First Duplex a bad idea?

Question

After two unsuccessful attempts to buy a SFH (outbid on short sale and HUD home), I'm looking at a duplex to live in half and rent half.  I know nothing about real estate and was directed to BP by a friend.  I like the idea of the duplex because compared to SFH it actually has value beyond appreciation, but after hearing the rules and seeing #s on BP i'm questioning my decision to pursue this duplex.  It will have to be 3.5% and FHA because I don't have 20% for a multifamily.

The Numbers

Price: $155,000

- Interest & Principle $748

- Mortgage Insurance $166
	
	
		
		
			- Home insurance $66
		
		
			
			
				- Taxes $405  = $1388 4.25% Rate

- Mortgage Insurance $166

- Home insurance $66
		
		
			
			
				- Taxes $405  = $1388 4.25% Rate

- Home insurance $66

- Taxes $405  = $1388 4.25% Rate

Rental income is only $800 per month on one side right now.  I'll be living in the other.  I'm confident I can get this to $1000 as I research the area.  The current tenet is month to month and hasn't had a rent increase since November 2009.  The location is very good.  Mostly residential in a area close enough to Chicago to grab commuters who feel they're getting a steal by coming south.

I want to live there for a 2-3 years and then move on and rent both sides.  I thought it was a good opportunity compared to just buying a home to live in with no investment strategy, but wow I think I'm gonna get raked over the coals compared to the deals I'm seeing on BP.

Is this a good idea?  Keep in mind I can cover the mortgage, insurances and taxes fairly comfortably on my salary if necessary.  There are NO other duplexes selling in the area (rents are high now).  I want to make a smart decision, but am afraid I'm making a buy for the sake of making a buy.

Britt Abbey · Answer

From my point of view... this is not a deal to make.

Assuming you're mortgaging 96.5% ($149,975) that will put you in the hole every month.  At 4.25%, your principal and interest would be $736/month.  Now add on 1.2% of the loan as mortgage insurance, and you'll add another $150 to the bank each month.  Your mortgage payment without taxes and insurance would be nearly $890. Now factor in the 50% rule, your monthly expenses for everything else could be an additional $775, making your total cost per month $1665 while only bringing in $1,550.

For me, I'd want to see the purchase price around $100,000.  Your monthly mortgage would be $475(Principal/Interest) + $120(PMI) = $595.  That would leave you closer to $100/door as profit.

Jonathan Pliszka · Answer

@Luke Franklin Welcome to BP, Luke. I live in a multi-family unit that I own in Chicago. A few things to add to your numbers. A lot of older duplexes in the Chicagoland area don't have separate heating controls. Does this building have separate heating controls and utilities? I would include a water/sewage/garbage bill to your numbers.

If you have the means, try putting down 5% and doing a conventional loan with a smaller PMI payment. Talk to your mortgage broker about it. I have a mortgage guy out of Homewood who may be able to help if you want to PM me I can pass his info a long. As a FYI, I used a FHA loan on my property and I'm now trying to refi out of it to get rid of my PMI payment.

Troy Sheets · Answer

Search 50% rule, it's been covered so well Brandon Turner made a video about it. To have us analyze your deal, list all the numbers here and I or someone else can help you break it down.

The catch with owner-occupying a multi is, many times, to get a house in an area you'd like to live in, it's going to break even at best instead of cashflowing, especially a duplex. The upside is, you can live there for a reduced price or possibly free, use FHA and get in with only 3.5% down and have your start in REI.

The above is why I would recommend looking for a 3-4 unit MFH as you have a much better chance of living there for free and once you move out it can cash flow!

Jabari Marshall · Answer

The realtor has not got back to me as of yet on the details in regards to roof, heater, etc.  Can you help me out a little on the details of how the 50% rule works.  From what i understand half of the cost of the potential rent would go towards expenses, which would be $775.  What expenses should fit into that 775.  I'll be manageing it and living in one unit.  Would my cash flow be half of the 775?  This is the part im a little confused about.

If this is not a good deal, what price would make it a good deal or how can i make it a good deal if possible

Troy Sheets · Answer

Obviously a 2-4 unit is a great way to get into REI, the only tough part is finding something that cash flows that you'd actually live in. This deal seems pretty marginal. What do the comps say? How old are the systems in the house, the roof, etc.? Have you read about the 50% rule?

Chris Adams · Answer

@Luke Franklin I don't see insurance factored in, I see Mtg Insurnce but I am assuming that is PMI, not insurance on the building.

I always advise people wanting to live in a duplex to look at this as if you rented out both sides. Because long term that should be a the goal, both sides rented,

I ran the numbers thru my excel pro forma program, but i created an estimate of $2,200 for dwelling insurance, and left off PMI. Assuming that both sides would rent for $800 then this duplex runs at a 1.21 DSCR (Debt Service Ratio)

My minimum requirement is a 1.20 on my single family homes, but for a duplex this formula works fine. Im going to assume you will manage the property yourself and back out the management fee, add in your PMI of $166 and I come up with a positive cash flow of $2,872.00 annually. This DOES NOT include repairs and maintenance, for which I would estimate $500/unit/yr and this is only an estimate.

With all of that being said, I think its smart to buy a 1-4 unit building and live in the unit for your first adventure into REI. The benefits far out weigh the risks, because you stated you can pay the nut on your own if needed.

In the long run you will gain tax benefits, equity, and experience. All with less risk than if you buy a single family home and rent it out.

One last piece of advise is to use a portion of the positive cash flow to knock out that PMI as fast as you can, while keeping reserves for maintenance.

Jabari Marshall · Answer

@Troy sheets & Lucas pfaf, I have a very similar duplex deal but it is here in Philadelhia.  This would be my first property and i want to know if it is a good deal and a good way to get into real estate.  It was listed in July for 180k they have since come down to 165k, i was offered 155k.  Apparently the owner died, so i assume they're motivated to sell?  Should i have come in at an even lower price?  The building is 1480sq ft.

Duplex
2bd/each unit
2car garage
rents for 775/month each unit
taxes $2,345.00
Mortgage insurance  $100.00
property insurance  $100.00

Luke Franklin · Answer

Thank you to all.  Great to have someone to bounce ideas off who have more experience.  Let me attempt to address each and give some more insight to my situation.

@Stephen Underhill

Thanks for the input.  It is kinda scary that it doesn't meet the 50% rule.  And yeah I learned about the FHA 10% down means the PMI drops after 78% equity, but lasts the entire loan if I only put 3.5% down.  It sucks because it hurts cash flow in the present AND the future, but at the same time I'm hesitant to take such a huge chunk of my savings when I wonder what else I could use that $10,075 for (fixing up property, my next purchase, etc).

@Elizabeth S.

Thank you.  Let me address some of your insightful questions.

• How long do you want to live in a duplex? At least 2 years so I can be counted as a seasoned renter and the lender will credit the income from the other side.

• If you bought a single family home, how long would you live there?  Probably at least 3 years.  That's part of the reason I want a duplex, it will force me to stay vigilant and in the real estate seen as I look to get OUT of the duplex.  If start with a SFH I'm afraid I won't be able to find time or $ for an investment property.
• Are you planning on staying in the area you are buying in? For at least 3+ years.  I also have family in the area who could manage a property for me (assuming cash flow is high enough to justify a manager...)
• Do you have a cash reserve or make enough money to develop one for emergencies? Yes, but my reserves will take a hit when I buy.  My wife and I live pretty far below our income levels.  At current levels can save 20 - 30 thousand each year.
• Have you ever lived in a duplex?  No, but currently rent in a 3 plex house.

@Troy Sheets

I would love to grab exactly what you have, multi with more than two units. However, you nailed it.  Nothing in my price range where I would want to live. And  I've never land-lorded before and an established duplex is less intimidating!

@Lucas Pfaff

Thanks for the encouragement.  I've been thinking along the lines you laid out.  Is this property going to cash flow fantastically or be a keeper for 30+ years.  Perhaps not, but can it be a starting point?  I hope so.  We currently rent for $600 a month, but that's about to go up to $750.  If it's close to a wash, I'd rather do the duplex and learn the renting trade while building equity in something.

I realize it's not the best possible opportunity, but that's ok.  I need a starting point.  I'm not terribly afraid of the cashflow because I don't need to live on it.  What I am afraid of is this property becoming an albatross around my neck for future opportunities.  If I buy the property and fix it up as I live there and am able to increase rent, will I be able to either create a positive cashflow or sell the property to buy another?  Or will this be a property I'm stuck managing, making almost nothing and can't unload?  Of course you all can't answer these questions, but they are rattling around in my head!  Thanks everyone.

Lucas Pfaff · Answer

Also being from Philly, I agree with @Troy Sheets in regard to where you can and can't get particular properties in our area.  I do believe they are available but the time and effort necessary to find them is not something I would advise for someone just starting out.  And based on your assertion that there are not other duplex's in the area you have a similar issue (unless you look somewhere else).

At this point I don't see any glaring issues to stop you from purchasing the property above.  YES, there are better deals out there.  But if this is your first property then the purchase will help to educate you for the next (which I'll imagine is 100% investment and you wouldn't live there).

Additionally, and this is BIG for me. What are you paying in rent now? How much will your monthly rent payment go down if you live in one of these 2 new units? Although not strictly considered cash flow, if you are able to decrease your expenses now it will effectively do the same thing as increasing income (cashflow). Obviously, this only lasts while you live in the unit. BUT, if you are having trouble with a down payment now this is something to think about as it can be an effective strategy for creating savings for property #2.

Good luck and let us know what you decide!

Troy Sheets · Answer

In some areas, like Philadelphia, it's much harder (nearly impossible?) to find a MFH that will cash flow in an area you may actually be comfortable living in and that will attract tenants that you're actually comfortable living with. I'm not willing to move my family into a rough area to cash flow on a MFH every month. However, I am willing to purchase and live in a MFH (Quad in my case) that will allow me to live for free while the other three tenants pay all expenses including PITI, maintenance, vacancy, legal fees, management, etc. (thanks 50% rule!) every month.