First time under Contract - Is this a good investment?

Question

Hello, I live in Dallas TX and have been eager to get into the investing game. I am currently under contract for the first time on a Duplex in Lower Greenville. The location is the BEST - three blocks away from all the popular bars and restaurants. The street the duplex is on is sprinkled with mainly single family homes in the range of 650K-1.1M. Very safe neighborhood and would be easily rented. Also, the lot is HUGE for this area. Looks like lots alone in that area are going for around 400-500K. And you know what they say... LOCATION LOCATION LOCATION :)

I have the duplex under contract for 427K. Each side is 2 bed 1 bath, 1100 Sq ft.The plan is to use an FHA loan and live on one side. However, my biggest concern is the age of the home. it was built in 1925. Right now, one of the sides is renting for 1750 and the other for 1250, so bringing in a total of $3000 in rent per month.

According to my lender, with only 3% down I am looking at monthly payments of 3400 total. So my concern is, if I were to move out of the duplex after a year and rents did not change, I would be down $400 a month. However, I do believe I could get increase rents fairly easily with a few upgrades - maybe even as is.

Another thing to note is that by moving in to this duplex, I will be saving 400 dollars a month in rent as is, so seems smart for that angle.

Is it smart to buy a duplex with an FHA loan if you feel you may just be breaking even on mortgage payments down the road? In my opinion, other people would still be paying off my mortgage over time so still seems like a good idea.

Keep in mind, I've had my eye on the Dallas market for Duplexes for awhile, and this is the only one I've seen in an area where I would actually want to live that I can afford.

Thank you in advance!

Katie

Steve K. · Answer

As a pure investment, it's not good (due to the negative cash flow factor). However it's not a pure investment, it's your primary residence. If it was a pure investment, you'd be putting at least 25% down and wouldn't have PMI which would probably change the cashflow to slightly positive. So you might take a look at those numbers and evaluate the deal that way.

I'd say whether or not it's a wise move for you personally depends on a few things: how does it compare to your current living situation/how badly do you want to live there and how long do you plan to live there (whenever you're talking about your primary residence, there's a "soft value" to consider)? How confident are you on appreciation and rent increases over the next few years? What condition is the property in? How capitalized are you (what is your ability to absorb big expenses if/when you have them like a major capex event)? How handy are you? Considering the property is nearly 100 years old, it's possible that maintenance and capex will be quite expensive. Does it have "good bones"? For example if it's wood frame, plaster and lathe, original cast iron plumbing, dated electrical... hard pass, that will be a major money pit. However if it's a solid brick construction with updated plumbing, HVAC, electrical, newer water heaters, etc. then the age wouldn't scare me. As Chris said, with vacancy, maintenance, repairs and capex factored in you will be negative quite a bit on this property with only 3% down as it is even when things are going well. If it turns out to be a total money pit from a physical obsolescence standpoint, this could be a major drain on your finances. Can you afford to keep paying for this property and what is the strategy to eventually make money from it?

If you're stretching your finances to make this happen, such as by using most of your savings for the down payment, I definitely wouldn't do it. I would only do it if you have some reserves, which you will need, and a sound plan to achieve a return from the property besides principle pay down and depreciation tax benefits alone. If you can make inexpensive improvements and raise rents significantly, put more down to have lower payments and avoid paying PMI, or can force appreciation by adding value/put some sweat equity in and then refinance in a year to get your cash out, then it starts to make sense. Maybe you can increase gross rents by renting by the room, having a roommate, or using the other side as a short term rental? Or decrease operating expenses such as by shifting utilities to tenants? You said the lot is huge so maybe there's a way to use that extra land to make more money (add a unit, add storage sheds/parking spaces you can rent, create a garden/gazebo/outside work space that will enable you to raise rents, just spit balling here)... I would want to find a way to make money from the property personally. As it is, it sounds like you're paying for the location which is essentially banking on appreciation and the ability to raise rents. That's not a bad strategy if you are confident in the location and make plenty of money in your day job or have money to support being cash flow negative for a while until the value goes up. But if you're looking for immediate income from the property, this isn't the deal for you unless you have a strategy to increase revenue/decrease expenses quickly.

The fact that lots nearby are selling for more than the property is a good sign because it speaks to the quality of the location, but it may also be a red flag about the condition of the building if the land would be worth more without the building on it. It also doesn't really help you out unless you're planning to scrape it and redevelop (or you have a developer interested in doing so who you could sell it to for more than you are paying). Keep in mind it can cost quite a bit to demo a building. Definitely check the zoning and see what kind of redevelopment would be possible, as that may help you on your exit, but you're talking about a totally different strategy there which doesn't really do anything for you presently unless you flip it to a developer. If it's zoned for a mid-rise 5 story building and the surrounding area is booming, then yeah maybe there's some redevelopment potential there that is valuable, but it's unlikely the seller didn't realize that and bake it into the price. You'll have carrying costs throughout your ownership term to factor in unless you can come up with a way to achieve some positive cash flow. Good luck!

Chris Seveney · Answer

@Kathleen McCabe

I would still consider it a cash suck but need to look at numbers closer.
once you move out it’s an investment. You could be paying $ out of pocket which yes is paying down principal but what is your return vs risk.
could the money be used better elsewhere and make a better return with lower risk.?

I invest primarily in notes, so for the $15,000 you are putting down you could get 8-10% return which would be $100/month cash flow without any more out of pocket. That is just an example but it’s what fits your criteria. For me this deal would not work as it is not making really any money it’s covering only a part of your expenses.

Kathleen McCabe · Answer

Hi @Kenneth McKeown, Thank you so much for your reply and its so nice to hear the perspective of an investor in the Dallas area. 100% what peaks my interest most in this deal is that is in such a great location. I am in my late 20s, and I still want to be in a central area that is walking distance to bars and restaurants. Right now I rent in a pricey apt in uptown, and I just cant imagine throwing money away like this for another year. This is the first duplex I have seen in an area I would LOVE to live that I can afford. Any other duplexs in the 400s appear to be in areas like Arlington where I could never get enough rent to make up for the payments let alone even want to live there personally at this point in time.

The good news is too that my estimate for a monthly payment of 3400 seems high. I got a 2nd opinion from a lender who is an investor himself and his estimate was 2900 a month. So, AS IS with rent it is cash flowing 100 dollars total. Not much, but like I mentioned there is definite room for improvement and I feel I could easily bump the rents up with minimal improvement.

However, the new curve ball is that based on my inspection there are most likely foundation issues... so using an FHA loan may not be possible. ugh... I just made a new post asking for guidance with that and hoping the BP community knows a way to make it work.

Thanks for your help!!

Best,

Katie

Kathleen McCabe · Answer

@Steve K. Thank you so much for your reply! You make a lot of great points. There current rents are definitely below market value, so I do believe there is some wiggle room there with minimal improvements to the property needed. I feel like because the neighborhood is so popular so I do not anticipate vacancy being an issue in fact one of the tenants has been in the place for seven years and wants to stay! (hence the low rent though...) According to the the neighbors, he's a really great guy and quiet. As for appreciation, Its hard to tell? The neighborhood is already built out, but its so popular that I cannot picture it going down at least. The lot values sell between 400-500K. Right now the land is zoned for SF or duplex from what I know, but it would be interesting to see if it would be possible to build another unit in the backyard... Because for FHA I only have to put 3% down, I do have financial wiggle room to make improvements. However, I would not be comfortable putting 25% down, if that makes sense. I do have a very solid job at a large tech company that allows me to float additional maintenance if needed down the road.

Thanks again!

Kenneth McKeown · Answer

@Kathleen McCabe I'm very familiar with essentially all the MFH areas in the DFW metro-plex and this it not a BAD price for LG. I'm personally building in a nearby community myself. You're going to get a lot of peoples responses saying this is a horrible purchase - which it in a sense is. It's not really a true 'investment' but rather a sacrifice to some extent in your position but not really an investment. Now I say that lightly as I believe all homes should be called an investment because at least your money is going somewhere.

Now - when it comes to downtown, you're going to have to accept that positive cash flow is impossible. It's probably impossible in any downtown location of any large metro-plex. As you mentioned - my lot itself before we tore down the old house was mid 400k. However, you also have to consider build cost - so lot value isn't a big sticking point. Your taxes are always going to be high here however and with a 100 year old home - maintenance and cap-ex can kill you. However, and I tell everyone I help that wants to be near downtown, you're not sacrificing as much as you would be in a low income area of Arlington - so be aware of that. You're purchasing likely in an A class neighborhood downtown so the numbers are never going to "work". BUT - as you mentioned before, you're saving money from renting but that doesn't account for vacancy or any other costs.

So without reading all the other replies since none of them are local and know our market - I would ask yourself this... are you wanting to pay for the location? If so - you won't be buying a positive cash flow property. If you aren't concerned about location - then I'd strongly suggest you look elsewhere.

Kathleen McCabe · Answer

@Chris Seveney Thank you! I really appreciate it. That makes complete sense. The last factor though is the lot value, based on comps, the lots in the area alone go for 469K. I have it under contract for 427K... Lot value is not really a factor I've heard talked about much, so I am not sure how much weight that should have in my decision.

Kathleen McCabe · Answer

@Chris Seveney - Thank you for your reply! I totally understand what you are saying. I could live there probably two years to save money on rent but can't see myself there long term, so I would definitely have to make improvements to increase rent so that it breaks even if I were to move out.

Is it really a cash suck if the money is still going towards a mortgage? Also, I feel like holding onto the land is actually the most valuable part of this deal, not even the duplex itself.

But also, at what point am I just talking myself into a deal? I feel like I have the angel and devil on my shoulder in this situation.

Thanks!

Katie

Kathleen McCabe · Answer

@Avery Carl I believe there is definitely room for a few improvements. The side going for 1250 could probably go for at least 1400 without any touch ups. The bathroom is very basic / simple as well as the kitchen, so could perhaps modernize those a bit.

Chris Seveney · Answer

@Kathleen McCabe

What you are not taking into consideration is other expenses like capex and maintenance.

You are cash flow negative just based on the mortgage/taxes/insurance. You will also have vacancy, capex etc which should run you between $600-$1000 per month, so you are looking at a very large negative

If you want to live there to save money that is one thing, but to move out and use as a rental later on will be a huge cash suck on you.

Avery Carl · Answer

My question is how much room is there for improvement in those rental numbers? Can you get more if you do a few updates?

First time under Contract - Is this a good investment?

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