2 potential deals - which one?

Question

Since the beginning of the year I've been moving forward with trying to get into this.  I've looked at targeting my focus on a long term buy and hold rental strategy.  So I contacted a broker I've done other business with who also has some rentals of her own.  I started looking at a few places with her that have been on the market for quite a while.  I have two prospects that are priced in a decent range for what they are and have potential seller financing.

First, is a small 1000 sq ft single family built in the mid 1800s.  It's been vacant for a couple years and in desperate need of updates.  In fact, it's going to be close to a complete rehab in order to bring it up to a livable state - not to mention up to code.  I've estimated it will be around 8000 - 10000 for updates.  Anticipated retal income, as it currently stands is approximately $700 in this market - per my broker.  After renovations and updates, we figure it will be between $800 and $850 depending on the finished product.  It's currently 2 bed / 1 bath.

The second one is a turn of the century 3 unit residence that's currently fully rented and generating around $1200 / month.  It needs some major help.  Foundation, plumbing, electrical, heating, etc. as well as some cosmetic updates.  Based on my estimates from a cursory walkthrough, I would budget no less than $20000 to stabilize and update.  I would figure on removing at least two of the tenants in order to fix the back two apartments (month-2-month with no lease, so shouldn't be an issue).

So, I'm jumping in, but I'm hesitant to bite off more than I can chew the first time out.  I'm leaning towards the first house since even though there's a lot of potential work, it's a little more straight forward due to it a) currently being vacant and b) being very simple in its construction.  The multi-family place seems like a nightmare to me, but it's rented and currently generating income.  With investment it could generate more, I'm sure and also bring in a better quality of tenant.

I understand there have been very few details here, but given the two deals, which seems better on its face?  Is it smarter to go with the multi-family due to the potential for more income even at a higher acquisition cost for purchase plus rehab, or is the single family a better starter?

Thanks

Brad B. · Answer

@J Scott - That's probably my biggest source of fear on this particular place.  What's visible isn't horrible and hasn't scared me away; it's what's not.  Unfortunately, without pulling down plaster, it's hard to tell.  When I did the last walkthrough, the basement was dry and very solid with no signs of major issues.  The floors were solid with no signs of rot or other bad things going on.  The roof was just torn off and redone about 3 years ago.  But it's always the stuff you don't know about.

On the flip side, I'm trying to be pragmatic about it as well.  This being my first, there's a chance I will hate everything to do with it.  In which case, even if I double over my estimate and invest $20k on rehab, I'll hopefully be able to recoup some or all of what I owe on the note in the event I decide to get out.  I'll be out a chunk of change but I'll have a lesson learned in what not to do under my belt.

Luckily, I haven't done anything yet as I'm still putting all my ducks in a row, so I have opportunity to revise and readjust accordingly.

This brings up another question.  Everyone has pretty much told me my estimate is too low on $10,000 to update 1000sq ft.  Is there a rule of thumb that you guys tend to use to provide a benchmark average?  Knowing this is rental grade (i.e., not running hard wood floors and granite coutertops, etc.).

Thanks

Samuel S. · Answer

I agree with Jason here. I just fixed my 1000 sqft townhouse and also went little off with my estimate, but there are things that you might consider changing or re-doing after you start the work on that property. In my case I decided to put new, HVAC system and cage over my AC unit instead of used one, and few more. ( Thinking kicks in - "it's better to fix it all while it's vacant and contractors already there). Given the fact, that the place is 150 years old I would definitely expect unexpected. Did you check Buffalo for rentals? Friend of mine just relocated to ATL from there and he owns 22 rentals in Buffalo, NY. He told me he was looking to sell some of them to invest more in ATL area. All of his properties are rented and are in 25k price range. PM if you interested

J Scott · Answer

Regarding the budget on the SFR, listen to what others here have suggested.  $10K won't go very far, and for a house that was built 150 years ago, opening up walls is going to be opening up a can of worms -- you could end up with a LOT more work than you expect.

Even if you can get that one into rental shape for $10K, what kind of deferred maintenance are you still putting off?  If none, it sounds like a good deal, but be certain the numbers work.

Brad B. · Answer

@Mark - Thanks for the response.  This is my first investment of this type, but I have the benefit of having been on the periphery of construction and contracting for most of my life.  I'm not even remotely that guy, but luckily I have some good and knowledgeable friends and family to guide me.

That said, I'm in the process of reworking my budgets and estimates now.  10k seemed to work for me, but if experienced people are saying it's too low, then I'm going to do the due diligence.

@Jon - The bath is mostly cosmetic.  The fixtures are older, but still very serviceable.  The biggest problem is that someone thought it was a good idea to make it hospital green on the walls.  The kitchen has some older cabinets but they are still strong and good after a strip and repaint.  The biggest thing I'm seeing is a new counter top.

It has a newer (5 years or so) stove, new hot water tank, newer washer and dryer in the deal.

Jon Holdman · Answer

The SFR seems like a decent deal, assuming you're all in at a reasonable discount to comparable properties and that there is rental demand.  The electrical estimate seems reasonable.  Always get at least three separate bids for significant work.  I still think your budget is low.  What's up with the kitchen and bath?  Are you touching those?

Mark Anderson · Answer

I think Jon's math is pretty good.  I too am concerned about your rehab budget on the SFR.  It seems low to me.  I'm assuming this will be your first rehab.  Did you get quotes yet for the rest of the work (other than the electrical)?  One of the hardest parts about doing your first rehab is you probably don't have relationships built with good quality contractors.

None of this is meant to scare you.  The best way to learn is by doing and the only way to build relationships with contractors is by actually giving them work to do.

If you know a more experienced rehabber in your area, buy him/her lunch, walk them through your house and get their input to see if your budget and scope of work are accurate.

Brad B. · Answer

Thanks for the reply Jon.

I'm looking to get into the single family for about $27k with an out of pocket of $5k plus closing costs.

I think rehab is a term I mis-used.  Basically I'm looking at new electric service with new boxes, switches, baseboards and smoke detectors (quoted $1500, counting on $2000), fix some of the walls and windows, open up some odd wall choices (non-load bearing), and so some  cosmetic work.  In a later phase, the plan is to do further upgrades to cover some ugly.  The exterior is solid, but plain and ugly.

The triple is holding firm at about $47k.  Rents are at or around the $400 per unit mark.

I'm not real wild about the triple but I didn't want my own prejudices in the way of determining the best deal given the basic situation.  I've tried to go into this looking at properties in terms of potential and cash, but the triple kind of overwhelmed me in thinking about what it needs.

Thanks for confirming what I think I already knew.

Thats the tough part about starting out.  With this much cash on the line, I don't want to make a huge misstep this early.  I think if I had some experience under my belt, the triple wouldn't bother me as much, but right now there's just too much stuff I don't know to jump into something like that as deal number 1.

Jon Holdman · Answer

What's the price on the first one?  Let me see if I can say what I would pay, and you can say if its in the right ballpark.  Assume you fix it up and get $800 a month.  I think you want to be all-in around $50K.  With 25% down that's $12,500 invested, a $225 a month payment (6%, 30 years).  That give you cash flow of $175 a month or $2100 a year, which is a 17% cash on cash return.

If you pay all cash, your cash flow is $4,800 a year, but your cash-on-cash drops to 9.6%

No way can you do a complete rehab of 1000 sq.ft. for $10,000.  I assume you mean plumbing and electric upgrades and basic finishes.  I'd put that more like $20K.  I spent about $17K on a similar rehab a couple of years ago.  Full gut in the kitchen, new plumbing and electric in kitchen and utility, new HW heater, new furnace, paint and carpet in the rest of the house, cosmetic fixup in the bath.  That's with licensed electricians and plumbers and a GC, but me doing a lot of the grunt work.  So, subtract off $20K and I'd pay $30K for this one.

If that triple is renting for $400 a unit, I woulnd't want to be into it for more than $20K a unit, and really more like $17,500.  That's $52,500, less your $20< fixup makes it worth $32,500.

If you mean $1200 a unit, then its worth quite a bit more.

Given those two choices, I'd buy the SFR.  If you decide this is not for you, its easier to sell.  I'd much rather deal with one tenant for $800 than three for $1200.