4plex Land Acquisition: How much is too much?

Question

Hi BiggerPockets,

I’m thinking of buying a piece of property in Detroit, MI (hear me out now) that could eventually house a 4plex. I know real estate investors have some negative feelings about Detroit but there are some positives to this market because of the manufacturing industry growth in this city. Here are some facts about the property.

-selling price is $300k

-PD zoned

-prime location

-empty lot (city water/sewage/electric but not hooked up yet)

-Detroit city property tax rate is high

I’d like to hear some opinions on this (agents, contractors, lenders). The reason I’m thinking of a 4plex is because I’d like to use an FHA construction to permanent loan with a 3.5% down payment. Despite the high property price, if I’m able to build at $125/sqft then I’d be looking at around $800k for land acquisition and building costs. Even with these expenses, the property still produces cash flow at 3.5% cap rate.

I’ll be living in one of the units so that reduces the chances of vacancy by a quarter. Also, I feel like the land value itself will only go up in the future due to its location.

I’m curious to know what you guys think of this.

Regards,

Tommy

Paul S. · Answer

Tommy, I laugh so hard when people talk about manufacturing growth or the auto industry in Detroit in correlation to property values/rental values. THOSE PEOPLE DO NOT LIVE IN THE CITY OF DETROIT!!!!! There are suburbs lining the boundaries of the city that have housed those exact workers for generations. Suburbs that are safe, have amenities, reliable city services, reasonable taxes, no city income tax, good schools. There has been nothing but a mass exodus for the last 60 years of actual working people leaving the city. What you have left in Detroit now is a very tiny bubble of white kids working for quicken paying crazy high prices surrounded by a barren wasteland of crime and destruction. There is money to be made in the wasteland if you can tolerate the tenant base... but you better buckle up.

Hai Loc · Answer

First of all I am assuming the $35k cashflow is after the mortgage payment because a 75% expenses ratio for a new build is highly unlikely. If so you need to figure out what the NOI is which is the cash flow + debt service..

Second.. CBRE 2H US Multifamily has Detroit A Class Cap rate 6% and B Class 6.5% for stabilized..   For argument sake lets use 6.25% and its applicable to this property..  It can be recognized as a 4plex or even 8plex with the garden units that may fall into commercial property status..

Lets assume the expenses are 50% of gross which would give us an NOI of $6k per month and $72k annually.. at a 6.25% cap the value is at $1,152,000

Have you explored both avenues of rental and resale? Because if you can divide and have 4 separate titles for each unit investors can buy this to cash flow..

So if the $1,152,000 valuation holds true is it worth it to invest the $800k  did you add holding costs etc?

Hai Loc · Answer

Before you go any further.. You are gonna spend $800k all in.. You have any clue what the value of the property will be once its done?  How much will each unit rent for or sell for?  You need to know these metrics before you even waste anytime speculating on building costs..

Tommy C. · Answer

Thanks Paul, very valid point!

Tommy C. · Answer

@Hai Loc thanks for the input and sorry to hurt your brain... this spreadsheet is a simple 4 square analysis tool that is widely used on BP. It is set up to be an initial analysis of an investment property. I included the mortgage payment as an expense because at the end of the day that’s exactly what it is. Also, I couldn’t include the purchase price due to the size of the spreadsheet but it was $800k.

Cap rate = net income $33k / purchase price $800k

Hai Loc · Answer

I don't know where you go this spreadsheet but you need to calculate the Net Operating Income

Mortgage should not be an expense. You expenses should be $5500  and your NOI should be $6500 a month $78k annually

Your cash flow is correct but the formula is NOI $6500 - Debt Service $3740 = Cash FLow

I don't know where you got that cap rate from when there is no value or purchase price to be found..

That spreadsheet just hurt my brain

Tommy C. · Answer

@Hai Loc thank you for the response. I included the mortgage payment in a rough estimate that I did for a rental scenario. However I agree with the resale question and I would definitely build the units to meet condo requirements. Here is a look at what I expenses I added... I accounted for 10% vacancy. Property management is 8% of the rental value. Assumed I can build at $110/sqft... The rental value is very conservatively assumed to be $12k but could realistically pull in $13k...

Tommy C. · Answer

@Hai Loc, Yes I would spend $800k all in. I'm not sure what the value of the property would be but I do know that it would produce a yearly cash flow of $35k... Some details about the rental units:

There would be 4 row style units that are 2bed/2bath, they would rent for $2k/month. Below each one of those units (garden level) I would have a 1bed/1bath unit that would rent for $1k/month.By doing this, I'm getting $12k of rent per month, and my expenses come out to $8900... Monthly cash flow of $3k

Tommy C. · Answer

Hey @Drew Sygit  thanks for sticking up for the BP rookie! Those are interesting points that you bring up. I hadn’t even thought about security of the construction site during the build.

As far as the original post, I re-read it and realized I left out some valuable information... I've been able to answer some of my own questions by working out the numbers but I do have one concern that would prevent cash flow on this property and that is building rates. Does anyone know what the average building rate is per square foot in Detroit?? I'd like to achieve a cap rate of greater than 5% but its just not possible at $150/sqft. However, at $100/sqft it is possible. Another item of concern is property taxes. I crunched the numbers and I’ve come to the realization that the Detroit millage rates are absurdly high. It’s hard to produce any cash flow when you build a $500k building with land acquisition costs of $300k. The reasoning is because my taxable value of the property would be around $400k and I would have to pay $40k per year in property taxes alone. With the high property taxes, my cash flow is definitely contingent on building costs. Any insight by contractors would be greatly appreciated!

-Tommy

Drew Sygit · Answer

@Tommy C.: Don't let Paul stop you from pursuing a solid project.

Paul does his best to make sure "newbies" understand the challenges of investing in Detroit real estate. While the surrounding suburbs are safer and easier to invest in, the returns and potential growth are also lower.

The success of your project will depend on location, location, location. You'll also need to have a solid plan in place to secure the project against theft while under construction and vacant.

To get more comments and advice, you'll probably want to share more numbers: specifics on the planned units, projected amenities, projected rents, etc.

4plex Land Acquisition: How much is too much?

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