Are either of these a worthwhile deal?

Question

I am looking to buy my first rental investment property, and after analyzing the market where I live (Traverse City, MI) for some time, I’m thinking there are other places within an hour or so that may provide more bang for my buck.

I’m considering two places, both located in a lovely little village near Lake Michigan about an hour from my primary residence. The village is very close to a larger town that has a hospital and large-ish school system and many retail and restaurant-type establishments, so there’s plenty of folks there looking for long-term rentals.

Property 1:

This is a duplex, built in 1895. It was purchased by the seller in 2003 and extensively remodeled in 2004. It is approximately 1100 sq ft and has an upper and lower level unit. I’d consider this a class B property in a class B area.

Both apartments are currently rented to long-term tenants, for $800 and $650 per month respectively. The rent seems to have only increased by about $50 per month on each apartment in the last 5 years, so there may be some potential to raise it.

Asking price is $139,000 so the rental income to purchase price is 1.04% - not great but as I said the rent is probably due for an increase and the property has been on the market for some time so there may be room to maneuver on price.

I don’t have details on the expenses of this property but using the 50% rule and assuming 20% down and 4.5% rate the monthly mortgage is about $550, meaning $200 per month cash flow.

Property 2:

This property is a 4-plex in the same village, built in 1900. It has been updated quite extensively since 2013, including 2 new refrigerators, new windows upstairs, complete remodel of 1 unit, and a new roof in 2015. Also, the exterior looks a little outdated and the landscaping looks a bit shabby, so I’m thinking there may be some quick equity to be earned by improving the cosmetics of the property. Currently 2 out of 4 units are rented with 2 vacant. The property is 2 levels and 2200 sq ft. Asking price is $139,900. It has been on the market for 2 weeks.

The four units rent for $500, $575, $475 and $500 respectively. The seller lists itemized expenses of $646 per month, not including vacancy, management fees, cap ex, repairs and maintenance, snow removal. Using the 50% rule, with the same assumptions as with property 1, the property should cash flow at about $450 per month, and comes in at about 1.5% monthly income / purchase price.

Any thoughts? Because I'm new to this I tend to favor the duplex in my mind because it's been nicely renovated and it's more attractive, but that's probably just the newbie in me talking. I know I should be looking for ones that could use a little attention for their potential to raise rent and improve ARV. Also, the 4-plex has had some important recent improvements like the roof and windows, meaning cap ex would probably be lower in that property than the duplex, where the roof is > 30 years old, for example.

I’d appreciate some insight, advice, suggestions, warnings or whatever else anyone might like to share!

Thanks

Jonah Hartsburg · Answer

Nice analyses! Here are just a few of my thoughts to throw out there. First, I would look at your goals and how much of your energy you want to invest in these. Assuming you’re going to self manage, do you want just 2 units for now? Do you want to try to find tenants and do any of these repairs yourself on the quad? Are you looking for quick cash flow by putting in a low of work or would you prefer an easier slow, long-term process of wealth building?But strictly from a monetary investment standpoint, the quad sounds more appealing. If you think you can do the cosmetic repairs and get the units filled, I suggest speaking with a realtor in the area on what comps you’d be looking out to try to pull out your cash with a refi. Hypothetically you’d be looking at a quad that cash flows with minimal of your money left into it. Now there are many more things you could consider, but if you are truly feeling indifferent about both places after considering your options, you could just send in low offers on both and see which one goes through. Sounds like the duplex might with it being on the market longer.

Conrad Pels · Answer

@Dennis M.Thanks Dennis,I’m beginning to see what you mean. I went to a showing yesterday and the place is quite a dump. Im sure some investors would have been licking their chops with excitement at the rehab possibilities but for someone who is just starting out, it seemed way too overwhelming. My biggest issue with it is that there were so many things that needed attention, it would be really hard to accurately estimate the rehab cost. On top of that, how can you be sure there aren’t hidden skeletons in the closet, ready to jump out and surprise you after closing on the deal.I think for my first property I’m going to be looking for something either turnkey or requiring a small amount of work so I don’t bite off more than I can chew. Am I being too timid here? What do you more experienced folks think the best strategy is for a raw beginner to get their feet wet?

Dennis M. · Answer

i own a 1876 duplex . Your going to have issues on a house this old . Knowing what I now know ,I would never pay anywhere near those prices for a house that old . The fourplex seems like a headache and at those numbers it’s very exciting . I’d pass on both deals neither seems like a good value to me

Jonah Hartsburg · Answer

@John Ellis Nailed it. I wouldn’t add to what he said. More leverage isn’t always better, but getting better returns on your money is the main reason for high leverage. Plus, if you can buy below market on each property, you earn more instant equity with each buy. So I would look at your ROI after you have the expenses down and know how much you need to put in of your own cash (including down payment, acquisition costs, and rehab). Then you should take a personal assesment to balance the ROI with your risk assesment of how much you can property manage and if the market takes a dip soon. Again, a deal is a deal is a deal is a deal...so if it’s a deal and you have some left over for unexpected repairs/maitenance, it won’t matter as much how leveraged you are.

John Ellis · Answer

Hi Conrad,I used to own multi-families in Saginaw and have a few thoughts regarding the properties you're interested in buying. Historic buildings cost quite a bit more to insure, if you haven't spoken with an insurance agent as to exact costs you might want to look into that. I've found that Foremost Insurance gave pretty good rates and is easy to deal with. Repairs and maintenance can run from zero a month to about 500.00 on a typical 4-plex... most common issues are plumbing and heating related-expect 150.00 average per service call. Preventative maintenance will save you a lot of money. If you hire a snow removal company, expect to pay a lot. Can't stress this enough. In a choice between a 2-plex and a 4-plex, the 4 unit is a better pick for this reason: there will be occaisonal vacancies. No getting around it. If you have a vacancy in a 4- unit, the other units will be a buffer against the loss of income. Also, should the long term tenants from the duplex move, it will be harder to find a qualified renter at 800.00 or more per month than it will to find a renter at 500.00 for the 4-plex. If you are considering doing third party payers (MSHDA, etc.) they will generally pay about 575.00 per month for a one bedroom unit so you'd see a nice increase over current rents.Lastly, are utilities paid for by tenants or owner? If by tenants, you're good to go. By owner, make sure you budget for that. Water will be 100-200 per month, electric pretty low most of the year but expect a jump in summer(air conditioning,fans) and gas is very high in winter.None of this meant to discourage, rental homes are great investments, but it's important to be prepared. Best of luck!

Conrad Pels · Answer

@Jonah HartsburgRent currently $525 avg, $2100 total. Expenses $1100 approx. NOI $1000. Mortgage $600, cash flow $400.After $30k-$40k rehab. Rent $625 avg, $2500 total. Expenses still $1100. NOI $1400. Mortgage $600, cash flow $800.I do have access to the cash needed to rehab. But, would I be better off taking out another loan for the rehab and saving my cash for a second property purchase? Is more leverage (borrowing) always better?

Jonah Hartsburg · Answer

Great! Keep me updated on what you find. It’s good to hear the cap ex seems recently updated. I would definitely look into how the utilities are split. That makes a huge difference in cash flow. All it takes is for one unit who doesn’t pay utilities to run up a careless bill that eats all your cash flow. Can you break down the rent for me again? Are we still talking about the fourplex? NOI is $1400 for three units in the fourplex if you were to live in one unit? Then what’s your financing looking like? Will you have the cash to put the renovations in if it needs $40k (or over time at least)? I’m going to see what it looks like refinancing out of $182k ($139k purchase, $40k renovations, $3k for acquisition costs). I’m plugging the numbers into our proforma (even though the BP calculators are very detailed if you wanted to use those). Also, if you use the desktop version of BP, you can should be able to insert a photo. Thanks for letting me take a look at your deals!

Conrad Pels · Answer

@Jonah HartsburgNo, I forgot to include the repair work. Thanks for the reminder.Ok, so I drove by the property today, and I have a tour scheduled for Wednesday with my realtor. The property is aesthetically mediocre, although it’s definitely not a dump. Is there any way to include pictures in these posts? I haven’t found a way yet. One good thing I noticed during the exterior walk around was that the units appear to be individually metered for gas. So, although I’d pay for some utilities, it seems the tenants pay for some others.The important thing from my point of view is that it seems structurally sound, and many of the improvements made by the seller have been of the larger and more important structural type (new roof, new refrigerators, new upstairs windows). Most of the work that needs doing is cosmetic in nature. I think 10k worth of landscaping and a new exterior paint job would do wonders for the place, and I will know when I’ve toured the units how much work they need inside. I know one of the units was remodeled recently.So, I’m thinking the rehab may cost $30k or so, or maybe up to $40k. I believe after the rehab I can increase the rent from $525 avg per unit to $625, thereby increasing the NOI from $1000 to $1400, and the monthly cash flow to around $750. Perhaps that’s an overly optimistic figure. From my calculations it should come in at around 1.4% if I allow $40k for rehab and can increase the rent by $100/month.

Jonah Hartsburg · Answer

@Conrad PelsRunning comps isn’t really an exact science, especially when there aren’t local properties to comp similarly. Then from an appraiser aspect, I would probably go ahead and see if you can chat with a local appraiser and see what they say. I don’t have enough personal experience to say for sure how they would handle it, particularly with the actual person making their subjective comps and within their understanding of the market. How much work does the fourplex need? Have you included the repair costs in your rent to all-in cost ratio (which was about 1.5)?

Conrad Pels · Answer

@Jonah HartsburgThanks a lot for the reply, Jonah. I agree it might be a better deal to try to pick up the 4-plex and do the work in order to increase the equity and potentially get my invested money back. I don’t think there are any going to be many comps because it’s a small village (only around 1000 people) and I doubt there are other 4-plex properties. The nearby town which is much larger has higher priced real estate so comps there wouldn’t really be relevant.Question about comps... Would an appraiser be solely looking at other properties that are exactly the same or very similar (triplex or 4-plex) or do they also look at the sale price of other homes that are a similar age, condition, sq footage, etc, even if they may be SFH? Sorry if that’s a dumb question but I’ve never heard it answered before.I love the idea of a 4-plex because I could conceivably rent out two apartments while working on the other two, thereby still covering the mortgage and most expenses while I’m able to rehab at the same time. Then again, this is my first investment so maybe the duplex which is more of a turnkey place would be a smarter way to “dip my toe in the water”. I can definitely see benefits to both.