What to buy and where? Considering a 2 family in Brooklyn

Question

Hello all,

This is my 1st post. I have been lurking around for months reading all of the excellent information on the site. Its really fantastic a community like this exist. I am 36 and was fortunate enough to buy a Bed Stuy Brooklyn 3 family brownstone, 3 years ago. I purchased a shell for 860k and did a gut reno on it. It cost me roughly $1,000 to live here including all utilities. I have roughly 1M in equity in the home and considering putting 25% of it to good use. I was kicking around tapping into a Equity line that has a fixed rate option and using that money to put a down payment on another property. I am a mortgage banker and have good accessibility to funds and  decent resources to find properties.

I have read enough on the forum to figure out NYC is really an appreciation play. I have also been temped to invest into the Baltimore MD market and just recently made a solid contact there. I know of an off market 2 family deal in Flatbush. I don't know quite enough about the property yet such as exact location, condition, etc, but should know more info in the next couple of days. There is no innovatory in Flatbush whatsoever and agents that I know and work with seem to consider it a solid investment with good upside potential. I have read a lot of post from Investor Lew and Adam who are also here in Brooklyn.

Few questions to start I would like the communities input on-

1. Would you consider using a HELOC or fixed rate 2nd mortgage a safe play? I would still have plenty of equity left.

2. If so, and I allowed myself a 200-250k budget to play with, what would you buy? If I buy this 2 family in Flatbush, I highly doubt it will turn a positive cashflow. I think I would break even at best but do think there is a lot of upside for appreciation in the neighborhood with values skyrocketing everywhere else.

3. Buy a few SFR in MD that would cash flow

4. Look to purchase Multi Families out of state?

5. Look to purchase an apartment building out of state and put 20% down?

Appreciate your feedback. Thank you in advance,

Jay

Llewelyn A. · Answer

@Justin S.

@Alexander Monnin

Thanks for mentioning me Justin and Alex.

Justin, you have fulfilled my first requirement in Investing.

If you plan on living for a long time in a very high quality City in a location which is desirable and will continue to be desirable, you MUST buy your primary residence there or you may become priced out eventually.

That has happened to a LOT of my friends and relatives.

Now you can live in Brooklyn without the fear of having to move because you cannot any longer afford the rent.

The next step in your strategy depends on what you need.

If you were like me when I started out, house hacking in Brooklyn 20 years ago, but with a very good Salary, there was no point in making anymore cash flow than my professional job.

The great thing about Appreciation plays is that you don't pay Taxes on the Capital Gains until you Sell.

Even then you can do a 1031 Exchange.

If you can keep the properties until you die, then you never pay taxes (but your Estate might).

There is even a really great Tax Loophole which will allow your children to inherit your Property Tax Free and then step up the basis! I'm sure CPAs on BP can comment on that if they would like.

Anyway, there was no point on me pursuing extra cash flow which would be Taxed immediately. It was better that I not get taxed and reinvest any extra money into more Real Estate.

The funny part is that because NYC Rents moved up tremendously in the last 20 years, for instance, a 550 sqft apt I rented in the year 2000 was $500 per month. That same apt is now $1,850 per month, my cash flow has moved up incredibly well too.

I shouldn't say it's funny because when that same property moved up from $140k in the year 2000 to $1 Million today, it does so because of the increase in Rentals as a major factor.

I'm sure this was the same for you in your Bed-Stuy property you bought 3 years ago. I have bought two properties in Bed-Stuy in 2014 and 2015. Both have done incredibly well and the cash flow is crazy.

I'm not going to beat a dead horse.

So, the next step depends on whether or not you need the cash flow today and don't want to wait until the Rents appreciate.

If you don't want to wait, then seek out cash flow now properties.

If you were like me, then continue to buy in these high appreciating areas and wait for the Cash Flow.

Another benefit that is generally overlooked is the Mortgage Balance reduction when it is entirely paid by the tenants.

If you financed the building with a $1 Million fixed rate Mortgage and the tenants paid it down in 30 years to zero, you effectively made $1 Million in 30 years. That works out to be $33,333 per year. Buy 10 of these buildings and you will make $333,333 per year.

Again, the funny thing is that these properties can break even in cash flow and never appreciate and you can still make a lot of money on just Mortgage reduction.

I think these kinds of strategies are generally overlooked because there are a vast amount more Investors that need cash flow NOW than there are Investors like me that could wait.

Another reason why I think that expanding your Career to get more seed money is a great and very safe Strategy.

I know there is a lot of others that believe investors should get out of their day jobs to be full time RE Investors. I don't believe that at all. It's too risky until you finally have stability and consistent cash flow or become independently wealthy in your Investments.

Why throw away what you have learned instead of being the best at what you do for work? Then in the meantime, grow your Investments so that you can have the choice to switch Careers once your Investments can support your lifestyle.

When I got started, it only took me 6 years to be financially free. From what you have mentioned above, it looks like you will follow in the same footsteps!

Alexander Monnin · Answer

@Justin S. I vote for staying in Brooklyn.  You've already had success there.  Also, could you point me to Adam's profile, If he is anything like Llew, I would love to learn from him.

Justin S. · Answer

Hey Adam K.,

Thanks a lot! I am currently collecting 5k per month in rental income. I do not have a pension so I foresee holding onto my Bed Stuy property long term. I also try to max out my 401k every year. My home is located in the Stuy Heights historic district.

I am not looking to quit my job and cash flow is not currently more important then finding high appreciating properties. I am getting married next month and do not have any children but that is on the horizon. I am a little concerned about this rising rate environment we are in, so any money I take out of my current property I would look to have a fixed rate.

I like your idea of reinvesting in Brooklyn but I don't know how likely it is I would be able to find 2 3 unit properties in Crown heights. That would be amazing though. I have any realtor I know keeping me informed of any opportunities. As you know, this market is ultra competitive, so finding properties isn't easy. Even if you have the connections!

I absolutely would not have 1M in equity had I purchased out of state. Its funny, when I was purchasing in Bed Stuy 3 years ago, and buying a shell on top of it, everyone told me I was nuts and it was a horrible idea.

Thanks again for your input and contribution Adam. I appreciate it.

Llewelyn A.,

Awesome idea on doing some homework on Franchises. Ironically, we do not have any in Bed Stuy but we have plenty of entrepreneurial coffee shops. It really is the true indicator of progress in a neighborhood. I have also been reading your book recommendation. You had mentioned it on another thread and I already had purchased it. Your insight and wisdom is greatly appreciate and I too, would be interested in taking one of your classes.

So based on everything you said and I have absorbed, in this current marketplace, you would even purchase something that had a current negative cashflow if you saw good future potential gains? How do you draw the line in the sand and come up with what that limit would be? I agree, 90% of investors would not make that move but even prior to you and I interacting, I shared a similar mindset.

Adam K. · Answer

@Justin S.

Congrats on the Bed-Stuy property. You certainly got in at the right time. With regards to your next step and the questions in your post, there are a few factors about your specific situation to consider. For example -- how much rent are you currently generating at your property? If your rents are maxed out, selling it becomes a more realistic option (I probably wouldn't, but I do believe some parts of Bed-Stuy are starting to level out - really depends on the specific location).

Are you looking to quit your job (making cash flow more important)? If not, I believe you're better off continuing to invest in NYC and also it allows you to take on more risk. And as @Llewelyn A. points out, if you have a job that supports you, trading appreciation for cash flow results in a bigger tax burden now. Also, keeping a W-2 job makes you a much more attractive borrower, but you're a mortgage banker so you probably have connections the rest of us don't.

Are you married / do you have kids? Again, this informs your risk profile. If you are single and steadily employed, I'd say you can afford to take out a lot more than 25% of the equity.

So here are my general thoughts:

1) Unless you have a reason to believe your home's value will decrease, it's a safe play. I believe that any equity that is just sitting in a property and is not delivering a return on its own is being wasted. I am always trying to pull equity out of properties to reinvest if possible. Perhaps that's too aggressive but I have a day job to fall back on and also live in a place I own so my expenses are low.

2) To put in succinctly, I'd buy the most units possible in a neighborhood with potential. I don't know your debt/equity ratio and again, you may have access to loan products we don't, but if there's no max to your loan size, I'd try to take out 500K of your equity --- that can buy $2MM worth of properties which could be 2 3-units in east Crown Heights or Flatbush or a 8 unit in Sunset Park or something comparable. Flatbush is a huge neighborhood and some areas are prime (near subways, close to nicer neighborhoods) and some areas are not (no subway access, nowhere close to parks, etc).

3/4/5) Out of state limits your appreciation potential and puts you at the mercy of PMs and you're never going to know the market as well as you know your home market.

I also see what you're saying about scaling, but with properties, quality beats quantity. If you're worried about cash flow, think about this -- do you think that had you bought SFRs in Maryland 3 years ago you'd be sitting on $1MM in equity right now?

@Laura Moreno Brownsville has a long time horizon. It'll probably develop eventually but it's a ways off, unless we're taking about the area that immediately borders Crown Heights/Bed Stuy. But the further SE you go, the worse it gets.

Justin S. · Answer

@Adam K.

@Llewelyn A.

Llewelyn A. · Answer

@Laura Moreno

"how can you predict the Selling Price?"

Here is a Quote from one of my earlier posts:

----------------------

I know Investors tend to think of only in terms of Today and find it very unpredictable to think of tomorrow, but please remember that even Squirrels think about tomorrow as they put away their Nuts for the Winter. If they didn't do that, they would starve when winter arrives.

The Future is VERY important.

Another analogy I like to use is to Drive your Investments like an Investment Vehicle.

When you look at past Data such as previous Sales, you are looking at the Rear View Mirror of your Investment Vehicle.

When you look at current data, such as the current Rents and Expenses to calculate your Current cashflows or your Cash on Cash Return, you are looking at the side view... watching the action go by as it is occurring.

When you look through the Windshield of your Investment Vehicle, you are looking at the road ahead.... seeing the path that it is taking you... and all the obstacles in the way.

You are less likely to CRASH your investment vehicle by focusing on looking through your Windshield than remaining fixated on the Rear View Mirror or the Side Windows.

If the bridge is out and you fail to see the bright red warning signs..... if your eyes are not looking straight through that windshield........ you will Drive your Investment Vehicle into the abyss down below.

So please..... Drive your Investment Vehicle like you drive your Car..... by MOSTLY focusing on looking through the windshield and occasionally checking your side views and rear view mirrors.

----------------------

I'd like to give a very fundamental understanding on Price Prediction.

There will be several factors which will contribute towards Future Price Appreciation. Examples:

- New Subway Line such as the new East Side Access East Side Access

- Large Developments like the new World Trade Centers and the Barclay Center

- Past Data (which should not necessarily be a prediction of the future, however)

- Jobs and Wages moving up

- etc.

Nationally, there is a natural Appreciation Rate for Housing. It's around 4% to 5%. However, that's a National Number. Places like SF and NYC are quite different. However, remember that some neighborhoods will have it's different dynamics of Appreciation.

In most of my Investment Neighborhoods, I've achieved around 9% to 13% Appreciation Rates.

When you are using 80% Loan to Value Mortgages, the ROI is accelerated on these Appreciation Rates.

Think of it this way, in 1999, I purchased a building for $140k. Today, it is worth around $1 Million.

If we work backward, we will be able to calculate the Appreciation Rate using the following Excel Table:

In Cell B1, we calculated the Appreciation Rate for this property at 11.54% and the Chart Below it merely demonstrates that using this Apprec. Rate, it achieves a Value of $1 Million in 2017 from a price of $140k in 1999.

HOWEVER, this is just the Appreciation Rate. This is not the Return on Investment (ROI).

You cannot use the $140k as the Investment. The Investment is calculated in the D to E columns, Rows 1 to 8.

Because I used a Mortgage of $119k and only Invested $28k including Closing Costs, I am able to generate extremely high ROIs.

If this property was kept by me (It's not, this is Marshall's property now and I'm just using it as a demo for this example), and I sold it today, the Sales Proceeds would be $837k as calculated in the G to H Columns.

I Summarized a "Simple Interest Calc" plus a Rate of Return Calc.

Yes, this property returned a 2889% total ROI, an equivalent of a 161% ROI/YR over 18 Years and the Equivalent of a 21% Rate of Return (RoR).

There are some things that weren't added to the Calculations such as Renovations (around $50k) and Positive Cash Flows (but it was Negative Cash Flow the 1st 3 years), rent Increases, Expense Increases, etc.

We would need a much more comprehensive Spreadsheet to do all the calculations appropriately.

Needless to say, this is a very BASIC analysis of a REAL purchase that I made. The only difference is that I sold this to one of my Students in 2013, and reinvested the Proceeds to a much more lucrative Bed-Stuy property. My ROI would actually be higher than calculated above if I take everything into account.

To a lot of Bigger Pocket Members, this kind of Calculations is very foreign to them. In fact, these kinds of Calculations is Foreign even to the people who have read a lot of books and taken Guru classes.

There are real reasons why sophisticated Math is not a part of Best Selling Investment Books. The Majority of Investors don't have the Math literacy to really understand these kinds of Financial Calculations. Therefore, the books which really brings sophisticated calculations to the reader, like this book: What Every Real Estate Investor Needs to Know About Cash Flow

will NEVER be on a best seller's list.

To come full circle, the above is a hindsight analysis. It's done to show the Reader how these calculations work.

We would need to make some conservative assumptions based on the Economics of the Property that is targeted and then work it forward into the future. I've merely changed a few numbers around and converted the Spreadsheet to a 17 year pro-Forma Business Plan:

We made the assumption of a $1 Million Purchase, Investment of $200k, Appreciation Rate of 5% (very low for this Property, however), and kept all the formulas the same.

We can see it's a profit of $1.497 Million but it's only a 749% Total Return in 18 years for a simple Rate of 42% Annualized and a RoR of 13%. This is still a pretty good Investment and we were Conservative on the Appreciation Rate!

Again, we did not put in Renovations nor Cash Flow.

I want to reiterate that this is by far not a sophisticated pro-forma calculation. It's just used here in a Posting as an Example. However, I suspect from my previous teachings that the 90% of Mom and Pop Investors have never been exposed nor have they absorbed these kinds of calculations.

I hope those Readers of this post who do not use Future Calculations can see the benefits of it and steer the Investment Vehicle safely.

Laura Moreno · Answer

@Llewelyn

Wow, Llewelyn, thanks so much for your very thorough reply. I really appreciate your effort. Thanks again. Let me read it again (and again) to fully understand it ...

I am back, I created this summary with 3 more questions for you at the end. Thanks so much again!

SUMMARY

- Make a complete research on micro-neighborhoods

- In general, in NYC, areas that don't appreciate fast are areas with high crime rate and areas close to large housing projects

- A cheap investment doesn't equal a good investment.

- Forget the price & study the difference between the Buy Price & the Sell Price (& of course the cashflow in-between)

- The best investments are the most predictable ones

- PREDICT the cash flows and the selling price

- Opportunity cost: it goes up if you buy where there's less future value

- Don't invest in zero or negative appreciating neighborhoods

HINTS an area would do well:

- Neighborhood price increase makes others (the ones that cannot afford the area) move to next neighborhood

- Franchises opening in the area (coffee shops, ...). They make the research for you.

- Entrepreneurial Coffee shops, fancy stores

- Look for major projects in the area (for example, Atlantic Center in Fort Greene?)

QUESTIONS

- How can I attend one of your Investment Speeches? I would love to learn more from you ;-)

- You say "The Reality is that you cannot know if an Investment is Great until you have the following 3 things: 1) The Purchase Price, 2) the Future Cash Flows and 3) The Selling Price." Now, I believe you can predict cashflows (with, for example, Zillow estimated rental) but how can you predict the Selling Price?

- Some others in BP say New York is mainly an appreciation market. Do you agree? How about the rental market in NYC?

Thanks again, I really appreciate the thought you've put into this!

Llewelyn A. · Answer

@Laura Moreno

@Justin S.

@Adam K.

LAURA: Someone recently told me the next investable area in Brooklyn is Brownsville. What are your thoughts?

I fully believe that NYC, including Brooklyn basically consists of Micro-Neighborhoods. Even within those Micro-Neighborhoods, there will be pockets of Blocks that will vary with how well they do, from extremely poor to extremely well.

As an Example, if you take Bed-Stuy, some of those pockets that did extremely well are Stuy Heights and the border closer to Clinton Hill.

While virtually all of Bed-Stuy is doing great, some areas will not appreciate as fast. Those will be the areas that are closer to the large housing projects where Crime is higher than the other areas.

There are a few neighborhoods that did even better than Bed-Stuy. Williamsburg was just a fantastic Investment since 2000. The appreciation you would have gotten there would far outstrip the other neighborhoods in NYC for the past 17 years. It's a transformation.

On the pessimistic side of appreciation, I had a friend, Marshall, that invested in a coop in the Bronx in a neighborhood called Westchester Square near East Parkchester.

In Feb 2007, Marshall purchased the coop for $70k. He thought because it was cheap in those days  it was a phenomenal deal.

In order to judge whether or not Marshall's coop did well, we need a Comparison. In May 2007, I purchased a 4 Family building for $1.2 Million and renovated it for another $450k, total is $1.65 Million.

Let's fast forward to today.

TODAY, Marshall's coop cannot sell for even his purchase price. He might have to take a loss as it's probably worth only about $60k.

On the other hand, my $1.65 Million ARV is worth approximately $2.8 Million CONSERVATIVELY. A Gain of $1.15 Million over the same approximate time.

Luckily for Marshall, he met me in one of my Investment Speeches at Queens College back in 2010.

I helped him change his investment philosophy about Investing in General.

A low Price doesn't mean it's a Great Investment. What matters is BOTH the Buy Price and the Sell Price and all the cash flow in-between. We normally call that the Total Return or more technically, the Internal Rate of Return (IRR).

The Reality is that you cannot know if an Investment is Great until you have the following 3 things: 1) The Purchase Price, 2) the Future Cash Flows and 3) The Selling Price.

I also like to say that the best investments are the most predictable ones. In other words, If you CAN PREDICT IT, you can PROFIT from it.

If you cannot Predict the Future Cash Flows and the Selling Price, the ROI is just a blind guess.

I would also like to give a second example, one which will redeem Marshall as he finally understood the power of a full Financial Education, learning about Future Value and the Internal Rate of Return.

In 2013, Marshall purchased one of my buildings in an area called Windsor Terrace, Brooklyn. It was a small 2 Family by Prospect Park. I took the proceeds and purchased a Bed-Stuy property right after for $900k but needed $375k for renovations.

For a lot of reasons, Marshall understood why Windsor Terrace was going to do well. In Particular, people just couldn't afford Park Slope (a very pricey adjacent neighborhood). They spilled over to Windsor Terrace.

Today, Marshall's Windsor Terrace Property is worth over $1 Million.

The same property I purchased in Bed-Stuy is now worth $2 Million at least.

There really is a lesson to be learned here.

I don't know enough about Brownsville to tell you where in Brownsville to buy or if you should buy anywhere there at all.

However, there is a trade off. We call it the cost of opportunity. If you buy where there is less future value, then over time your cost of opportunity goes up.

That's the lesson that Marshall had learned in his 2007 Coop Purchase and had corrected with his 2013 Windsor Terrace Purchase.

You will have to do enough research to know if you are going to suffer too high a cost of opportunity in the next 10 years.

BTW, I also have a cost of opportunity since I didn't invest in Williamsburg. BUT, my cost of opportunity is acceptable. Had I invested in Zero or Negative appreciating neighborhoods, I can't imagine what my life would be today. I'm so happy I fully understood Future Value and cost of opportunity to make sure I invested correctly.

You can probably save a lot of time in your research by looking for Franchises or other things that will already do the Future Demographics for you.

Look for Franchises like medium to upscale coffee shops, for instance. Before a Starbucks, there will probably be a lot of Entrepreneurial Coffee shops, then small franchises will open up like Connecticut Muffins, etc.

There are a lot of hints which you can get, including major projects which you can find on the City Websites or just by scanning the Internet.

There are a lot of people on BP that will tell you that you should not depend on Appreciation. Those people should understand that by excluding a conservative calculation of Appreciation, they may very well have a high cost of opportunity.

Justin S. · Answer

Thank you for the reply Llewelyn A.

We certainly have a similar way of thinking. I do well for myself and have very low overhead so having income producing properties right this very second isn't a concern of mine. Honestly, I would be more worried about having to take care of numerous properties out of state and the responsibility that comes along with that, then having a couple of properties here in Brooklyn breaking even. Seems more of a headache to me then anything.

As you know, it is getting harder and harder to find good deals in prime neighborhoods of Brooklyn. I agree 100% about breaking even on rentals but a lot of properties on the market don't even do that. Loosing a few hundred bucks a month I can also see until the rents catch up but loosing thousands a month I just can't see. The reason why I am mentioning this is because I saw a house the other day in Bed Stuy. 4 story 2 family, original condition, needed updating. 1.6M and that would have been a good deal for an owner occupant in todays marketplace but to rent and hold that house as a 2 family would have a negative cashflow of thousands per month unless you had 600k cash or so to put down. I just didn't see that being a wise investment.

The other thing I am well aware of I wanted your input on was the cash needed to purchase these buildings. I had mentioned I have roughly 1M in equity and was allowing myself 250k of that equity to use and invest. I could purchase many different things with that kind of money, my credit and income. It could be a possible apartment building out of state, many single and multi family homes out of state or one Brooklyn property. Figure I would put down at least 20% on a 2-4 unit property plus, as you know, closing cost here are insane, so that would be that. I would have the two properties and sit on that for a while until I saved more money to acquire more or accumulated more equity to extract from the investment property?

I guess what I am getting at is- I know the first one is the hardest and it all gets easier from there, but with this strategy, I don't see how I would acquire more then 2 properties anytime in the near future. Saving 250k doesn't happen overnight. Especially the way we are taxed here in NYC! :)

Laura Moreno, I can't say I am a fan of Brownsville.

1. I am not super familiar

2. I do not see any gentrification taking place there

3. Crime is still very high

4. Poor housing stock.

I could be dead wrong but I am just not feeling it.

Laura Moreno · Answer

Hi @Llewelyn A. !

Great post! I loved reading it.

Someone recently told me the next investable area in Brooklyn is Brownsville. What are your thoughts?

Thanks so much in advance and have a great day!

Laura

What to buy and where? Considering a 2 family in Brooklyn

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