California 4 Unit - Epitome of CA Excess?

[Craig Kleffman]

I thought I'd share this report I just generated.  

The report is here, incidentally:

https://drive.google.com/open?id=0B5YbSRYrt3Q8WXN1...

We're looking at, among other things, opportunities in Orange County for triplex and fourplex properties that we can attain using fha financing.  We qualify for the max - and I'm happy to leverage our way into a multifamily.  Uniquely, however, we need a true owners unit give the four person family I head (me, wife, and two young kids).  

So, we found this place for $1.75 million.*  It's a nice looking place - but how the hell do you make the numbers work?  Turns out you don't.  The itemized expenses are $12,000 a month against $8,000 of gross rents.  So, expect a loss of at minimum $4k a month.  

This is a triplex, with the main house assigned a rent of $3,400 a month.  So that, we would need to expect to fund a housing cost to our family of $7,400 per month (3400 in "rent" to ourselves and another $4,000 in loss a month).  

Then, I thought through - what about creative financing? What if we did an interest only balloon payment. Even then at a 5% interest only with a 10 year balloon, we'd have an annual finance cost of $87,500, or about $7,291.67 per month. With a traditional FHI mortgage the finance cost is PI of $8,057.74 plus another $850 for PMI; so nearly $9,000; the savings is about $1,800 a month, but that leaves a $2,200 a month loss - which is $26,400 in annual loss.

Now what is not on the analysis, however, is our tax issues.  We would take the loss which would reduce our taxable income.  We would gain access to a write-off of the property over its 27.5 year expected life.  So, the annual depreciation on a $1.75 million purchase would be $1.75mm/27.5 years = $63,634.54 as a reduction from our income on the property.  So that, instead of us being taxed on $190,000 of joint income, we would be taxed on ~$127k of income instead.  In other words, about 1/3rd of the depreciation ($63,634.54 /3 = ~$21k) in taxes we don't send to washington or sacramento.  But, even with an arguable (someone correct me if I've got it wrong please), tax benefit of $21k, we still end up about $49,000 LESS the $21k tax benefit still amounts to a $28k loss.  i suppose that's the speculative payment for hoping that soCal real estate appreciates at the rates it has done since the early 1960s.  I suspect one would not even break even on this property - even when including the tax benefit - for another 4-7 years.  

-Craig.

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* Yes, I'm aware FHA loans don't reach to $1.75 million - this is what generated me reviewing this deal to see how one could expect to do. I didn't want to get into the complex math of a seller carrying paper. Turns out, though, once I ran through the numbers - neither fHA nor private seemed to come close making a workable deal. The max fha loan for a fourplex in Oc is around $1.25 million for a fourplex.

[Chris Mason]

Hi @Craig Kleffman,

Yup, you've discovered that [ FHA + Retail Price + MLS + 2-4 unit = less than ideal ] in hotter markets.

We talk about FHA+MFR for countless hours each year, but I can count on one hand the number of these I actually do in that same given year in SoCal / Bay Area (eg, excluding rural California).

And for that handful, it's typically a slightly different formula:

[ FHA + Off Market + Discounted Price + 2-4 unit = win ]

Ain't nothing I can do as a mortgage guy to make FHA not FHA except give you pragmatic advice. It's FHA, and you're only putting typically 3.5% down, with mortgage insurance on 96.5% of the sales price. It is what it is.

So, pragmatically, you've got to Hustle Like a Wholesaler (HLAW) (tm) (yup I just made that acronym up and I'm going with it) and SELL to make it happen w/ FHA 3.5% down in the MFR space in a hot market. Drive for dollars, dial for dollars, knock for dollars, mailers, signs, networking, etc. You can pair that with your lender speaking with the seller to offer assurances that the loan will go through (eg, outsource some of your selling to your lender), but at the end of the day it's on you to HLAW if you want to be in that "handful a year" category and not the "oh look another hour of talking about something you will never actually do because you have no hustle" category.

You can also trade in that hustling for 15% down on a duplex or 20% down on a 3-4 unit (owner occupied in both cases). When you do 3.5% down on a MFR, you're really still doing 25% down. It's just that 3.5% is cash, 5% because you're an owner occupant, and the remaining required balance of the 25% down payment is in the form of your HLAW and sales ability.