What do you want to know before buying a rental?

Question

So I know I left this broad, but it was somewhat intentional.

I finally have the ball moving with real estate and it has always been my goal to take fix and flip profits, and any other profits from RE, to turn them into rentals. Living in Chicago I know I have to invest outside of the state and Cook county at a minimum.

So before buying a rental, or going back to what you wish you would have known when you started, what should you know?

Obviously market research and knowing what kind of rents you can get in the area and so forth are needed. They type of neighborhood and area of a city (this I know varies greatly between investor especially when it come to low income and where the line is drawn).

On the opposite side I know you need your team as well. PM company or no PM company you need your contacts that can fix the place when needed.

I guess I am just looking for a condensed version of what you wish you knew before you purchased your first property. I have read many book and been on here for years so I feel I have a pretty good idea but I feel like it helps eliminate the "cold feet" if someone tells you directly what you need or don't need. If I learned anything up until this point, it's to take action because things seem to typically come together as long as you are being smart. I guess the positive to me not knowing, and asking these questions now, is that I am 4 plus months out from being able to purchase a property so it will give me time to really know everything and eliminate fear.

Thanks for the help as always!

Nathan Emmert · Answer

To continue... to me, the biggest discrepancy is between duplexes and quads.  Most duplexes I see in my area are up/down with the down being in the basement.  Most quadplexes tend to be 2 stories with 2 units up, 2 on the main floor, and an unfinished basement.  For whatever reason, the appraisal values don't scale well with the income making for interesting investing choices.

Lets look at the 2 I bought.  The duplex was purchased for $72,000 and rents for $1,400 a month.  The quadplex was purchased for $124,000 and rents for $2,050 a month.  Based on % rent to purchase price, the Duplex looks better generating 1.94% rent versus 1.65%.  Assuming I put 25% down on both properties (didn't actually, but lets assume), the duplex would generate a higher CoC return.

But here comes the tricky part, the potential refi.  The duplex appraised at $86,000 so I bought at 84% of Appraised value.  Assuming I can get a loan for 75% of that value, I would be down to a $7,500 cash investment, greatly increasing my CoC return.  The quadplex appraised at $165,000 so I bought at 75% of appraised value.  With the same assumption on a refi loan, I'd be down to a $250 cash investment.  At this point, my CoC return from the quadplex is SIGNIFICANTLY higher than that of the duplex.  So which is the better deal?

I pay higher taxes and insurance on the quadplex, in line with the appraised values (something like 80% higher) but only receive 50% more rent.  I paid about 90% more for the quadplex to only receive 50% more rent... but with purchased equity, when I'm cash limited as I am, the quadplex looks like a gold mine...

Nathan Emmert · Answer

I'll answer this first but then switch it around a little if I could.

So lets assume both the SFH and Duplex are the same square footage on the main level and the duplex has the 2nd unit in the basement.  What I'm seeing from bank appraisals is that they will value them the same.  They tend to do valuations based on square footage type things and don't differentiate number of units.  A 2,000 square foot house is 2,000 square feet no matter if it's 1, 2, or 4 units.  So your LTV is going to be the same on both.  This same valuation would pass forward to taxes where I am, the taxes should be the same.

Now insurance will value them differently.  Insurance looks at the replacement cost of the building.  Having the finished basement in the duplex, the extra bathroom, the extra kitchen... those will all drive cost.  Your insurance premium will be higher on the Duplex then the SFH simply because the replacement cost is higher.

If you look at Freddie/Fannie... or even Homepath requirements, you'll also find the Downpayment requirements different.  Freddie/Fannie would do 20% on the SFH versus 25% on the Duplex, and I believe Homepath would do 10% on the SFH versus 25% on the Duplex.  From a CoC perspective, the SFH is going to be a much better deal.

From an appreciation stand point, SFH tend to appreciate faster.  Dollar for dollar, you'd rather be in SFH than multi families for appreciation.

The only downside to the SFH is when you have a vacancy.  If you try to keep your Debt servicing below 3:1 like most, even 1/2 a duplex being rented will still pay your mortgage.  But a vacancy in a SFH comes straight out of your pocket.  Would you rather have 10 $200 cash streams or 1 $2000 cash stream?  Some like the 2nd because they are chasing less checks... of course in the first situation if 1 person doesn't pay I'm still in pretty good shape where as the 2nd... ouch.

I think the issue you'll find is dollar for dollar, SFHs don't generate as much rent as Multifamilies.  The hypothetical you gave just isn't that realistic in my experience, the spread between the rent floor for a bare bones apartment and the cap for a rental home just aren't far enough apart.  I can generate $400 - 550 for 1 bedroom units... but 3 bed/1 bath homes are only going to generate $900.  Turn that house into two 2/1 units or a 2/1 and 1/1 and I'm going to generate $1,000 - $1,100.

Jeff Thompson · Answer

Nathan, Somehow I missed your response before, but I'm glad I found it! Thanks for the very thorough answer, that helps a lot in evaluating multi's.

This is of course referring to the flip into rental strategy: Ultimately the best ROI comes from a deal that has decent cashflow and all cash is pulled out at refinancing (ROI of infinity!).  Getting that percentage of ARV down should be the major focus.

Account Closed · Answer

In general what I've learned over 22 years of being a landlord in various markets it this:

1) Try to stick to newer properties.  They will need less rehab and cause you less stress.
2) In addition to learning the average rents for similar homes in the area it's important to know the DOM (days on market) to get that rent.  In a place with high DOM you need to account for higher vacancies which erodes your bottom line
3) Treat your good tenants like gold.  Charging slightly below average rent will lead to tenants calling less for repairs (they don't want to bother you because you may raise the rent.)  Furthermore, sending them a gift card at Christmas and taking time to meet them in person (even if you are using a property manager) sometimes means the difference between a long term tenant and a short term one.
4) In places where grow ops are prevalent make sure you visit the home every few months.

Those are some of the things that come to mind.  If I think of any more I'll let you know.

Mike Wolf

Matt DuSold · Answer

Nathan,

I have to echo what Michael said, that is an outstanding post! I appreciate the way you really broke it down. Thanks!

Michael X. · Answer

Now that was an excellent post Nathan.  I would like to see more posts like this on the Bigger Pockets forums.

Jeff Thompson · Answer

Can you elaborate on this Nathan?  I'm curious peoples experiences with how things work out as you scale up in units per property.  lets say a sfh at $50k  renting for $1000 vs a duplex that's also $50k for 2x $500. Both command 2% monthly, but which is likely to work out better?

Matt DuSold · Answer

Definitely Nathan, that is one of the main reasons that Chicago isn't very desirable!

Nathan Emmert · Answer

Matt... biggest things I'm looking for are property taxes, property insurance, and deferred maintenance.  If you keep your target area small enough, you'll have most of the rest covered property to property... but those three things can great skew your cash metrics.

For whatever reason, property taxes and insurance don't scale directly with rental amounts.  I pay about 80% more in both insurance and taxes on a quadplex that only generates about 25% more rent than a duplex... fortunately the bank seems to believe it's worth 90% more than the duplex so it was easy financing.

Matt DuSold · Answer

Wow Mike, thanks for the reply! Like Jon said welcome to BP! How are you finding the DOM for rentals?  Obviously it's easy to find on the MLS but as far as rentals goes, do you just watch them and keep a spreadsheet of when they go?

Ryan, you use 1% a month? According to most on the forum 2% is a good rule of thumb. I was looking at Indiana, Indy itself is kind of far away thats partly why I think I will go up to Milwaukee. Especially because I am up there for work several times a month anyway. Unless you can convince me otherwise... Haha

Thanks for the help guys!

What do you want to know before buying a rental?

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