Replace Steam Heat with Electric Heat?

Question

I am approaching the end of a 12-unit renovation in Derry, New Hampshire and I am experiencing some major trouble with the steam heat system. I am interested to hear some advice on how other landlords would proceed in my situation.

First, some background. I purchased this c. 1875 building in September from a slumlord for $520,000 ($43K/unit) and began what I knew would be a serious overhaul to double rents from $700/unit/month to the going market Class B+ apartment rate of $1300/unit/month. 5 months and $250K of rehab expenditures later, the building is completely re-wired and the 12 renovated units are tenanted at rents meeting my projections. With $190K/year of income and $98K of conservatively projected NOI, the building was just appraised at $1.2M ($100K/unit) and I have a nice cash out re-finance coming my way. Good news.

Here is the bad part. The boiler for the building's steam heating system just blew and it needs two sections replaced. The total cost of repair is $10K. The building's steam heat system was the one aspect of the building that I did not intend to immediately replace given that the boiler is only 9 years old and passed inspection before closing, but it has been a recurring headache during my 5 month's of ownership. Some radiators do not produce heat consistently, there have been steam leaks in the basement, and the previous owner clearly did not keep up with annual maintenance. The tenants also complain about the building being on one thermostat.

I am wondering if I should replace the two sections of the boiler for $10K and try to salvage the steam heat system, or if I should immediately convert to another system. I had the building wired for electric heat during the building's re-wiring, so it would be fairly quick to pop in electric baseboards. That would cost me $25K and the building would have a reliable, maintenance free heating system that offers thermostats in each unit. I know electric heat would be expensive for the tenants to pay for even in just 600 SF units, but I think I would be better off dropping rents accordingly and avoiding $15K/year in oil, lots of plumbing repair work, and many future headaches.

What would you do? Should I repair the steam boiler or convert to electric heat? What are my other alternatives, if any, and what is the associated cost? Please keep in mind that this is a 1875 building that would be difficult to run new pipe through.

Jacob Sampson · Answer

For 15% of a single years NOI (the $15k difference between fixing the boiler or going electric) I would go electric. Further, I would not adjust rent until I knew what the utility bills were and unless I was getting consistent complaints about cost.

Joshua Tessier · Answer

I would second the heat pump mini splits.

Ronan Donnelly · Answer

Hi @Nicholas Gray, congrats on creating so much equity as a result of your rehab, this is one of the things that I love about value-add strategies. It would be helpful to define what your plans are for the building e.g. if you plan to sell/refinance soon you may not want to take the NOI impact as a result of implementing electric (or mini-split systems which I have also heard good things about). If you plan to hold long term, for cashflow then it might more sense to do the more expensive, but longer term better option.Let the numbers guide you. Good luck!

Troy Zsofka · Answer

@Nicholas GrayYou may want to check out the ductless mini split systems (Mitsubishi is one brand). I don't know what the cost would be, or how many you would need in each apartment, so it may be untenable purely from a cost perspective. However, if you run the numbers, make sure to include any rent increase that you could expect to get from offering air conditioned units. That might be worth something in the market. I believe these systems would accomplish the following:1) Allow you to put the cost of heat (and A/C) on the tenants.2) Offer the tenants a less expensive solution than electric heat.3) Offer the tenants relatively efficient A/C as compared to the cost to run window units.4) Cost you a heck of a lot more than electric heat in regards to your initial capital outlay, but I don't believe the maintenance cost is much.This is just an idea that I know has been gaining popularity. I have zero experience with them. Also, my portfolio consists of mostly single family and a couple duplexes; so I have no idea how much more rent could be demanded by offering A/C in a small multifamily property, but I would imagine that if the building and units are nice overall, it could be a selling point for higher-end tenants. If you just dropped $250K I'm guessing you upgraded the units significantly, so these might be in line with the overall picture.In my experience with tenants and people in general, electric heat has a stigma that it earned in the 90's when oil prices were super cheap. Even though the cost delta between electric and oil is far less today, perception trumps reality for 95% of people; so just the words "electric heat" may affect the marketability of your units. Will you have to drop rents? Maybe not, but you may find yourself with lower tenant quality because the better tenants are renting elsewhere. Now, if the market norm is electric heat, it's a different story altogether, but I doubt that's the case here. I have 2 rentals in Derry; a single family on oil FHA, and a half-duplex on a heat pump. I'm fairly certain that electric baseboard in either would not be good.Another option would be to replace the steam boiler with a FHW boiler. I believe that's achievable in some situations. However, my thoughts are that if you're going to spend a bunch of money on this, choose an option that results in individually controlled and metered units. If not for current NOI, then for the future possibility of condexing the property and selling the units individually (if Derry would allow it).Oh, one last thing. Cast radiators can be worth some serious money. I have heard stories of someone offering to a property owner to "take them off your hands" and then selling them for relatively big bucks. Make sure to look into that before someone does you a favor. I believe the value goes up based on how ornate they are, but any are worth at least something per section, or at the very least their weight at a scrap yard. Normally when I renovate I give away the metal for free, but cast radiators are pretty heavy and may be worth the time and effort to scrap them yourself.Happy investing,Troy