Chicago Multifamily Investing - Market Entry

[Jon Rusnak]

Hey Members,

Hopefully everyone is having a great weekend.  I'm looking for some feedback from investors, agents or other real estate professional in the Chicagoland area.  

My wife and I met with a real estate agent in Chicago's West Town neighborhood to discuss purchasing a multifamily home. Based upon our preliminary research and reading different posts here on BiggerPockets it seemed like an FHA loan was a great way to get started in Real Estate Investing (this is our first property). The agent we spoke with was not a huge fan of the FHA loans and recommended putting 20-25% down which based upon current inventory in the West Town / Ukrainian Village neighborhoods would mean that we would need a down payment in the range of $140-$180k. Thats a lot of cash for a beginner.

I was hoping to get a high level understanding of the challenges involved with getting FHA financing. Has anyone gone this route before? Is this in fact a recommended route for new investors? The 20-25% downpayment wouldn't be completely unachievable but would take longer time to save up.

It seemed like this particular agent deals with a lot of wealthy investors in Chicago so perhaps is just not willing to deal with a beginner investor.  Was this a scare tactic?

If the FHA loan is not the best route to get started thats completely fine as we are open to considering different neighborhoods, changing preferences etc. Hoping you could provide some guidance and information regarding the FHA loan process, pros and cons, investing in Chicago, your stories etc. Thanks for reading.

[Logan Allec]

@Jon Rusnak, welcome to the site.  Fellow Big 4 real estate tax manager here.  Congrats on another 10/15 come and gone.  Long story short: if you're currently renting, throwing away money every month paying off someone else's mortgage like I was, then house-hacking a three- or four-unit property using FHA financing is a complete no-brainer.  Just do it.  Find a hungry lender, get pre-approved, and find a young, hungry agent, and look on Redfin/Zillow/Loopnet every day, and get it done. If you currently own your primary residence, I think the answer to whether or not you should go this route as your first investment is a bit more complicated since you'd have to move out of your current home in order to move into your FHA property, and who knows what your SFR would be able to rent for (it may be very cashflow negative), and in that case it may be more prudent to put down a normal 25% down payment for a conventional loan on an investment property. Or of course you could sell your primary residence tax-free (I assume that someone in his 20s wouldn't yet have held his primary residence long enough to have exceeded the $500,000 exclusion). But that wasn't my situation, so I'll just speak to what I've experienced.

Now of course I can't speak to Chicago as I live in LA, but I can speak to purchasing a multi-unit using FHA financing since it's fresh in my mind.  Last month I closed on a fourplex using FHA financing, and I currently live in one of the units.  And by "last month", I mean September 10th.  I had been searching for a fourplex for 10 months--through the dead period in our office of May - July--yet the good Lord saw fit to open escrow on my first property on August 4th and get me in that property five days before September 15th.  It was an eventful busy season to say the least.

Anyway, the real kicker, the thing that made it very difficult for me to find FHA-eligible fourplexes was the FHA requirement that 85% of the monthly rents equal or exceed the monthly PITI. That requirement alone excluded a lot of properties within the rent-controlled city limits of Los Angeles, hence the reason I had to look a little further out (in a bedroom community suburb of LA called Santa Clarita). This obviously puts extra burden on your agent since he or she can't just throw at you any decent-looking multi-family property in your desired geographic area; there is now additional analysis to be done to compare the monthly rents to the anticipated monthly PITI. I think @Brie Schmidt above pretty much covered the reasons why agents may balk at an FHA buyer.

And as @Nick Patterson said, you will have to put in a BUNCH of offers since FHA offers are typically bottom of the barrel, and your agent probably knows that.  In my case, for example, I had been looking since November 2014 and didn't close until September 2015!  By the way, you are right on the money when you said of the agent you met with, "It seemed like this particular agent deals with a lot of wealthy investors in Chicago so perhaps is just not willing to deal with a beginner investor." The agent I was working with in late 2014 and early 2015 was a hotshot LA agent whose clientele was multi-millionaire cash buyers. Big mistake; I and my FHA goals were small beans to him. So I poked around on Bigger Pockets until I found a young, hungry agent who would get comps to me and submit offers on my behalf within MINUTES of me sending her the request rather than within DAYS or even WEEKS like the otherto get me comps or submit offers on my behalf. I also found a hungry lender who was eager to write any loan she should.

And in terms of additional burden on the seller by going FHA, yes, there could certainly be additional burdens on the seller if you want him or her to do the repairs to make the home FHA-approved. You see, when you get your appraisal, the appraiser will state in their report whether or not the property meets minimum FHA guidelines. See below for an excerpt from my appraisal report--note at the bottom that the appraiser noted, "***THE SUBJECT APPEARS TO MEET THE MINIMUM FHA / HUD GUIDELINES.***" However, if the property didn't meet these guidelines, either the seller would have to do these repairs, or I would've had to come out-of-pocket to have them done. And of course this indirectly puts extra burden on your agent since he or she knows that more hoops will have to be jumped through in terms of improving the condition of a property to get it approved for FHA financing vs. conventional financial. But as Brie said, the FHA requirements are NOT as strenuous as many agents believe.

In case you're interested, I've written about my personal experience house-hacking with FHA financing for your information below.  While I wouldn't call it a great deal, here are the metrics nonetheless:

Purchase price: $435k reduced by seller credit of $15k for net $420k
Down Payment: $15,225
Monthly Rents: $1,025 1-bed + $995 1-bed + $675 studio (hasn't been raised in 15 years) + $650 (bedroom in my unit) = $3,345. I am eventually going to raise the rents on the studio to $750 and rent out the unit I currently live in for $1,000, making the total rents $3,770.
Monthly PITI: $2,862
Interest Rate: 3.65%

So for only $15k up-front, it was worth it for me since I was kicking money out the door every month in rent previously, despite the fact that the property is older, and I know it will have lots of maintenance (such as this roof issue). So let's say I need to put $10,000 in repairs over the next few weeks before El Niño (which scares the crap out of me, and I'm pretty sure will not be pretty for lots of people with older properties in SoCal...but that's a different story). Even so, I'm in this thing for only $25k, and I've certainly done sillier things with $25k, and plus now I'm not paying rent and am now getting landlording experience on a cashflowing property in Southern California (though I know a lot of that cashflow will go toward maintenance...I'm not spending or investing any of the cashflow...keeping it all in reserve...who knows what the rains will bring with them?). Would I have gotten into this property for $100k+ (25%) down? Not a chance. But for $25k, why not?

And the real clincher was that I was throwing $700 away in rent every month, making somebody else rich, and if I could get into this property with only $15k down, it just made sense. Even if I somehow lose $700 a month on this property in unexpected repairs and maintenance, I'd be in the same cash flow position that I was previously, but now 1) a portion of my cash outflows (principal payment) goes to my own equity, 2) another portion of my cash outflows (interest, taxes, insurance maintenance) is tax-deductible, and 3) the remaining portion of my cash outflows (replacing a roof or a stove, for instance) is tax depreciable. These three things cannot be said about rent, which is just money down the drain into somebody else's pocket every month. Why pay off someone else's mortgage/build their balance sheet when you can pay down your own mortgage and build your own balance sheet or, better yet, have three other people working hard every month to build your equity? It just seemed like a no-brainer for me.

Let's keep in touch, man.  Connect with me privately, and I can elaborate more on my experience over the phone.  Would love to keep in touch with a fellow Big 4 BP'er in Chicago, which I hear is a hot market right now.  You never know when these connections  will come in handy down the line when we've got more bullets to invest.