Multifamily Purchase Advice

[Ashraf Abbas]

Hello BP multifamily experts and mentors,

I wanted to run my first investment option with you and get your take, as there are very few in-person real estate mentors in my area. I went to see this property recently with my real estate agent (who, unfortunately is NOT investor oriented and doesn't own any investment properties). I wanted to share what I learned after my recent showing/tour and hopefully someone can walk me through my uneasy feeling. The scenario is as follows:

Property Type: 4 units, one building with 2 stories built in the 1950s, each unit is 2BR 1BA 1,040 sqft. Includes detached 4-car garage, large storage unit per unit with laundry hookups. Heat paid by landlord. Safe and quiet B-class neighborhood. Landlord has owned it for 24yrs and is currently residing out of town, he’s just cash-flowing now. Tenants are all on month-to-month leases paying varying rents, total $2385 monthly. Local market rents suggest that units this big with these amenities should go for minimum $700/mo, max $850 if higher-end renovations done (too expensive for most potential tenants in this neighborhood).

Intended funding: FHA, I'd like to house hack for my first property. I'm single, no kids, using my savings for this investment. Already pre-approved.

Utilities: Electricity paid by tenants. Water, garbage and heat paid by landlord, with steam heat. Four 2yr old water heaters and a boiler that is approx 20yrs old. All located in the basement in excellent condition (probably the best part of the whole property). There are no washers or dryers on the premises (might be worth adding coin-op washers in the future).

Property condition: The garage is in complete disrepair, basically functions as a carport at best right now. The tenants are all lovely people, though they seem to be concerned about 1) the condition of the garage, 2) the fact that the windows all let in cold air (by the look of them, they're probably as old as the building) and 3) the lack of landlord response to their multiple other (small) concerns about the property. The window concern almost broke by heart, as the winters here in Wisconsin got to -38F this past winter. Other than this, the bathrooms are all original, with concerns for mold, older and very worn tub, toilet, vanity, peeling paint (lead expected, for sure). The kitchens all need help as well, the landlord has quite literally done nothing to renovate or remodel the property even with tenant requests as mentioned above -- effectively a slumlord.

The Breakdown: At FHA 3.5% down the leverage on this property approaches >30:1 and that is incredibly attractive for a first time investor. Even more so I see the immediate ability to add value to the property (storm windows, some paint, other small stuff). As a house-hack, this will not cash flow well -- I'll need to pay about $350/mo to budget for maintenance and the like, totally doable. The major issues are as follows:

1) Very likely that FHA will not even finance this property with the state it is in currently. What seems less likely is that the landlord (from herein referred to as "slumlord") will want to fix the minimum items necessary to allow the property to meet FHA guidelines. Interestingly though, the owner allowed the showing even after knowing FHA was the intended financing. Might be more worthwhile to negotiate a MUCH lower price on the property instead to account for cost of repairs.

2) Assuming somehow issue #1 is resolved and FHA clears the purchase: I am new to the area, and am not sure what the costs will come out to, but my hope is <$5-6k initially as I start my investment mostly replacing windows and painting (I'm told always to expect to pay more). The low acquisition costs are my priority right now. THE PLACE NEEDS A LOT OF WORK. I would fix things slowly to add to the property's value, increasing rents as time goes on and adding to my renovation budget. I am starting a new job in several months, and expect my W-2 income to increase >200K and will help me afford repairs easier -- but in the meantime need this property's costs to stay somewhat manageable. Is this a fair approximation? My fear at this point is what the inspection report will show and what that will mean for future repairs (purchase contingent on the inspection, of course). I need to know if the "let's buy this now and repair the property slowly as time goes on" tactic is a good plan for a value-play purchase considering all the above. Thoughts? What else should I look for?

3) To follow above question, what negotiation tactic should I use on price? Just get repair estimates and get the current owner to come down by that much? Does this work when dealing with slumlords? Is it valuable to consider any particular additional contingencies in the offer?

4) Does anyone here have an issue with landlord-paid heat that uses natural gas to boil water? Does this get expensive? As above, I plan to install storm windows now (in the spring-summer time) to cut costs in the winter. I'm planning to ask the owner for his utilities bills.

5) I’m not sure how to increase the rents to afford the repairs as time goes on. My first plan is to discuss this with the tenants -- to see if they’re WILLING to pay more for a nicer place to live before I purchase. My expectation is the answer will be yes, at which point they will all be locked into year-long leases. Vacancy costs are what will kill me though, so my hope is to avoid this. Are there other tactics?

Thanks for sitting through this long post, I appreciate your time. Looking forward to your responses!

• Ashraf