Rent by the Room Approach and How that Affects Appraisal

[Lauren Cutchen]

I am looking to purchase a single family home and turn it into a rent-by-the-room situation. PadSplit is suggesting to take away common spaces like the living room and dining room and turn them into bedrooms. I think this is an interesting concept, ran the numbers, chatted with the company, and it all seems good so far. I've identified a property that I can comfortably do this with. I need to install hard flooring throughout (probably vinyl), paint, and put up walls in a few rooms turning this 3300 sq ft, 4 bed, 3 bath house into a 9 bed, 3 bath house. I also need to expand and create access for parking. 

My question is the best way to finance this property. I do not qualify for a traditional loan...yet. Our goal would be to eventually refinance and take some money out for another project. So I have questions about the appraisal. 

Details: 

Purchase price $250,000

ARV (assuming cosmetic updates only) $300,000 - not a great ARV

Traditional Rent $1500/month - it was a rental house for years 

Rent by the Room @ $150/week (1 month min) $5400  - assuming fully occupied and before padsplit fees, expenses...

Cash flow: $2500/month

Estimating $50k for rehab - extremely conservative and we plan to frame and do the drywall, and painting ourselves. Large house = large budget. I'd prefer to finance construction costs, but can do this out of pocket if we needed to. 

1) Hard Money Loan - I would need to refinance after construction costs and updates. How will this kind of property be appraised considering we eliminated a living room, dining room, and bonus room? Would we refinance this into a commercial loan? 

2) My MIL is willing to finance this with 20% down and do an investment loan. Could we roll this over into an LLC or refinance into an LLC? I don't mind having a partner with this project, but I want part ownership of the property.

3) See if a bank wants to keep this in house? Would I show them a business plan for this project? I've contacted 2 banks that have said no. 

How would this property appraise after construction? I want to put an offer in ASAP. I prefer to do this myself without the help of my family. And if we did go the family route, what's the best structure for that?