Multiple Recurrent Leaks - Need advice on pivot strategies.

[Sam Kay]

Hello BP fam,

Need some advice. Purchased a 3 fam in Jan 2024 built in 2016 in an appreciating expensive market across the Hudson River from Manhattan NY. 2 units were vacant on acquisition and completed rehab in July, 3rd unit tenant vacated in May and completed rehab this week. Long road to property stabilization with multiple leaks from roof and facade being the major issues we dealt with. Roof was flashed and repaired in May. I isolated face leak source and focused repair was done by mason. All 3 units going on market as LTRs this week and then I discovered 2 NEW leaks. First is from roof along 3rd floor ceiling and I could not isolate source on leak test. Roofer with no answers - claimed from dryer vents. All roof vents are capped so that’s highly unlikely. Other leak along 1st floor ceiling. Investigating 1st floor leak would be quite involved with potential sources being bathroom above but hard to say. Many other upgrades done to force appreciate. Desirables: 8 min walk to trains to NYC and 2 parking spaces.I feel the property was not built well and future leaks are inevitable. 

I will be first time REPS in 2024 but unlikely in 2025. Self managing with Hemlane Complete in 2024 only. STR a suboptimal option in this market due to restrictive ordinances.

Purchase price: $1,260,000 with 11% down @6.75% fixed 30 yr

Total Rehab costs (labor + materials) thus far: -$70,390

Cashflow to date (NOT including Rehab Costs above): -$60,237

Projected Cashflow: 3.1% with 3 LTR tenants 

Wanted the group’s expertise on options as I am considering parting ways with this property given the number of leaks that have come up in this relatively young property.

1) In 2025, 1031 into another (potentially more units) multifamily at least 20 years old.

2) Investigate leaks/Stabilize and proceed with original plan as LTR and accept uncertainty related to potential future leaks.

3) Proceed as MTR (hospitals and NYC nearby) so that can intervene on issues during vacancy periods. Accept furnishing and management costs.

4) Other

Would greatly appreciate the community's wisdom on this. Thank you!

[Joshua Christensen]

@Sam Kay

Leaks are inevitable.  Unfortunately, on a property this age you don't anticipate it.  Honestly, since you are identifying the problem and correcting it, I'd stick it out and push through.  Sounds like a nice area.  You'll have difficulty selling it and breaking even with disclosed leaks.

OPTION 1

hold on with long term rental strategy

OPTION 2

Increase your revenue with 1 furnished MTR for the medical groups.  These tend to rent for a higher rate than traditional long term contracts.  Then lease 2 units on long term to create stability and certainty.

SOLUTIONS?

Find a new roofer.  Have you investigated full roof replacement to seal it completely and gain a warranty on the roof for a few years to eliminate leak concerns?  Especially going into the snowy season.

1st floor leak is suspect for sure.  If it is the bathroom, I'd start by pulling the toilet to see if you have any problems there.  Check the supply line to the toilet & the supply lines under the sink for potential culprits.  Sometimes those valves fail.  Secure the flooring since any leaks could cause subfloor damage under a toilet. 

Best wishes.  Sounds like a tough one.

[Sam Kay]

@Joshua Christensen

Thanks for this helpful strategy on evaluating the Floor 1 leak. 

Regarding Floor 3 leak, I am entertaining a full roof replacement but may Karnak myself first since that leak could not be reproduced on my test and appeared after a heavy rainfull. water ran along a joist. 

I am strongly considering MTRing floor 1 and LTR floors 2 and 3. And then 1031ing into something else early 2025.

My Real Estate only CPA advised against 1031ing this year.

TY!

[Ashish Acharya]

Just focusing on the tax issue for you:

1031 Exchange in 2025: If the leaks keep coming, selling and doing a 1031 exchange into a more reliable multifamily could be your best move. It defers taxes and lets you get into a more stable property. However, if you plan to do cost segregation because of your REPS status, the deprecation recaptures from bonus dep cannot be deferred with 1031. Please keep that in mind.

[Evan Polaski]

@Sam Kay, regarding the first floor leak, I would hire a plumber to pressure test the property.  Are these seperately metered?  If so, you can test each unit separately, as it seems obvious that the first floor leak would be from the second floor, but water is a tricky situation.

For the roof, I would certainly get several groups out to let them diagnose the issue and bid the resolution.  Not only will you likely find vary wide price differences for the same repairs, but you will also likely get differing opinions on what is causing it.  They also make those moisture meters, that I have had roofers use in my attics to attempt to trace back sources.

As noted, in my market, if you have active leaks that you are aware of, they need to be disclosed when selling a property.  I am guessing you will encounter the same.  Maybe the market is hot enough that you could still turn a profit selling as is, but typically, sellers will ask you to take care of them before closing AND likely pay less for the property simply because there are known defects.

[Sam Kay]

@Ashish Acharya

Thanks for this! I will bring it up with my RE CPA!

[Sam Kay]

@Evan Polaski

Thanks for this. All units supplied by 1 main line. I wasn't aware of a pressure test. 

The roof itself was repaired/silvered by the seller a few weeks before I acquired. My roofer capped and flashes areas a couple of months later. 

The recent slow roof leak into the top floor apartment was after a major rainfall. It wasnt dripping. Removal and examination after ceiling drywall removal revealed the water tracked along a joist and saturated the ceiling from a focal point along the joist. There werent any drops into the apartment but simply ceiling saturation. My roof water leak test could not reproduce the leak albeit the amount of water from a garden hose can't compare to a major rainfall. 

I think I will Karnak the roof and reassess if it occurs again. 

Regarding the First floor leak, the ceiling isn't soft or saturated - just discolored. It's unclear if this is discoloration from an old leak that bled through the ceiling paint that was applied during the April renovation or truly an active slow leak somewhere. I'm having a good trustworthy plumber come out. 

[Joshua Christensen]

Quote from @Sam Kay:

@Evan Polaski

Thanks for this. All units supplied by 1 main line. I wasn't aware of a pressure test. 

The roof itself was repaired/silvered by the seller a few weeks before I acquired. My roofer capped and flashes areas a couple of months later. 

The recent slow roof leak into the top floor apartment was after a major rainfall. It wasnt dripping. Removal and examination after ceiling drywall removal revealed the water tracked along a joist and saturated the ceiling from a focal point along the joist. There werent any drops into the apartment but simply ceiling saturation. My roof water leak test could not reproduce the leak albeit the amount of water from a garden hose can't compare to a major rainfall. 

I think I will Karnak the roof and reassess if it occurs again. 

Regarding the First floor leak, the ceiling isn't soft or saturated - just discolored. It's unclear if this is discoloration from an old leak that bled through the ceiling paint that was applied during the April renovation or truly an active slow leak somewhere. I'm having a good trustworthy plumber come out. 

 Sam, Have you opened the ceiling where the leak stain is?  A small 18 inch square would suffice, then you can just patch that section.  You could then see into the ceiling/floor cavity to investigate where it's coming from, if anywhere.  Maybe as you said, its an old leak that was already repaired prior to your knowledge.  A small patch is an easy repair for investigation purposes.

[Evan Polaski]

@Sam Kay, I have never had to pressure test a house after water service is started, but I have replumbed more than a few houses, and pressure testing is a rough in inspection requirement (same with gas lines).  

Typically you can disconnect and drain lines somewhere near main, then hook up an air pump to the lines and pump air into the lines. If everything is solid, you will not lose any pressure.

If you do, you at least know you have a leak.  And if you are really lucky, you may get a whistle or hiss that is audible through the drywall to start narrowing down the location.

[Alan Asriants]

Lots of these new construction builds were done very cheaply, and since it is wood framing with siding, flashing stucco, etc; if the proper flashing drippage and caulking wasn't done correctly you will often find leaks.

I see this all over Philadelphia with Properties built around that same time that are deteriorating due to contractors missing these small ticket items. 

Often times inspectors overlooked them as they are very small and minor but as you can probably already tell, they are extremely important and prevent water intrusion.

Your best bet would be to contact a very reputable Siding/roofing contractor and have them go through the entire property and put in the proper drippage flashings seals and caulking necessary and have them insure the work. 

The material itself is not expensive, it is the time and labor to get it done and to do it diligently that is expensive. Literally sealing and flashing the nooks and crannies 

Also if you have any stucco, replace it with Hardie board. Stucco at this time (at least in my area) was poorly done with improper drainage and sealing. 

[Gabe R. Gonzalez]

Does the roof still have a warranty from whoever installed it? It may have been voided by subsequent repairs, but wouldn't hurt to find that out. This is me thinking with my property manager hat... 

Maybe you have some rotted decking - have you noticed any pooling water with heavy rain? Is the membrane secured to the parapet wall correctly? Water could find it's way there and travel ways away from the point of penetration. 

[Gino Barbaro]

@Sam Kay

What do you think it's worth right now? Do you need to do a 1031? If it was me, and I found another opportunity, I would cut my losses, especially if you can't fix the physical issues. Can you imagine this building in five years? I call it ROE, return on effort. Is it worth all the effort you're putting into three units? 

There are positives: Location and appreciating market.

If you're looking to hold for long term appreciation, that would make sense. This is not a cash flow play, and projecting a %3.1 return makes it a challenge to operate.

Good Luck

Gino

[Dave Foster]

@Sam Kay, Using a 1031 exchange from a property with higher risk or actual repair costs into a property with less risk of capital costs can be very helpful to you.  Thanks to recent clarifications from the IRS you will also be able to defer not only the capital gain and normal depreciation.  But also the bulk of the depreciation from your cost segregation.  1031s and cost segs can be used together now.  That's a powerful combo which could get you into a better space if the leaks are driving you mad!!

[Sam Kay]

Appreciate all the insights!

@Evan Polaski That makes sense. Will consider with trusted plumber who is coming in a few days. 

@Alan Asriants I believe all of this! I may need to find this trusted roofer soon. The roof seems to be OK unless there is a severe rainfall. But still, this situation will only get worse. I may be getting close to a full replacement if roof leaks progress and happen with only mild to moderate rainfall. Good advice re Hardie board!

@Gabe R. Gonzalez Roof was silvered by previous owner prior to my acquisition and offered a 3 year warranty but since then, I brought in my own roofer who has worked on it. I think I'm heading towards a full replacement if leak recurs. That will give me peace of mind, especially since I am self-managing with a demanding primary career that is not in RE. There isn't any rotting that I noticed. There is pooling in areas away from the drainage pipes though. There is stagnant water. But the roof leak mainly occur with severe heavy rainfall.

@Gino Barbaro Property is worth about 1.31-1.41M (about 50K-150K appreciation since acquisition). Ofc selling a property with active leaks would be a concern. I have no problem disclosing though since it's a hot market and finding a buyer shouldnt be too challenging. My hope was with a buy & hold strategy, I could refinance within 1-2 years. At 6% interest rate, it would be a 5.6% COC (~$1200/month).

@Dave Foster Can you share where this clarification was made? My CPA has advised not making any moves until 2025 to avoid raising red flags ie cost seg, putting into service, and then selling all in the same year. 

[Dave Foster]

@Sam Kay, It's an interesting question for sure.  There isn't much specifically codified around that.  Although your CPAs advice is similar to what someone might give if contemplating a cash out refinance immediately followed by a sale and 1031.  It could look like you were attempting to take out profit ahead of a 1031 exchange.  and it would be better to complete the 1031 and then do the cash out (or in your case the cost seg).  The principle is the same.  I'm not sure the risk is the same.  There are accountants on both sides of this.  So it is going to be up to what you and your CPA are comfortable defending if ever questioned.