Zombie-slow-flip-duplex under contract . . . now what?

Question

Due diligence during inspection period--what are we missing?

We are under contract with our first duplex, that is currently tenant occupied but rotting away, which we intend to slow flip.
https://www.realtor.com/realestateandhomes-detail/402-Quinnell-Ave-N_Lakeland_MN_55043_M86377-3096

This property (up-down duplex, each unit a two bed one bath) is in rough shape, definitely a zombie in its neighborhood. Our preliminary estimate for rehab was $60,000, making a purchase price of $152,500 a reasonable deal (note that we are planning to use as our primary and rent or Airbnb the other unit, estimating an average rental income of $1000/month).

The inspector is scheduled, we have J Scott's spreadsheet and book on Estimating Rehab Costs in hand, and our realtor is pulling comps to provide an accurate after repair value (ARV).

Our inspector is a former general contractor that is helping in an advisory capacity with respect to estimating rehab costs.  We plan to run our own numbers to get as accurate as possible by the end of the inspection period.

We will use our refined rehab estimate and ARV to better determine if the number make sense for a slow-flip, i.e., break even (or come close to it) over a two year period. After all, its our first deal.  We are in it for the education, not a profit.

Are we missing anything big that we should be doing during the inspection period?

Thanks so much BP Community for your insight!

Tim

Timothy Busse · Answer

My due diligence period is coming to an end. During the inspection with HomeSight Inspections (who I would highly recommend), we found old Zinsco breaker boxes and some active know and tube. Working though my insurance broker, we are trying to find a carrier that will insure the property at a standard rate if we promise to replace the old (fire prone) Zinsco breaker boxes within 30 days.

Tip of the hat to Mindy and Scott for encouraging this move to reduce housing expenses and start down a new path toward (hopefully) financial freedom.

Timothy Busse · Answer

Happy New Year!  An update on the Quinnell Zombie.

We are about six weeks out from the closing date.  During the last few weeks we've hit several road blocks, also known as learning opportunities, unique to securing a conventional mortgage.  Below I cover two deal killers that don’t often get much attention: appraisals and insurance.

First, let’s set the stage to illustrate why the appraisal deserves some thought.  As part of our purchase agreement, the seller requested that we provide a Written Statement several weeks ahead of closing. (For those in states that don’t commonly use Written Statements, it is essentially “seller’s contingency” in the form of a formal commitment by the lender to follow through on the mortgage.  After a buyer submits a Written Statement, they stand to lose the earnest money if the deal fails for lack of financing.  Additionally, if the buyer cannot get a Written Statement by the agreed upon date, the seller may cancel the purchase agreement.)

So, well ahead of the Written Statement date, we had locked in our interest rate just south of 4% and submitted all pertinent documents to the lender.  The lender then scheduled an appraisal.  But the Appraiser raised a red flag: She refused to appraise the Quinnell Zombie because it is not recognized as a duplex by the city, i.e., it is not permitted for use as a multifamily.

To remedy this permitting, the Appraiser requested either (1) a kitchen in one of the units of the up-down duplex and all doors separating the units be removed or (2) the seller get a conditional use permit from the city allowing use as a duplex.

As the buyer, we want the benefit of our bargain, i.e., a duplex to house hack.  After all, this is an attractive feature of the Quinnell Zombie.  While the seller advocated for the easy fix of removing the kitchen and doors, we insisted that they obtain the conditional use permit.  Also, keep in mind that the current tenants are still living there, so removing the kitchen would have necessarily displaced one of the tenants.

With this decision, however, we turned over control of the deal to the seller.  Remember that the seller can cancel the purchase agreement if we don’t get the Written Statement in on time . . . which turns on the appraisal . . . which cannot be completed until the seller gets the conditional use permit.  See what happened there?  In summary, the seller could simply delay getting the permit and cancel the purchase agreement after the Written Statement date passed.

In this way, the appraisal can be a critical aspect of a deal.  So, even those of you finding great deals where the appraisal will come in well above the agreed purchase price, you may benefit from asking yourself what could go awry with your appraisal.

We asked (in writing) to extend the Written Statement date.  And the day before the Written Statement was due, the seller extended the Written Statement date.  We were lucky that the seller is still committed to keeping the deal alive.

Second, with respect to insurance, a deal may turn on your ability to secure a policy.  That's because most lenders will require homeowner's insurance to protect their interest in the property.  In our case, the Quinnell Zombie is old.  It is old enough to have knob and tube wiring and Zinsco electrical panels (think Federal Pacific Electric or Pushmatic panels).  But I guess not old enough for a full electrical retrofit . . . until now.

While knob and tube or an obsolete electrical panel may not be inherently dangerous if properly maintained, there are several concerns that insurance companies don’t like.  In fact, some insurance companies will not insure homes with knob and tube or certain electrical panels.

I our case, after the inspection, we first asked for the seller to replace the electrical panels, knowing this may be an issue.  But they refused.  So step two was to see if we could actually still get an insurance policy.  It turned out we could, but only if we get an electrician in to perform and inspection and provide a statement regarding the condition of the electrical system.  According to our insurance agent, all we need is a statement from a licensed electrician that the current electrical system is safe and functional.

We were lucky to have a seasoned insurance agent on our side that found such as flexible policy.  But this illustrates that insurance, namely the inability to obtain a policy, can be a deal killer.

While we haven’t gotten an electrician in yet (we are waiting to make sure the seller gets the conditional use permit before spending any more money) this seems like a low bar.  And yes, we are planning to replace the electrical panels as well as any knob and tube wiring.

Here is to keeping the ball rolling.

Timothy Busse · Answer

The price flux was due to a bad septic system.   Seller went back to market with price adjusted to pay $23k for quoted septic system replacement.  So, septic plus closing costs ($29,500 total) make sense at $159,000 offer price.

Current renters are paying $750.  So reasonably solid, though hoping to add more value (and increase rents) after a slow rehab cash flowed by income (easy fix when dropping my mortgage payment over $1,600 by moving into this place and selling my primary that I bought off emotion rather than logic).

Thanks for the discussion Alex G. and Carson Wilcox !

Carson Wilcox · Answer

Yeah Price is totally in flux on this property... if no value has been added why would you pay more then they wanted 7 months ago?  Offer $151500 or something.

Sewer?

I would ensure you get rock solid dependable numbers for what it can really rent for... realtors are full of it most times... and then really factor in your overhead into that.

Alex G. · Answer

The house was listed on 4/3 at $149,900 and, again, on 8/8 at $210,000.  What happened?

Timothy Busse · Answer

Good tip @Will Fraser!

Negotiated as part of the offer to have the current tenants out a few days prior to closing (pushed out well past the Holidays because one body wants to be "that guy").

Hoping to turn around one unit quick to get rented and then live in the second unit.

Will Fraser · Answer

Hi @Timothy Busse, great work getting everything lined up to conquer the inspection period excellently.  The only thing I would add to this would be to have the currently active leases in hand and review them DURING the inspection period.  You’ll want to make sure of the lease amount, the security deposit amount (which HAS to be transferred, ideally at closing IMO), and the ease of cycling the tenant(s) out at your desired time.

Zombie-slow-flip-duplex under contract . . . now what?

Due diligence during inspection period--what are we missing?

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