Journey to $5M with Multi-Units: FAQ

[Nichole Stohler]

Hello BP community! We’ve followed BiggerPockets for years and a few months ago I posted in the success story forum on how my husband and I went from complete real estate failure and debt to coming back and buying a $5M property in 6 years. Some community members asked questions in the post about things like how we got started, when and how we “traded up” properties and why we chose certain exit strategies. Others asked about books we’d recommend and other resources.

In this thread, we are going a step further and answering those questions and more that you might have.   We came up with the most frustrating or challenging aspects of multi-family and will post in this thread each week.   Here's the first post:

Gotta know where you stand.

Your opportunity awaits. What kind of financial base do you have right now to go after your first property?

So you’ve been listening to BiggerPockets podcasts for months… You’ve decided you want to start with multi-units. Where do you actually begin? How do you know where to start? In later forum posts we’ll talk about the business plan but before you can build the plan, you need to know where you stand today. In this post, we’ll look to answer how much money you’ll need to get started. Let’s begin with some very basic property research.

Research

First, we need to determine how much do multi-units cost in your area? At this point, we are NOT doing a full property analysis but simply starting to determine how much you’ll likely need. When it comes to your first multi-unit, there’s a lot of discussion on BiggerPockets about “house-hacking” which means creating rental income that can cover the costs of your monthly mortgage. A common house-hacking scenario described is to buy a duplex, live in one unit and rent out the other.

Very sound strategy… but is this an option for you? House-hacking is not a one-size-fits-every investor. What if you already have a house? What if you have kids in school and there aren’t any multi-unit properties in your district? What if your local area doesn’t have multi-units in safe neighborhoods?

You may be wondering why we are trying to determine this so early in the process. The reason is that as we get into the mortgage options there are some scenarios that will only apply if you will be living in the property. And, the various pros/cons of different types of mortgages include the amount required for down payment.

Ok. So, is house-hacking right for your first multi-unit? Here’s a simple decision tree:

What did you decide? Or, not sure yet? If not, take a drive and see what you think of the properties currently for sale. Maybe list out a pros/cons for your situation.

Now we are ready to look at costs. Let’s use the below example multi-unit costs as a starting point for this analysis with a purchase price range of $100k-$219k. We’ll be using the Phoenix 4-Plex as our case study property throughout this series of posts.

Determining Gap to Down Payment

How much money are you going to need for the down payment? This depends on the type of loan and your credit rating. The great news about properties with 4 units and under is that these properties are still classified as residential. With a residential mortgage you’ll have lower qualifications and the ability to lock in long-term fixed rates.

For our first 4-plex, we worked with Dan Francis, who is a nationwide residential mortgage lender. Because of his experience working with investors, Dan understands the funding details of rental properties as well as tax and income. We caught up earlier this week and he shared the different types of residential loans available and pros/cons of each for investors.

One question you may have is when should an investor start the prequalification process?

Dan’s recommendation is to start as early in the process as possible. He has found that many times potential investors have misconceptions about what is required. Some people might think they don’t have enough of a down payment or that their credit score won’t qualify. A good mortgage broker will help you create a plan for your specific situation.

What types of mortgages are available and could be part of your overall plan? Dan provided me with the following initial guide on mortgages that can be leveraged for 4-units and under:

Looking at our case study property which has a purchase price of $219,000, and using the guide above, we can see that the minimum down payment amounts would be:

• House-hack + FHA = $7,665
• House-hack + VA = $0 (!!!)
• Stay in primary home = $32,850

With a clear direction on the initial funds needed to get started, we can now focus on saving for the down payment. In our next post, we’ll dive into this.

[Nichole Stohler]

Six Ways To Get Money For A Down Payment

Sometimes, the biggest hurdle to getting started in multi-units is finding money.    If you are looking to buy your first multi-unit, what resources are available to you?  And which option or combination of options is right for your situation?

Let's use a case study property that has a purchase price of $219,000. For this property, the down payment will be $7,665 if you'll be living in one of the units or $32,850 if you won't be using as a primary residence.  

Narrowing our case study to assume you will not be living in this property. We'll also assume that you want to generate income from this property that you can use as you choose (as opposed to inside an IRA).

So how can you come up with $32,850 to buy your first multi-unit? 

Here are six possible options:

Should you borrow from your retirement savings?

Does your employer allow you to borrow from your 401k plan for general purposes? Some employers enable borrowing but restrict how the funds can be used. Examples include buying a first-time residence or to pay for education expenses but other employers allow general purpose loans that could be used for a down payment on an investment property. Looking at information from www.401Khelpcenter.com, the rules around borrowing can include:

• Percentage. Usually up to 50% of vested balance to a max of $50k.
• Prior loans. If you had a plan loan in the last 12 months, you’ll be limited to the amount listed above less the outstanding balance of the prior loan.
• Pay back. Over 5 years.

The loan payments are deducted from your payroll checks as you payback. Interest on the loan is often prime plus 1%....but you are paying yourself back. Yes, there is the opportunity cost of not being in the market but you are using these are funds to buy cash-flowing property and jump start your business.

One of the downsides of borrowing from your 401k is that if you leave your employer prior to payoff and cannot pay back within 60 days from leaving, the funds obtained from the 401k loan are subject to income tax and 10% withdrawal penalty.

Help from your primary home?

Do you have equity in your primary residence? If so, you could raise funds through a home equity line of credit, a second mortgage or a cash-out refinance. Getting approval will require not only enough equity but also a good credit score and certain debt to income ratios. The types of options here include:

Good credit? Consider a personal loan.

Have you thought about an unsecured personal loan? Local credit unions, banks and even crowdfunding sites like Lending Club and Prosper are possible funding sources for a personal loan. The loan amounts are smaller than home equity options but if you don’t have equity in your home a personal loan could be an option. Doing a quick search, I’m currently seeing some lenders offering loans up to $25,000.

The drawback of a personal loan is that rates will be higher since the loan isn’t secured by an asset. The interest costs should be part of your calculation when looking to buy the first property and this type of loan would be a priority to pay off as soon as possible with cash flow.

How about a side hustle?

There are so many options to make extra income including driving for Uber/Lyft, freelancing through sites like PeoplePerHour, pet/house sitting, house cleaning -- the list goes on.

In the past, I’ve worked at a couple of part-time jobs in the evenings after my day job.  First, I did telemarketing for a small credit union helping grow their personal loan business. Telemarketing wasn’t really all that fun but letting people know about their options for personal loans was interesting and the hours fit well around my day job. I also worked in customer support and order fulfillment for an e-commerce site that sold school supplies. This was a fun job but just a bad side of town and some really late nights.

For more ideas on side hustles, check out some of the BiggerPockets blog posts here and here.

Downside…. Well… is there one to making extra income?

Painless saving?

When we were deep in debt I discovered the world of personal finance blogs. Have you ever checked out sites like The Simple Dollar or Mr. Money Mustache? These personal finance communities provide valuable education and tips on reducing expenses.

One tip that we learned from these communities is to automate finances and saving. The way this works is to set up an online-only savings account where you cannot quickly access funds. Then, either have your company payroll send a certain amount to this account with each paycheck or set up an automatic transfer from your main account at set intervals.

When your income is variable, another great tip is to set up individual accounts for major expenses like mortgage, insurance, car payment, etc. When you receive larger income, place the excess amount into these accounts. Then set up auto-deduction directly from these accounts for each creditor - mortgage, car, etc. This way, the payments will be made automatically and you’ll have those payments covered during the lean times.

Should you work with a partner?

Tricky question. We had a bad partnership experience (unrelated to our real estate investing business) that could have been a great partnership. The struggle was ultimately around business philosophy….we are more conservative and wanted to take things slowly and also make sure we had plenty of funds in reserve. Our partner wanted to aggressively expand and take profits out of the business right away. We ended up parting ways but had to get lawyers involved in order to recoup our original investment. Painful at the time but…..

What a great learning experience!

How do we approach a partnership now?  Define our expectations, walk away if it isn’t the right fit and when both parties are in agreement, work with a lawyer to draw up partnership contracts.

Here’s some tips if you are considering a partnership:

• Determine equity percentages. Who is bringing the most funding to the partnership? Who will be doing the most work? Who will be getting the mortgage. Answers to these questions will help you determine what is a fair split of equity.
• Agree on roles and responsibilities.
• Work with a lawyer to draw up partnership agreements which define roles, responsibilities, equity, contingency plans and exit strategies.

There we have it! Six ways to come up with the down payment for your first multi-family. Which ones have you used? Are there any others that we should add to the list?