New to investing in Sacramento, am I analyzing my deal correctly?

[Alester Thomas]

Hello BP Community,

New investor here, under contract for a first investment property. Hoping my numbers are feasible as I acknowledge this isn't the most ideal deal. I posted this elsewhere but reposted this here as I felt it was more relevant to people who are already familiar to the Sacramento market.

Property is a duplex in a B/C neighborhood in Sacramento County, listed for 425k, under contract for 400k. Each side is 1200 sqft, 2bd/1.5bth, 2 car garage and driveway. Current tenant rents one side for 1500 and I will occupy the other side paying myself rent of 1500. My situation: I'm 27, have a decent job and have saved 60k in order to invest in something. I don't have the best credit, so I went FHA so I could go 3.5% down at a 3.3% rate with 0 pts. PITI is 2450. After inspections, the property will need 20k in rehab and renovations. Also I will need to replace the roof in a couple years (15k, but I'm attributing that expense to CapEx and will pay myself back with that). DP with closing costs is 20k. I am keeping 15% for CapEx, Vacancy and Maintenance (is this not conservative enough?) I will be managing the property while there and when I leave. Current tenant doesn't pay water, sewage, garbage which I will have to eat until I change the lease.

Projected Rent Revenue - 3000

PITI - 2450

15% Reserves - 450

Cash Flow = 100

Yearly CF - 1200

Total Investment - 40000

ROI - 3%

I acknowledge that 3% isn't great. Pro Forma makes it nicer with the possibility to raise rent to 1550 or maybe eventually 1600/side. Also, I'm not sure if investors take IRR into consideration with the principal paydown from the tenants, but that makes it nicer too. Though, I understand that money isn't realized until you sell or refinance. The other thing is refinancing from FHA to conventional (takes 8-9 yrs to reach 20% equity w/o app or depreciation) would take away the PMI and bring down the PITI to 2100 with 4.5% financing which would make the cash flow better, but would start over the 30 year term (not sure if that's good or bad to do). I'm considering that with my FHA financing, I'll be on the losing end of bidding wars with some of these cash/conv buyers. I got this into contract because I was the first offer and quickly got it under contract. The seller later got much better and higher offers and would really like to back out. Does this seem like an okay deal for me to do seeing how the market in Sac is? Thank you in advance!

[Evan Licht]

Hi Alester,

I would account for water sewer garbage and see what your numbers come in at. I don’t think it would cash flow after accounting for that and I don’t think you can just pencil tenants in to paying that for you and still getting 1500+ in rent. 

On a more positive note, if you plan on house hacking it could still be a worthwhile property to purchase. Rent out the other room on your side it could be a great property for you. It’s better than renting imo

[Carrie K.]

That's fairly tight, but I think it could work. 

Additional negative factors to consider:

• You didn't account for property management (10% or $300/mo) or yard service ($80-100/mo), if for some unexpected reason you had to move out of state.
• Have you double-checked that that rent is typical for the area? I took the liberty of looking at pending 2400 sf duplexes, and since there was only one, I ran the address through Rentometer. All I could see without a pro account was that the neighborhood's average rent for a 2 BR is lower than $1500. But those might be for apartments rather than a duplex home like this.
• Since your math doesn't include water, sewage, and garbage, that probably eats that additional $100 and a little bit more.

Additional positive factors to consider:

• Between $20k of renovations, mortgage paydown, and your credit starting to improve, you might be able to refinance to lower your PMI fairly quickly. (PMI varies based on credit and I believe also equity.) The renovations should be helping your value quite a bit. Perhaps by the time you'd need property management, you'd have a lower payment.
• I think you'll probably have adequate reserves. You would have about $20k in reserves to begin with, adding $5400/year minus whatever maintenance or vacancies come up every year (so let's say adding $3k/year). In a couple years, you'll have to replace the roof, so let's say that's in year 3, dropping you to $14k ($20k + $3k * 3 years minus $15k). That's still over 6 months in mortgage payments and larger than most surprise repairs. It would be nice to get that a bit higher over time, but it seems adequate, assuming you're right that the roof can wait for awhile.
• Since you've been able to save $60k, I assume you'll be able to save a little bit more just in case, even after covering the water, sewage, and garbage?

I did see that there are lower-cost duplexes in the market if you're feeling uneasy about this, but I'm not sure exactly what you're looking for, and you're right that getting under contract is not always easy. Good luck, whatever you decide!

[Alester Thomas]

Thank you so much for taking the time to look at my deal!

[Alester Thomas]

Thank you for your replys guys! @Evan Licht @Carrie K. You both are right, I do need to take into account utilities. It would be about $100/mo. The current lease the one tenant is on from the previous seller has it so those utilities are covered by the owner. My goal by next lease is to change it so the tenant pays a surcharge of $100/mo for utilities (I've seen quite a few landlords this in Sac). I'm not sure if this counts as a rent raise, but even with CA statewide rent control at 5% plus inflation 2%, I can raise the rent by $105. So I can atleast do this for year 1 and start raising the rent at year 2. For any new tenants, I'll have them sign on with the utility surcharge. In terms of comp rents, this property is a little unique in that it looks more like a town home. It's got decent sq footage at 1200 for a 2 bed 1.5 bath plus the 2 car garage and driveway. Since it's hard to find a true comp value for this unit, I was assuming that rent of 1500 because a tenant just signed the lease for their unit as it is, non-renovated. Normally 2bd/1bths go for 1200-1300 at 900 sqft with 1 car garage. I'm also speculating that rent control will bring rents up overall. I will be renovating the side I am living on and put it back on the market for rent in a year or so.

I can definitely save about 20k every year with my current job, but my plan is to not put into this house what I can't pay back with my reserve fund. Difference is I'm paying a lot upfront rather than 7-10 years down the line. So I wouldn't have to replace the roof for another 25 years or so since I'm doing it in a year or so. My CapEx portion is 200/mo, 2400/yr, In a 25 year span it's 60k which would cover roof, HVAC replacement, re-flooring, re-painting, water heaters etc.

I currently am only limited to on market deals, I haven't connected with many people with access to killer off market deals for multifamily. I feel like most MF owners are investors and list on the market anyway rather than wholesalers. What is on market right now in Sac barely cash flows. Most properties barely cover the mortgage with any reserves with my FHA financing, even after pro forma. Right now the standard 1 story 4bd/2bth 2x1 car garages 1800-2000 sqft duplexes are renting at most 1200/unit and are going for 350k.

The other thing is that, since I'm living in it for a while, my wife and I need it to be somewhat of an okay area to live. The ones we see that sort of make the numbers work are in South Sac or Del Paso Heights. We night drove this property and checked out. It's slightly on the sketchy side but It's better than the war zones that are out there and on a cul de sac. That was just an external factor for us. Our strategy is to buy and hold something that can stand on it's two legs so that if my wife and I go to school (she's going nursing, I'm premed) and can't work, it can a least cover it's own expenses and just pay down itself, if not provide some cash flow eventually.