what what you do? First purchase high interest rate East Bay, CA

Question

Hello All,

Id really appreciate some advice on a property that Im looking into purchasing for my first investment/home in the east bay, California. Price 1.3 mil. Its a multiunit with 3 houses on one lot. All are occupied with tenants. The gross rental income is 8050. I was initially planning on continuing to rent them out but the lender for that option with 15% down didn't like the fact that the homes were detached and that one of them was un-permitted. It is a place I would like to live and so I looked into additional loans add went the portfolio route, but no success thus far.  The rates just seem really high. I went from 3.62% 30 year fixed to a 6.25% 5 year ARM.  I just think that interest rate is a lot. It puts my PITI at 8262 monthly not including utilities (~ 240/month) and then saving for cap ex, vacancy, and the repairs necessary to bring the un-permitted unit up to code. Also lawyer fees to deal with the move-in and subsequent payout (~ $15000) It's in an up and coming area though I do think the rents are close to the max for the neighborhood currently. Certainly the place will appreciate, but Im concerned about waiting for that. The current loan requires 15% down and is at 6.25% 5 year ARM.

Thanks!

Kam T. · Answer

You also may not be able to make the unit legal, at all. There's more to it than just the building code, including allowed zoning density, required parking, required open space, etc. that you would need to satisfy that may make it impossible to legalize the unit in its current configuration. Also consider the potential financial liability (and insurability) if something went wrong due to the unpermitted work. Many insurance policies won't write a policy or cover a claim arising from unpermitted work. So I would advise against paying for a triplex that's really a duplex. Deals are like busses: there's always another one on the way. No need to chase a marginal deal.

Brian Garlington · Answer

@Bunmi Ajose

Bunmi,....there's a local lender that I work with as well. I own investment property here in the East Bay so I know the lay of the land. In a nutshell, you should not be buying a "3 unit investment" that when fully rented out does NOT come close to meeting the 1% rule.  You will be cashflow negative from Day 1 on this and I would NOT be betting on appreciation in the Bay Area at this moment. If you want more info let me know.

Jaysen Medhurst · Answer

With those rates, that price-to-rent ratio, and one house being un-permitted, I would run far and fast from this deal, @Bunmi Ajose

Dan H. · Answer

First at that rent ratio my conservative pro forma that allocates more for maintenance and cap ex than those suggesting a different market (meaning a conservative pro forma) would show that as cash flow positive with a conventional 30 year at 80% LTV.

Second, the ADU regulations allow, for the next 5 years, converting an existing non permitted unit to ADU/JADU by only addressing heath and safety codes.  There has never been a better time to convert unpermitted units to permitted ADU/JADU.

Unfortunately, without the conventional loan this will be very cash negative unless your LTV is low. You need to work the financing to make this viable.

Good luck

Matt K. · Answer

Doesn't oak have mini lot program so you could turn them to condos ...

Carlos Ptriawan · Answer

Actually it's great idea if you live in one of the unit. Almost living for free. PS: You could rent out the illegal one with Airbnb or Airbnb Arbitrage. I guess that's in Oakland.

Bunmi Ajose · Answer

K.T. -- very good point. Ive tried to follow-up with the city regarding this but I haven't gotten very far yet. Certainly Im willing to do the work to get it permitted. The neighborhood does have similar units like this, but for all I know they could be un-permitted too. Carlos - good points. I really doubt an economic collapse like 2008 unless there is an associated geopolitical collapse. I certainly don't expect Bay Area prices to rise much more. I think they will stabilize or fall only slightly. My reasoning is based on the fact that there's such a large population here that is just waiting to buy. Even if prices fall slightly people on the sidelines will start buying.  Thats why I think a decline will not affect the Bay Area greatly.

Carlos Ptriawan · Answer

$433k/unit in east bay is equal to a 3-4% cap rate. This is a normal fourplex price in south bay/east bay. I suggest if you go ahead with this deal is to build another unit (ADU) or do some value add. It wouldn't be easy. Although whoever is selling you the MF, he/she will be very happy :-)Your biggest risk is actually not from the low rent-to-value ratio but if there's a sudden economic crash or meltdown like in 2008, where bay area house price is heavily reduced and end up at foreclosure. Also, don't expect Bay area price to still rise rapidly, in fact, higher price homes already having lower bid and the rent can't catch the price. This is a very simple mathematic formula.

Derek Smith · Answer

@Bunmi Ajose

The interest rate is the least of your problems. I would suggest going out of state.  Also, California tenant/landlord laws are awful for the landlord.

This would not be my choice for a first deal.

Best wishes either way. Feel free to reach out if you have anything questions, etc.

Bunmi Ajose · Answer

Hello Matt and Brain,

Matt- thanks I'll send you a message

Brian- thanks I'll send you a message too. when fully rented its at about .77 at least at the initial rate I had. That was the best I had seen for the east bay at least thus far and then with the base allowed rent increase I figured I would get there, but yes it doesnt meet it now... Im certainly interested in you thoughts regarding appreciation in the Bay Area. while I don't think it will be equal to what it was I think it will keep pace with inflation... is that not correct

what what you do? First purchase high interest rate East Bay, CA

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