. and have difficulties finding places to rent in this very low-income and rural town. These students typically are backed financially by their parents willing to pay these "cheap" rent prices to put their kid through graduate school. The graduate school is less than 10 years old and still adding programs, and while dozens of people have begun converting old of homes/office spaces to rental units to capitalize on this obvious opportunity, it remains an investors paradise.

The situation:

The house is a ~1400 sq ft brick ranch style home on a good plot of land that we recently had surveyed and parceled into two individual lots. The first plat has the house (recently appraised at 154k) which requires more work than we'd like to put into it. The second plat used to contain a mobile home years ago and has town water/sewer/electric hookups not currently being used. Our goal is to sell the first plat with the house and use the money to build a modest modular duplex on the other plat to rent.

We are both very inexperienced when it comes to building and renting, and need all of the information we can get- what are some unforeseen costs associated with building a modular? What are some questions we should be asking prospective builders? What are some costs associated with hooking up utilities and electrical to our modular and what should we be searching to get an idea of cost? 

A general breakdown of the costs you would look into as an experienced builder/investor would be very appreciated. Not looking for specific money amounts obviously, I can figure that out on my own as long as I have some direction. Just want a general itemized list of potential costs to look into, such as cost to develop land, build foundation, permits, delivery and building of modular, hooking up utilities, etc.

Thanks in advance!

[Kevin Sobilo]

Quote from @Anthony Pollachioli:

@Kevin Sobilo:

Tax implications are never based on local laws because we are talking about FEDERAL taxes. If local laws changed federal taxes localities would prevent residents from having to pay at all! A gift would of course be WORSE because then you would be on the hook for capital gains on the ENTIRE SALE PRICE.

What I suspect is that you "inherited it" but that when you transferred title into your name the deed showed $1 because that is allowed for close family transfers and avoids state transfer tax aka tax stamps on the sale. At least that's how it would be in my state. So, I suspect my original response may still be on point with regard to federal taxes.

I think your mindset about renters may need some re-evaluation. Renters, ESPECIALLY those who know they are only looking to rent for a finite period are generally focused on function over aesthetics. You aren't selling someone their forever home. You are renting them a place for a couple years max. So, updating a 1940s ranch is a perfectly reasonable sounding thing to do. In fact a 1940s ranch isn't even "old" in many parts of the country. For a rental in my market that would be NEWER than average as most rentals were built 1890-1920.

There are so many other options to consider. Could the house be converted to a 2 bedroom and studio? Could it be rented by the room rather than to a single tenant? Does it have a basement or garage that could be converted into livable space.

A remodel sounds to be like lower hanging fruit. Less investment, less time, less risk. So, I would try to look at that with fresh eyes and evaluate every possibility imaginable before dismissing it.

There is a tendency with people, especially new investors to want to create "what they like". What you like may or may not make the best sense as a rental investment. Me personally, it took me a while to understand what the expectations were for rentals in my market for different classes of rentals and it was much different than I would have expected at the beginning. For example a C class rental in my market is on average functional but VERY dated looking like the finishes are from the 1970s or early 1980s. This is what an entry level working class family expects to find on average here. This will vary from market to market, but you want to understand your market IS, NOT what you WISH it was.

For a renter you describe including a washer/dryer is probably more appealing to them than having a brand new modern aesthetic as in many markets those are not typically included. This is just one example of how expectations may differ from how a new investor might believe.

 Not sure why I put "local" but re-reading the same article I read a few weeks ago, it does change the way the IRS views the sale. i.e. it is no longer considered a "sale" but a gift. The house was not inherited, it was sold for a $1 to us several years prior to the resident (a family member) passing away. Here is the link for reference, I'm sure you could make better heads/tails of it but we still plan on talking to a financial advisor. (https://ibuyer.com/blog/can-you-sell-a-house-for-one-dollar/... Regardless, we have considered your input and are willing to attempt to evaluate the cost of rehabbing versus selling and building. Here are our concerns;

- Some of the floor joists have been exposed to excessive moisture and are rotting away. There are a few joists I can physically stick a finger into the wood is so soft. This seems like a costly fix, as well as a rental safety concern

- The basement leaks, the basement is below ground and built into a hill, and there is always stagnant water in certain spots of the basement floor regardless of amount of rain, which only makes it worse. We have since put in a dehumidifier but too little too late it seems, I believe the basement will need to be sealed.

- The unattached garage (built into same hill) has drain run off that goes underneath the driveway and into the road. Drainage pipe is broken/clogged somewhere and water drains freely under the driveway. I recently had to fill a sinkhole that formed in the driveway that was at least a foot deep with gravel and top with asphalt patch. A short remedy for a potentially much bigger issue.

This is all aside from a very outdated kitchen and flooring which I agree is purely aesthetic, but considerable costs. It is a 3 bedroom with 1 bathroom. 1 bathroom I don't believe will be attractive to potential students. Converting to a 2 bedroom and studio may be possible, but is all additional cost on top of structural concerns previously mentioned.

We do not have a lump savings to cover the cost for this rehab. We have talked about taking out a HELOC, but then we are making payments on a home for an unknown amount of time for it to become rental ready. That is what led us to believe it would be easier to sell and turn the money directly over into a new build.

All of those concerns out in the open, I'm all ears. Rehabbing was our first thought and is not out of the question. Do you still think that would be the most viable in our situation? How would you go about financing the rehab? I assume our first step would be to get a quote from a structural repair contractor?

1. Wood rot is certainly serious, but depending on the extent might only require sistering new lumber besides the compromised sections. I haven't dealt with rot like that myself but I have dealt with joists that have split or that were compromised by a plumber carving them up like a turkey.

2. With basement water, the first place I look it outside the house. There are often things that can be done externally to help with the situation. Ranches have larger roofs so more water shedding from the roof during a rain. Directing that runoff away from the house is more of a priority with a ranch for that reason. Also grading the surface to force surface water to run away from the foundation even just a few feet can make a difference.

If a larger issue with the hill exists, I would bury drain tile and catch some of that water from the hill and direct it around and away from the house.

If I could not mitigate the issue sufficiently outside the house, then I would probably add a sump pit and perhaps some kind of perimeter drain in the basement in the most problem area.

Old home basement aren't meant to be perfectly dry like a modern house, but you do want to keep them from being constantly "wet" as opposed to occasionally damp.

3. I know you think of the kitchen remodel as a "considerable cost", but often times old cabinets can be refurbished by painting them and possibly changing hardware. Flooring can be a basic vinyl or even a DIY job using peel & stick flooring.

Expensive materials is more risk for the landlord because when they get damaged there is more likelihood you will lose money on the deal because collecting damages exceeding deposits if difficult.

Like I said, look at what typical rentals look like in your area. I suspect the typical is not exactly what you're now imagining.

4. I am not a fan of HELOCs when you need the money for long periods. I would just do a cash-out refi with a 30 year loan. You can probably get 75% of the appraised value So, over $100k. That will cover not only the rehab but also the mortgage payments and carrying costs until the rehab is done plus more to invest in whatever else you choose.

Rates are a bit high at the moment but try to get something without a prepayment penalty and then refinance in a couple years when hopefully rates are lower.