First time duplex investment - good or bad?

Question

Hi all,

I am a new real estate investor. I found a duplex and want to see if the deal is good or not. Would appreciate any feedback.

Normally, for a duplex, I would house hack as experienced investors recommend. But I recently bought a SFH and moved to the house. After the purchase, there is already increase of appraisal value of my own residential property. So, If I sell my primary home, there will be capital gain tax (I think ~20%). So, I would buy the duplex and rental it for a couple of years until I sell my primary home.

This duplex is listed 500K. It looks like the home price increased by 100K for the past one year. I plan to put an offer of 525K.

Expected income: Total rental estimate is ~ 3000 per month.

Cost estimate: 3700 (consisting of mortgage (P&I), tax, insurance, 5% vacancy, 5% repair, 5% capEx, $100 property management). There is a potential to increase rent, based on rental analysis from Rentometer.

Financing: conventional loan with interest rate 5.3% for 30 years with 20% down payment. (the rate is guess from the rate I found online today. Still waiting for the rate from a lender)

So, from the first month, there will be -$700 cash flow. For the 1st month mortgage, principal is ~$500. The rest is interest.

This does not seem like a good investment to me. However, I plan to move to one of the duplex unit after 2 years, after selling the current primary resident home. I found you are exempted from capital gain tax if you sell it after 2 years of living.

Investment perspective, does this make sense? I mean, buying a property with negative cash flow?

S .Giger · Answer

My opinion is that it's not a great deal, though I think you're chasing the right rabbit. Part of the strategy is finding a great deal, or as the cliche goes, "make your money when you buy." I wouldn't want to tie up a down payment in a negative cash flowing property when it could be used on a better investment with positive returns. I think your estimate for a property manager is low based on your rent estimates. At the numbers you posted, you would be subsidizing your tenants living in the duplex.

Sometimes we as investors are so hungry to seize the initiative that we have a hard time to have the discipline to say no! I've been there before, to include having an offer in. I had to go to the county office and research the zoning situation to bring me back down to earth that the property wasn't capable of what I was hoping it was. Put yourself in the shoes of pitching this to maybe a buddy or two that wanted to provide investment cash to purchase the property. Would they go for it if you pitched it honestly? Would you feel you had their capital in the right place doing what's best for them and their families?

That being said, you found a property, went through the motions, ran the numbers, and talked to lenders. All of that is an education and great practice evaluating potential deals! At some point you'll run the numbers of one that's a win.

Nolan Ring · Answer

@Jason Sung

If it starts out with negative cashflow and you plan on moving in which will lower the cashflow even more, your pockets will be hurting. I would look around more and find a property that cashflows right away. Especially if you plan on moving into it. If it doesn’t make sense financially then it probably doesn’t make sense to buy!

I hope this helps!

Alex Gunnerson · Answer

Hi Jason, in general, people tend to assume that negative cashflow = bad, but that isn't always the case. Obviously we want all of our properties to cashflow, but if you have reason to believe that the property is going to significantly appreciate in value it may be worth it. With that being said, -$700 cashflow would be a little more than I would be comfortable with personally, but everyone's situation is different. The other thing I would add is that from what I have seen, duplexes usually don't appreciate as quickly as single family homes.

It sounds like you are asking the right questions, good luck on whatever you decide.

Dan H. · Answer

>Expected income: Total rental estimate is ~ 3000 per month. Cost estimate: 3700 (consisting of mortgage (P&I), tax, insurance, 5% vacancy, 5% repair, 5% capEx, $100 property management)

Your cost estimates seem way too low.  Pm fees Al inclusive will be closer to $300.  Maintenance/cap ex of $300/month for 2 units is too low.  In most areas vacancy of 5% is too low especially for small unit count owners that do not have dedicated team for the tenant flip.  This likely places your -$700/month cash flow as optimistic.

0.6% monthly rent to value ratio also is indicator that this property is likely to have negative cash flow.

At my point in my RE investing I have zero issues purchasing an initial negative cash flow unit.  There is a poor relationship between initial cash flow and actual cash flow over a long term hold.  This is because the RE market is efficient.  The price reflects both anticipated appreciation (both rent and property) as well as perceived risk.  by the way cash flow is taxed, most other sources of RE return has deferred tax.  this implies cash flow in at least one way (its tax situation) is the worse form of RE return.

I care about total return.  Is there a value add opportunity? What is the rent growth outlook?  What is the appreciation outlook?  Is the selling price below value?

Do you believe the Cleveland RE investment purchased 10 years ago would have achieved better cash flow than the San Francisco purchase from 10 years ago?   On average it is not close.

Know your market.  Know it’s opportunities.  Do not ignore initial cash flow, but recognize its limits and that by itself it does not define a successful RE purchase.

Good luck

Lawrence Potts · Answer

@Jason Sung

It depends on what you do with it! If you decide to rent both sides, could you AirBnB one side? Could you rent both out to traveling construction workers on per diem and prevailing wage? What industries are nearby? People that own properties near oil fields cash flow like crazy because the companies pay the rent for the workers because housing is so limited during good oil times and labor increases significantly. Could you increase the rent by renting by the room? Can you add an ADU? Convert the garage into another bedroom? Park a tiny house in the backyard and Airbnb it? Let’s be more creative here.

If you can float negative cash flow and it appreciated $100k in a year, I’d say do it. If it’s going to cost you -$700/month to earn $100k in equity in one year, that equates to paying $8400 for the month to receive $100k. That’s equivalent to getting a $100k loan for less than 9% down. But if you can’t float it and you don’t think it’s going to appreciate another $100k in the next year, maybe not. But I wouldn’t let slightly negative cash flow prevent you from tapping into $100k in equity to buy a better deal. You have to remember too that you are getting more than just cash flow from buying real estate. You’re getting tax write offs, depreciation, capital pay down, networking and relationships, experience, etc. So determine what it is exactly that you want or need from this deal and find out if it’s worth it. If it doesn’t align with what YOU want or need, then don’t do it. But I would recommend not doing the deal if it doesn’t cash flow if your goal isn’t necessarily cash flow. Write down what you want and reverse engineer that plan and see if buying this property is going to take you there, if it’s your MINS 👍

Shamika Beckley · Answer

New to REI and wanted to inquire on why the zoning situation is important.  Thanks for your response on my post earlier tonight too! I would love to hear your take on it. Thank you!

Drew Sygit · Answer

@Jason Sung

Confused about your overall investment strategy!

You want to sell your current primary in 2 years to generate up to $250k tax-free. Nice idea.

But, you want to move into a duplex you've been losing money on for two years and then sell that in 2 years also?

You're also banking your entire strategy for the duplex on future appreciation, referencing past appreciation? How is past appreciation, especially 25% ($400k x 125% = $500k current value) a guarantee of future appreciation?

How is any of this a sound business strategy?

Monique Pett · Answer

I’m going to echo others here. A few thoughts.

1. There are deals that cash flow, so why pick a deal that doesn’t? 2. why not buy a SFH that does cash flow instead?

Not too many pros to loosing money in this game. Best of luck to you

Katrina Razavi · Answer

To +1 what other folks are saying -- it just depends on your situation and your comfort in floating negative cash flow. In high growth cities (like Dallas), it can totally pay off in the long run, so just b/c the cash flow is negative doesn't mean it's a horrible deal right off the bat, especially if you're gonna move into it down the road. You can also get creative and PM it yourself, raise the rent, etc. to lower the loss.

Another thing you may wanna consider is pulling a HELOC from the increased value of your primary home to help w/ the duplex purchase. (wasn't sure if that was implied or not based on your primary home's appreciation). Good luck!

First time duplex investment - good or bad?

Most Popular Reply