How to finance a condo unit to be used as a rental property

Question

Long time listener and reader, first-time poster.

I have been scouring my area (Central New Jersey) for two years to find a value-add deal and have had very little luck. I am a strong believer in the BRRRR strategy but have found most investment properties in my area are asking astronomical cap rates; the worst part is they are missing many normal operating expenses in the setup sheet. I have mainly been looking for 4-10 unit buildings. Due to the lack of available inventory I am thinking about buying another unit within the condo association I currently live in (mainly an appreciation play with limited cash flow; our area was hit hard with the recession and many people found themselves underwater on their property). I am on the board and well aware of the rental process at the association as well as the current financial status of the association. I'm really looking for someone's expertise/experience on how they would finance it or have financed it in the past and how it worked out.

1. Option 1 - Pay for the property and renovations in cash. Cash would come from: partial my own money, partial funding from HELOC on my own unit, remaining from friends/family hard money. Once the unit is renovated and rented out, I assume that the unit would have to be refinanced based on the market approach and not based on NOI. Would a lender even factor in the rental income for the financing? I would be approved either way but am curious to know as this could impact future deals.

2. Option 2 - Take out a mortgage for the purchase and pay for the renovations with my own personal funds. I believe I'll ultimately have more money into the deal if I proceed this way. Also, I'm not sure how they will factor in the HELOC I recently obtained

3. Option 3 - Open to hearing anything else you may recommend

I prefer to leverage (not only because I have to, but also because I'd like to have cash available for future real estate acquisitions) in this type of deal but do not feel I truly know what the property will appraise at if I proceed with option 1. Any help is greatly appreciated.

Stone Jin · Answer

@Drew Donovan I have a similar circumstance as you in that I invest in a large MSA, there are 1000's of units of luxury rentals that are being built in the Phoenix suburbs to the point where I'm thinking it's over built. I own condos in the market and the last couple years have been great, rising tide raises all boats as my rents are now much higher. My product is a B in an ocean of A so I know that when the tide goes out and the A class rents drop, the b class rents will drop faster. I'm considering selling a few now to realize the appreciation and would not look at additional product that will one day have to compete with the A stuff in the current market(when the prices readjust I may reconsider). I guess my point is current trend is not the forever trend, and while in a strong economy the HOA is strong, what would happen in a weak economy when 1/3 of the owners can no longer pay the dues (the dues will increase as I have seen in several different communities we own in during 2010). My point is just be cautious in an environment of raising interest rate, potential market readjustment and a high competition. Good luck with your endeavors.

Tarik Turner · Answer

I would be interested in hearing the numbers on these condos Purchase price Reno ARV

Drew Donovan · Answer

Stone Jin, thank you for your reply. I completely understand your take on the appreciation play. My condo is about 45 minutes by train to NYC. Over the past 10 years, there have been roughly 1,000 luxury rentals developed as the market continues to expand/spread outside of NYC; there are another 500 or so rental units in development in the immediate downtown area. The condos are very inexpensive relative to the surrounding areas. As the rentals continue to come to market (no condos are planned for development as they don’t pencil out), I believe the demand for existing condominiums in the area will increase as the cost to buy will be far less than what tenants are paying in rent. Outside of the financing, the difficult part for me is making sure I get the condo at the right price and m keeping the rehab cost down as best I can. The common charges and taxes take up a substantial part of the proforma. It’s probably best that I continue to be patient and disciplined if I plan on investing in my area

Stone Jin · Answer

@Drew DonovanOption 1 will likely allow you to have the least skin in the game once the plan is executed. My lender has always allowed me to count the rent as part of my income for the underwriting.Option 2 is the traditional path.Option 3 you could invest outside your area. I'm just not a big fan of the appreciation play at this point in the cycle. As interest rates go up and affordability remains roughly the same, value must come down to meet the demand. If you are not cashflowing from the start and banking on appreciation, it just sounds risky to me. Is your area booming with job or population growth?