Negative NOI on Coastal California Triplex

[Alex Henige]

Myself and my wife just entered escrow on a triplex in a small coastal California town named Cayucos, in which we live. We are both real estate rookies, aiming to expand our long-term rental portfolio.

We currently own a duplex in the same beach town, Cayucos, in which we live in one unit and rent out the other. This was purchased in 2020.

We saw this triplex come on and off the market over the past few months and watched the seller continue slashing their purchase price. After their third price slash, we made an offer and after a week or so of negotiations, our offer was accepted and into escrow, we went!

What we like about this property, is that it is only 1 block from our current duplex, and can physically see the new triplex from our current duplex.

Here are some deal notes:

Listing - https://www.zillow.com/homedetails/3189-Shearer-Ave-Cayucos-CA-93430/2088459196_zpid/

Purchase Price - $1.45m

Down Payment - 20%

Seller Credits - $50k

Interest Rate - 5.85% (after seller credits to buy down rate)

The negatives about this deal that we are struggling with, and seeking advice throughout the community, are the following.

• - 2 of the 3 units are filled with tenants paying below market rate.
• - We would need to aggressively either raise rates on the tenants or evict them, in order to perform light rehab and bring in new tenants for market-rate rents.
• - Current tenants are on month-to-month leases.
• - We’re currently consulting with local RE attorneys and PMs to learn more about this process per our local laws.

Even if we're able to get rents up to the market rate for the Triplex units, the property would still be performing with a negative NOI.

Projected Rents and Mortgage:

• - Unit A (1 bed/1 bath) - $2500/M
• - Unit B (2 bed / 1 bath) - $3000/M
• - Unit C (Studio) - $2000/M
• - Total - $7500/M

• - PITI - $8800/M

• - Negative NOI - $1300/M

Our local credit union bank which would be carrying the loan, has a great program that allows you to rebuy your rate once a year for $800 at whatever the base interest rate is at that time. Our goal would be to continually buy and re-lock in our rate, down to 4-5% within the next 2-3+ years.

If we were to achieve this, the property would break even.

Long term, we see this property as a great asset with steady appreciation, principal paydown, and tax benefits.

We could also improve our personal living situation, by moving out of our other duplex unit, freeing up that unit to cashflow on that property, and moving into the nicer triplex unit with no shared walls and ocean views.

I am reaching out to the community, to see if anyone else has moved forward with properties with a similar situation (negative performing NOI in the near term, for a breakeven or cashflow situation in the future / a property with tenants and below market rates). If so, what did that deal look like for you and is there any additional advice you would suggest we seek in addition to our thoughts above?

[Dan H.]

There are a lot of expenses in addition to piti.  Maintenance/cap ex (I would allocate $750/month), vacancy (5%), PM (8%, even if not using PM allocate for it as you will be doing this job and it takes time/effort), miscellaneous (2%)).

Your units are rent controlled.  Read AB1482.  You can raise rent 5% + CPI capped at 10%.  The 2 most common ways to no fault terminate is to move family into a unit or do a rehab extensive enough that it cannot be occupied. No fault termination costs one month rent to be paid to the tenant (pay after it is vacated, do not forgive last month’s rent). 

Good luck