10yr Interest Only for Quadplex? First Deal

[Evan Tuuk]

I'm under contract on two duplexes (next to each other on the same property so I just call it a quadplex). We are set to close in 2 weeks and we've hit a little snag in the process! We are going with commercial lending because we couldn't get anyone to take it on the residential side. My plan has been to self-manage for the experience, and do a slow value add with two units that need some updating. Now lending wants to require that I hire out the management. That puts me at a negative cash flow and would require a much more aggressive approach to adding the value which I'm not sure I'm up for. 

We were working with a 30-year fixed loan at ~4.6%. Another loan option is a 10yr Interest Only at ~4.5%. Any thoughts or concerns with the Interest Only? The cashflow looks nice, of course, and the 10 year option gives lots of time to really improve the property and boost rents, etc. But I know I'm then not really building equity in the property either. So many things to consider. I'm trying to strike a balance of trying to tackle problems that arrive and not just back out because it's different or scary, and recognizing when it's not a deal I'm willing to do.

Any tips, advice or encouragement?! Thanks!

[Brenden Mitchum]

@Evan Tuuk, welcome to the BP community!

You are actually building equity in the property, even with interest only payments. By renovating and bumping rents, you are effectively forcing equity into the property by making it more valuable than when you purchased. You're also going to be getting some "natural appreciation" from the housing market, unless there's a significant recession at or near that 10-year mark. When it comes time to pay off that interest only loan, you shouldn't have any problem doing this with a refinance. As I already mentioned, the exception would be a bad recession close to 10 years from now. Have a plan B & C for that scenario..

One questions though, Is the loan interest only for the whole ten years or is it only for a year, then principal kicks in (this is common). If it's the former and you're buying at a good price, this sounds like a steal. 

Hope this helps a bit! Please, feel free to reach out anytime if you have other questions or just want to chat!