Should I convert to a duplex?

Question

Hello!

I own a 5 bedroom 3.5 bath 3,000 square foot home in Rapid City, SD. I'm in a nice location right between 2 busy hospitals.

There are a couple of duplexes down the road from us that have an excellent occupancy rate. All with long time tenants.

My basement has 2 bedrooms and 1 bath. There is also a large 12x14 storage room that could be converted into a room too (or opened up for a kitchen). There is also a large open space between the living room and one of the bedrooms that would be a great kitchen/dining room area.

With some work and rearranging I believe it could be converted into a duplex. There is direct access to the basement via a back door. I would need to add a sidewalk. There is a large 3 stall heated garage. Possibly wall off one of the stalls for the basement tenant. I would absolutely need some sound proofing. You can hear too much downstairs! Large yard that is .8 acre with garden, deck, and basketball court. The rental market here is good. About 36-40% renters. It is also a vacation destination for Mt. Rushmore and the Black Hills. I could potentially use the downstairs unit as an Airbnb. There are also several traveling nurses that rent in our area too, so that is another option. Housing market is currently over priced.

Long story short...would it be worth converting to a duplex? I would stay upstairs and rent out the downstairs unit (a bit of a house hack). Rent for 1,000-1,200. I have about $65,000 in equity. Appreciate any suggestions/direction/input. I would be a first time REI with this project. Or, should I take my money and invest it elsewhere?

Thank you!!!

Seth S. · Answer

Hey Jeremiah -

I am by no means an expert but I guess it depends what you are looking for. Here's the way I see it (3 options).

OPTION 1

Let's say you spend 30 000$ to get it up and going (all fixes you mentioned + new appliances and all), then rent it for 1100$ / month. I assume you will be paying all utilities, as well as other  expense (additional insurance, cleaning, yard work, snow removal etc). So let's do a simple pretend calc:

Utilities = 150$ / monthOther expenses: 100$ / month Vacancy: 5% CAPEX: 5%Repairs: 5

(1100$ - 250$) - 15% = 722.5$/month = 8670$ / year --> This gives you a 28.9% ROI.

Even if you use up all 65k in equity to make the rehab, and if we are conservative and use the 50% rule, you are still at 10% ROI.

If I was in your shoes, I would find the best way to rehab for lowest possible amount (but still make it really attractive to potential renters) and do it! Then take the rest of the money and look for a turnkey somewhere (if that is what you are interested in) with a conventional mortgage.

Let's say you get something in Memphis (as you suggested) for 70k. And the rehab of your place took out 35k. That means you are putting down a 25k down payment (5k for fees and others). You are looking at:

P&I = 269$ Taxes = 95$ (approx @ 1.5% cost)Insurance = 85$ (approx cost)CAPEX & repairs: 5% (total as it is turnkey)Vacancies: 5%Property Management: 10%

(269 + 95 + 85) + 20% = 538.8$ / month in expenses

If you can get the place rented for 600$ / month, you cash flow 61.2$/month or 734.4$/year - only 2.9% ROI - horrible.

OPTION 2

If you can get that same Memphis place for 70k with the same numbers as above, but you buy it cash (no mortgage), then it looks like this:

Taxes = 95$ (approx @ 1.5% cost)Insurance = 85$ (approx cost)CAPEX & repairs: 5% (total,as it is turnkey)Vacancies: 5%Property Management: 10%

(95 + 85) + 20% = 216$ / month in expenses

If rent can be 600$, then you cash flow 384$ / month or 4608$ / year - a 6.5% ROI only.

OPTION 3

Do the first part of OPTION 1 (fix your place and rent it).

Then do a BRRRR for the Memphis market - whatever is left over from your place's rehab, put it to buying a home in need of work, then find investor/lender/partner and work on it to BRRRR it as soon as possible and see how those numbers go.

I would personally pick option 3 if I was placed in a situation like yours. Having something at home that I can do and manage, and avoid a lot of the fees that come with an out of state investment - priceless!

Will Gaston · Answer

@Jeremiah Ratzsch have you contacted Zoning yet? If it were me that's the first call I'm making to see if it is even allowed.

I would be very careful about doing conversions if I'm a first time RE investor. Zoning in my market requires that any conversion (SFH to duplex or vice versa) has to have the entire property be brought up to the current code. In one case I had to redo a stairwell, add additional insulation and add support to an existing deck because I was changing more than 50% of the structure in the conversion.

I wouldn't advise against doing it but just understand what your Zoning department is going to require to do it correctly.

Michinori Kaneko · Answer

ah, got it. I was under the impression that Memphis was a pretty hot market so i would have though the returns there are better.  Thanks.

Seth S. · Answer

@Michinori Kaneko you are absolutely correct; I totally messed up the second part of the calcs. I did it correct on the top of Option 1, then downhill from there :( Thanks for catching that!

Also, I am not investing in TN, nor do I know how properties cash flow there, but it was a simple example.

@Jeremiah Ratzschsorry for the mess up mate; please re-evaluate the numbers based on the actual calculation method of subtracting the % CAPEX/Repairs/Vacancies/PM from the final amount of Rent - Fees.

Michinori Kaneko · Answer

@Sev Stan

Im sorry but your calculations don't make sense. why are you multiplying 20% to P&I + Tax + Insurance?  Capex, vacancy, and PM has nothing to do with rest of your expense.  you need to multiply the 20% on the rent, not the remaining expense.  So for instance you should be taking 15% of $1100 rent in your first example, which actually reduces your monthly income by $60.  In any case, if he can get a proper zoning, then of course it will be a great investment... after all for a small investment you are generating extra few hundred $ a month.

For one thing you should NEVER invest in a property that is $70k and only generate $600 of rent per month anyways, unless you are playing the appreciation game and you are expecting a significant appreciation (in which case your analysis needs to include the P&L from that as well) so example you are not very comparative.  if the numbers you are giving is real number for Memphis you should get out of investing there.

I also think Vacancy/Capex of 5% is low, but that's just my opinion.

@Jeremiah Ratzsch hypothetically this all makes sense, but you also should consider other factors.  For instance, MFH does not appreciate as fast as SFH. MFH are value off of their rental income, which is not the same as SFH.  When you sell the property, you will only be able to sell to other investors while SFH you have larger population to target.  There is more to consider here than just monthly cashflow.   Personally, i think your best bet is just doing AirBNB as that would require least amount of $s to invest, most amount of income, you can do it or cancel it any time you want to, and you don't have to worry about any of these things I've mentioned.  Good luck.

Jeremiah Ratzsch · Answer

@Sev Stan awesome! Love the response and the math. Very very helpful.

I also agree that I need to get some estimates from the contractor before pulling the trigger. All great suggestions.

The yard will be a pain and I need to keep that in mind.

Next steps:

1. Zoning

2. Contractor

3. Consider the options @Sev Stan laid out.

Awesome input and I'm super grateful to all. Thank you!!!

Michinori Kaneko · Answer

I've stayed at AirBNB where they converted their basement as a unit to rent out. it was really nice. To convert to a duplex, you need zoning approval, which can be expense and time consuming (and you may not get approval).  But I think you can still use it for AirBNB.  it will require more of your personal time but you can also get more revenue than renting it out. Like @Cassi Justiz said, you would need to consider how much $  you are putting into and how much net income you can get from your rental.  I'd get a contractor to come take a look and quote you on how much it would cost you for the project.

Just FYI Large yard is not good for rentals, especially for MFH.  because it costs money to maintain the yard.  with MFH that cost will usually reside with the owner. smaller yard on SFH are ok because tenant is willing to take care if its smaller.

When I invest in SFH i target 12% cash on cash return.  if your project can't at least meet that then i'd invest elsewhere.  I would note that with properties, you can also get more return from appreciation of the property and repayment of your mortgage principal as well, so you'd need to target more than 12% for your project (since you will not get returns from those two).  I assume with AirBNB you would have no issue meeting that return % though.  The only other thing to consider if is you are willing to spend your time managing it.

Juhi Bhardwaj · Answer

Hi Jeremiah,

Get with the contractors get the $$amount to convert the SFH into MFH and first thing check on the county permits for your area!!!!

Juhi

Jeremiah Ratzsch · Answer

Excellent suggestion! Greatly appreciated. I shouldn't just assume because of the duplexes down the road. I will start with zoning. Thanks again!

Should I convert to a duplex?

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