Add a 3rd Bedroom or turn it into a studio?

[Matt Lorenzo]

Hi all,

Thanks for stopping by to read/help. I just bought a duplex in Cleveland, Ohio and the top unit has an attic space that includes a set of stairs and doorway that leads directly outside the house. Technically, this can be turned into a studio apartment.  My question is, would it be best to turn the top floor into a 3rd bedroom for the top unit, or, would it be better to renovate the top floor into it's own single unit. 

I plan to hold this property for a long time so it's not a flip. I want to make sure I add value to the home and increase my cash flow as much as possible. 

Thanks very much.

[James Wise]

Originally posted by @Ben Smalley:

I gonna go ahead and disagree with @James Wise - I would 100% turn the upstairs into a 3rd unit. I am actually doing this with a property right now so I can give you specifics if you DM me.

Overall though you submit some forms to the city for a minimal fee. You will then need some drawings for a site plan which is relatively minor as well (<$1,000) then depending on the renovation that amount will vary. You will need to add a small kitchen, bathroom, and second exit if there isn't one. But overall let's say it costs $20,000. 

You will EASILY make that back in value. Look at the difference in sales price between 3-units in the area and duplexes. That alone is worth $20K. Then if you are getting $450 a month in rent that is $5,400 a year on a $20K investment which is 27% return. Even if my $20K estimate is low a 20% return is still great and adding value. Way better than an extra $100 a month in my opinion. 

If you don't have the cash or appetite for that then make it a 3 bedroom in the short term. Or if you have other investment opportunities to earn more than 20-27% then take that.

 Issue with your plan above is that your estimate of the cost is less than half of the actual cost. While your estimate of cashflow on that 3rd floor unit is about double what you'd actually receive. To get a legal 3rd floor unit up there you'd need to do the following.

• Go through zoning & planning.
• Install a 2nd form of egress to the 3rd floor.
• You may need to install a dormer to provide appropriate head space. The majority of these duplexes in our market don't even have legal head clearance in the 1 existing rear staircase in the rear of the property.
• Insulation.
• Rough in plumbing to the 3rd floor. This need to tie into 2nd floor units plumbing.
• Install an additional gas meter.
• Install an additional furnace.
• Install duck work to the 3rd floor. This means that you need to go through the 1st & 2nd floor units.
• Run gas lines to the 3rd floor. This means they need to go through the 1st & 2nd floor units.
• Install a 3rd electrical meter. This means you might need to upgrade electrical service to the property.
• Install rough in electrical throughout the 3rd floor unit. This needs to come from basement & go through the 1st & 2nd floor unit.
• Install electrical for 3rd laundry setup in basement.
• Install plumbing for 3rd laundry setup in basement.
• Patch / fix any disturbance to the 1st & 2nd floor units.
• Install appropriate amount of windows for legal living space.
• Install / finish drywall on walls.
• Install / finish drywall on ceiling.
• Paint unit.
• Install flooring.
• Install kitchen.
• Install bathroom.
• Plumbing finish work in bathroom.
• Plumbing finish work in kitchen.
• Electrical finish work.

No scenario where all of that comes anywhere near $20,000. Beyond that the other factor is that we now have a tenant paying $450/mo. Yes we are scheduled to receive $5,400 annually from said tenant. In actual practice it doesn't work that way. You have repairs, vacancy, non payment, additional utility fees & on & on. At best you can expect to earn an average NET cash flow of $2,700 or so on that 3rd floor unit when factoring in expected operating costs. In addition to that, don't kid yourself on who you're putting up there. A 3rd floor $450 attic tenant ain't no high class tenant. It's going to negatively effect the lives of the other 2 tenants, which is going to negatively effect your bottom line. This 3rd unit is now an additional person who's going to ad to the noise, laundry & parking disputes that are already prevalent in these types of properties when there are 2 tenants. In short these additional issues are going to cause you to see much more frequent turnover when installing a 3rd floor unit in these duplexes as opposed to sticking with the status quo or finishing off the 3rd floor & getting a much higher quality 2 floor tenant.