Refurb Duplex, STR, cash out refi; advice on refi strategy?

[Samuel W.]

Hi All!

I'm about to close on my first deal on 5/30 in San Diego, CA!!!!

It's a currently occupied duplex, that is rented waaay below market: $1,700/mo, $2000/mo respectively. Other units in the same neighborhood, same model, are renting at $3,395/mo each.

One tenant is currently month to month, and the other's lease is up in August.

We want to renovate ASAP! The same model home, upgraded, just one block over, sold in April for $1.32M.

We purchased ours for $1.05M and can get it up to same/similar condition as the $1.32M property with minor investment (~$50k).

We plan to renovate as soon as we can get the tenants to vacate. We then plan to turn into a STR and cash out refinance ASAP to Repeat.

According to AirDNA, current ADR for 2bd and the zip is $286 with 83% occupancy (for slower months March-April). Since this is a duplex, total potential ADR is $572 for both units (~$14,242/month), with significant upside in the summer and holidays.

What is the best strategy for cash out re-financing here?

Some background:

For the purchase loan, we had to get a no-ratio program, 30 yr fixed interest only, 1% discount rate, with a 1 year prepayment penalty for this property as it was way under rented.

My W2 income (for loan qualification purposes) will significantly increase in July (due to stock awards), thus potentially opening more doors to other products/strategies.

I believe it will be worth paying the 2.5% (~$15,750) prepayment penalty to get the cash out in year one, but open to thoughts on this.

Thanks in advance for your help!! The BP community is amazing!!

[Dan H.]

It is not clear if this property is in the city of San Diego or San Diego county.  If it is the city of San Diego, STRs are to be on a quota with those owning existing STRs having priority.  This implies if you are city of San Diego, you likely will not be able to rent the property in durations less than 30 days. 

AB 1482 will apply to your property.  You can usually terminate the tenant lease for an extensive rehab which seems to be your intent, however the city of San Diego has an eviction moratorium so you cannot evict at this time if your units are in the city of San Diego.  If your units are not in the city you can evict for an extensive rehab which is a legal reason for a no-fault eviction.  You will need to pay the tenants one month rent for a no fault eviction.  Read AB 1482. 

As for the BRRRR, it is what we usually do. The first challenge is refinance appraisals in San Diego are very conservative. They generally are far below what the appraisal would show for a purchase agreement. Prepare for this.

STRs present challenges getting conventional financing. The issue is most loans do not count STR rents. You may want to look into 2nd home loans but I have had issues getting these loans on some RE that was only a little more expensive than your ARV.

I believe prepayment does not make the seasoning period vanish.  Assuming the seasoning is at least 6 months, I am unsure that it would be worth paying the prepayment penalty.  This implies at most the prepayment could get a refi 6 months earlier than the 1 year period. I suspect it would depend on where interest rates were likely to be headed.

A more recent item is interest rates are rising very fast.  By the time you have done the rehab and the loan is seasoned (which ever is longer) the interest rates could be significantly higher than today.  This could result in significant negative cash flow.  

There are a lot f things to consider especially if your units are in the city of San Diego.  If they are not in the city of San Diego, you still have AB 1482 and financing challenges. 

Good luck