Buying first multi-family property

[John Spaight]

Hi everyone,

I've read several books now on real estate investing. I'm setting up a Wyoming LLC and writing a business plan. I want to focus on properties in university towns and rent to young professionals, junior faculty, graduate students.

The property I have in mind is a solidly built, arts & crafts house with hardwood floors, a large lot, mature trees, and an excellent location near a major university. It is fully rented to medical students and residents. It generates rents of $88,800 / year ($7,400 / month).

The property is listed at $800,000. I calculate the operating expense ratios at around 39% (the property very well maintained - but maybe this is too low). The property should have positive cash flow of ~$12,300 / year (not counting any paper loss - but I calculated this at $1,300 for year one). 

The cash on cash return is 12%.

The homes in the area are expected to appreciate by 4% next year. They increased 7% last year. This property is on the higher end of local home costs though, so that makes me a bit nervous about re-sale. But I am going to pursue a buy, hold, and rent strategy for at least 5-7 years on this property. 

I've never done this before - so not sure if this is a good deal. I think it is - but would love to hear feedback from more experienced folks on this forum. 

Kind regards,

John

[Peter MacKercher]

@John Spaight

A few thoughts about your evaluation:

Never assume that the property will be fully rented 100% of the time -- you don't even want that since it's a sign that your rent is priced under market. For a top-tier property you'll likely be approaching the top of the market ask, depending on a few factors. Ask around for the average vacancy for your area, determine whether or not that's seasonal (based on semesters), and also make sure you're very familiar with the general rent ranges for comparable units.

The owners will have rent statements for the property, along with leases and records for the maintenance, and while you're free to ask for proof of all those there's no requirement for disclosure for that stuff without an accepted contract that stipulates as much; hopefully your agent (and hopefully you're working with an investment-friendly Realtor) has good contracts for that kind of disclosure. As my CPA says "In God we trust; all others we audit." People will of course present their property in the best light, so that 12% CoC might be less.

Inspections can also reveal a number of surprises, even if everything looks good-to-go on the surface. There might be a number of deferred maintenance items that could present upcoming capital expenses. Mature trees could also present a number of problems if you have a big storm come through, or add expenses for lawn maintenance during the fall. The general expectation is 50% of income goes to expenses, so 39% is probably too low. You'll want wiggle room there anyways to put cash in a sinking fund for unexpected/expected maintenance expenses.

Even with "expected appreciation", don't factor that into your purchase. If you're buying to make income, evaluate the property based on that metric alone. One strategy at a time. This is market-dependent, but you'll only be in a more secure position if you consider appreciation as icing on the cake rather than the whole meal -- especially for your first purchase.

As far as it being a good deal, well it might make money, it might not -- those questions really depend on your experience, how you manage, how you finance the deal, and your exit strategies. Look around at other deals and see what your market has to offer, especially since, as you said, this property is coming in at a premium price for the area which will make your exit more tricky.