Zone as 5 unit (commercial) or 4 unit (MF) for cashout refi?

Question

Hi all,

I'm analyzing this deal in Philly that is a 5 unit home not legally zoned. It's a SFH that's been divided and rented out as separate units. I'm thinking of using a lawyer to apply for zoning/use variance but I'm not sure whether to keep it as a 5 unit house or combine 2 of the units, or convert basement into laundry + storage rental and make it 4 units.

Price-wise it's a really good deal. As a 5 unit commercial unit, if I multiply the income by the Gross Rent Multiplier (~8) then there is a ton of upfront equity. If it's a 4 unit multi family then it's hard to say as there are basically no comps. (If I take the difference of a triplex vs a duplex nearby and take it up to 5 units then it's still a great deal).

My biggest concern is what my exit plan would be. I want to get it zoned legally and put in seperate meters and do a cash-out refi. Will it be easier to do this as a commercial 5 unit or as a MFH?

Other relevant info: I will be purchasing this under a LLC. I have great credit score. Very little recent income to show but enough asset to cover this purchase + reserves.

I also want to get a small mortgage (maybe about 30% of the total cost) to finance the purchase. Is it possible to do this even if I have little income, but the numbers make sense? If it helps there are tenants on lease that comes with the building.

Your input is much appreciated!

David Haynes · Answer

I agree with @Rich O'Neill

Unless its zoned RM1, its a long shot to convert it to a legal multi. And even if you get approval for RM1 zoning, the building's square footage dictates how many units you can create.

And here's the real deterrent. If it's not legally zoned, the bank will be forced to value it as a single-family. Its current income wouldn't phase them.

Being an illegal triplex when zoned a duplex is one thing (which is actually something I'm going through right now). But being an illegal 5 unit when zoned a SFH is the extreme. I'd stay away from it unless it has value as a SFH.

Rich O'Neill · Answer

@Jennifer T. before you get too excited, check into the zoning issue heavily. It's not always as easy as it sounds to get a zoning change in the city. Going from SFH to 4-5 units is tough if the zoning doesn't already allow it. Talk to your zoning lawyer before you go too far down this road. You also need to consider the need for a sprinkler system. Depending on your SOW, the city may require one to be installed.

As for 4 vs. 5, as long as the layout isn't too choppy I would argue 5 is better. Might be a little more expensive to finance but it sounds like you have more equity that way and you have more units to spread risk.

Good luck!

As for 4 vs. 5, as long as the layout isn't too choppy I would argue 5 is better. Might be a little more expensive to finance but it sounds like you have more equity that way and you have more units to spread risk.

Good luck!

David M. · Answer

@Jennifer T.

I agree that zoning will probably be your big issue. I know people "throw out" the concept of putting in for a zoning change. But, if the town doesn't want commercial, or even multifamily, in an area, you won't get your request approved.

Also, realize that since you say you are purchasing with a LLC, then all the "residential" aspects pretty much go out the window. You will have to use to commercial financing since legal entities are not eligible for conforming residential loans (I'd highly recommend not following residential lenders advice to swap the Title back and forth with yourself just so they can sell you a residential loan).

I'd recommend focus on making sure the property is "classified" correctly, and follow the corresponding path. Good luck.

Stephanie P. · Answer

Financing is much cheaper and easier to get as a 4 unit (for both you and the person you're going to sell it to). If there are 3 unit comps vs your 4 unit, they'll just use the per unit amount for the comps when doing the income approach, but the sales approach is where your value will come in.

If you go through the hassle and expense of making it a 5 unit, the income approach will be used for value.

Aaron W. · Answer

@Jennifer T. Looks like you have a nice opportunity here!

You should run an analysis on keeping it as a 5 unit versus 4 unit. What rents can you get? Typically, the more units you can have, the better.

Also, you'll want to look at the cost to zone the property. I've never rezoned anything, so can't speak to the cost.

In order for you to qualify for a mortgage of any kind, you will need to show stable income. Even though the tenants will be paying the mortgage and operating expenses, you still have to have other sources of income. For rental income to count by the lender, they'll usually want to see a couple years of the consistent income coming in.

Is there someone you can partner with who has consistent income to come in on this deal?

Best of luck!

Zone as 5 unit (commercial) or 4 unit (MF) for cashout refi?

Zone as 5 unit (commercial) or 4 unit (MF) for cashout refi?

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