How to buy your first duplex in San Diego, CA with FHA loan!

Question

We are looking into buying our first duplex/triplex in San Diego, CA with an FHA loan (3.5% down payment). We would like to live in one unit and rent out the other unit. I have used the bigger pockets calculator to figure our the monthly cash flow and the CoC ROI. However, I usually end up with a negative monthly cash flow of -$900 and CoC ROI of -20% for a property that costs around $1000000. I looked into duplexes with each unit having 3 bedrooms and 2 baths. Can someone please explain what my error is? Is the problem that I am paying around $900 mortgage insurance per month because of the FHA loan with 3.5% down payment? What is the average monthly cash flow and CoC ROI in San Diego for a duplex/triplex? What criteria is important when buying your first duplex in San Diego using an FHA loan with 3.5% down payment and you would like to live in one of the units? Any help is highly appreciated!

Maxwell Ventura · Answer

@Stelios AndongYou won't able to go FHA on a 3-4 unit because of the self-sufficiency rule. Negative cash flow is expected in the beginning. I'd double check w/ a local lender about PMI. $900 may be a bit high.3/2s will be considerably tougher to find than 2/2s and 2/1s. When factoring in principal pay down & tax savings (along w/ CF & Appr) your returns should start looking pretty good after only a couple years. From then on out count on compounding interest to accelerate your gains. For critiera: Look for a duplex w/ value add opportunities on the lot. Renovations, some sort of ADU play, and leveraging non optimized zoning, alley access. etc..

Lawrence Dy · Answer

@Stelios Andong Yes, it is common to see negative cash flow on a house hack when purchasing with FHA, 3.5% down payment, but that doesn't make it a bad investment. The key to minimizing the negative cash flow for an FHA house hack is to identify properties with unlocked potential or are undervalued in some aspect. This will typically require some work on your part to add value and unlock this potential (i.e. renovations, additions, exploring more profitable rental strategies, etc.) Don't be deterred by the short term negative cash flow and be mindful of the long-term potential and your long-term investment strategy. With some work and planning, you can eventually create appreciation and refi out of your FHA loan to eventually achieve better cash flow. One of my clients, who I helped purchase a duplex with FHA just last year, is already in the process of refinancing to a conventional loan as we speak. So it is very possible. Hope this helps!

Kenneth Donaghy · Answer

@Stelios Andong Yes many owner-occupied 2-4 units will cash flow negative, for my duplex I include in my calculations my rent and principal pay down, knowing in a year or two when I move, it will cash flow positive with equity. Also you will have very little likelihood of using a FHA loan on a 3-4 unit because of the self-sufficiency rule. 1)There is no problem paying $900 mortgage insurance, if it means you have the opportunity to purchase your first property and learn a lot through the process. 2) I can't really give you an average, it wouldn't be fair because not all variables are equal 3) Just like with any househack, the criteria needs to fit your needs, goals and expectations. Most importantly price/costs, location, condition, lifestyle.

Patrick McNerney · Answer

Hello all,I recently pulled off this exact situation in San Diego! I too was originally looking at fourplexes, but quickly ruled that option out due to the self-sufficiency rule. We ended up deciding on a duplex with a both units having 2br/1ba. The property was listed at 820K, but we made our offer during the peak of Covid fear back in Mar-May 2020. The house had no offers on it due to market uncertainty so we were able to have our offer accepted at 50k under asking with 2.5k in closing credits for a total purchase price of 767.5k. Both units were occupied with tenants so inspections took over a month and we stipulated that the house must be delivered with both unit empty so that added an extra two months onto the close. Overall it took us 4-5 months to close from offer to keys.Both units have quite a bit of deferred maintenance, some serious foundational issues on one, and were generally ugly on the outside. Luckily the interiors were in decent shape and are in a great neighborhood. The interiors didn't need much more than a fresh coat of paint and a good cleaning. Once we moved in we focused on revamping the yard of the rental unit to increase curb appeal and transform the asphalt yard into a nice usable space. Repairs took a little over a month and were able to lock in a great tenant within 3 days of listing. Repairs are still ongoing in the unit we are occupying and I am not looking forward to fixing the foundation as the repair quote have come in around 15-30k, but this doesn't need to be addressed immediately.The tenant is currently paying 2.2k/month for the smaller of the 2BR/1BA's. My PITI is around 4.6k excluding any repairs, so we are cash flowing (-2.4k)/month. It's not ideal, but we were paying 1.9k/month in rent for a 1BR/1BA in the same neighborhood. We were paying a bit more per month for a property we owned and was larger, but wait it gets better.I have recently decided to refinance the property due to surging home prices and our appraisal came back at 1.005M! This is going to allow us to remove our mortgage insurance completely of around 600/month, but rates have creeped up and I am now at 3.625% on my refi vs 2.99% on my original loan. Still our mortgage going to drop around 350/month with zero out of pocket as we are rolling the refi costs into the new loan. This is going to drop our PITI to 4.3k and bring our cashflow to around (-2.1k).Eventually we plan on moving out, renting out both units, and repeating the process. I must admit we got extremely lucky with our property in terms of location, timing, and price. The deals are out there you just have to look for them!Good luck on your searches and future investments everyone!

Twana Rasoul · Answer

@Stelios Andong When you are buying a $1M duplex with 3.5% down you are going to have a significant amount of mortgage insurance, but that's not necessarily a deal killer. Also, the number of bedrooms/baths doesn't necessarily matter as much, they matter more when you are comparing different properties in the same neighborhood. For example, if you have a property out in East County that's a duplex with both units being 3/2 and for the same price you have 2 units each with 2 bedrooms in a more central neighborhood that has more to offer, such as Hillcrest....the right answer is not necessarily the bigger units. I get as much if not higher rents in my small 2/1 units in better locations than I do with my large 3/2's further out.I have several duplex's in contract currently between areas around balboa park as well as some a little further east....a couple of them are being purchased with fha, feel free to shoot me a pm and I can give you an idea what each of those look like.

Patrick McNerney · Answer

@Keith Shadle North park. Hard to find a good deal there these days. The refi is just a standard 30yr fixed non-cash out to remove the PMI. I will be setting up a HELOC shortly to access the remaining equity once our refi closes. My mortgage broke has advised me it is a better way to access your equity for a variety of reasons.

Keith Shadle · Answer

Well Lordy @Patrick McNerney that’s awesome! Congrats!Appreciate the run down. What area of SD if you don’t mind me asking? Getting rid of your mortgage insurance with the refi was great. With the refi did you pay yourself back the original down payment?Wife and I are wanting to try and take on this similar type of deal while I got the W2 & before prices get too high in SD. Thanks for sharing.

Maxwell Ventura · Answer

@Patrick McNerneyProps to you for pushing through and having the foresight. I know it can be tough sometimes paying hand over fist for a small unit mix. People generally become wealthy through equity not income. Last month was 28% YOY appreciation here in SD County.

Keith Shadle · Answer

bump on this for any update. I'm wanting to do the same with a FHA in San Diego. Thanks too for noting the self sufficiency rule. I was only looking at 4-plexes but will now not due to the above. I assume a fixer upper duplex can't qualify for a FHA?

Chase Macherzak · Answer

@Stelios AndongHey Stelios, I am in San Diego too! I’ve been considering the same plan. Something you may be able to try to increase your cash flow a little bit might be to rent by the room. I’m a newbie in the space and haven’t gotten into my first property yet. I’m in the process of planning out my pursuit of my first two properties in SD within the next 5 yrs. Hopefully I’ll be in my first one by this time next year. I have read on other threads that renting by the room versus renting by the unit may offer some increased income. Just throwing an idea out there. Im not aware of this works in Cali or SD but putting it out there. Good luck! Can’t wait to hear how your plan works out.