Analysis of a 4-plex rehab with FHA 203k

[Alex M.]

All,

I'm in the process of purchasing my first property - to both live in and use as an investment. I'm a newbie to this forum - and to investing - and was recommended to post the numbers here. Any assistance with determining if I should move forward or walk away is very much appreciated. I should state that I started down this road prior to ever knowing about BiggerPockets. I found this site while trying to research if I was getting into a good deal or not, and am sooooo thankful I did. Concepts such as cap rate, cash-on-cash, etc are all new to me, as you will see if you read on.

The Property:

Description: Brick Row Home in quickly transitioning (artists, boutiques, cool restaurants, coffee shops, etc all moving in) neighborhood. Good location next to a large city park and public transportation (train), with street to street lot.

Zoning: Currently zoned and used as 5 units.

The Units: 1st floor front studio; 1st floor rear studio; 2nd floor 1-bed; 2nd floor efficiency; 3rd floor 1-bed. In addition, there is a 36x14 large brick garage that could be renovated into a really cool loft-style apartment, or rented out as garage or artist space.

Condition: Poor. New roofs needed for house and garage. All new electric, plumbing, drywall, windows, HVAC systems, etc. Estimated total costs of rehab: ~$150k.

The Price: Original listing price: $224,900. Initial offer: $200,000 w/ 5% seller assist SA). Following inspections and exploration of rehab costs, I revised the offer to $170,000 w/ 5% SA. Seller countered with $190,000 w/ 5% SA, and stated this is firm. My response of $180,000 w/ 5% was rejected, leaving $190,000 w/ 5% as the price to take or walk from.

The Plan:

Use FHA 203k financing to put 3.5% down (cost of purchase and cost of improvements rolled into one loan). Rehab entire property to make 4 very nice newly-finished apartments: 3 very open attractive studios (1 with a deck), and 1 bi-level 1-bedroom in the back (FHA financing requires reducing the property to 4 units max). Refinance property on completion and reduce mortgage costs, and/or extract a little equity to apply to next property. Down the road, restore the garage into a loft-style apartment and add that to the rent roll.

The Numbers:

Cost Assumptions

As can be seen above, there are a lot of add-on costs for financing with FHA. In particular, it assumes a 6-month rehab period with mortgage payments rolled into the loan, as well as a 10% contingency reserve for cost overruns. If I can manage these (time and overruns) then I get to roll these fees back into the principal.

Finance Assumptions

In looking at some of the investment criteria I've found on BP, I needed to make an estimate of ARV - I've used a little over 110% of the total property cost (purchase plus rehab) to approximate this. Also important to note is that I have taxes and insurance included in mortgage payment so as to keep the calcs simple - these values came from lender GFE.

Rental Income

I'm estimating potential rental income from my girlfriend who works for a property management firm and rents similar properties on a daily basis. I've currently assumed a 10% vacancy rate. I've also assumed an equal cost for unit #4 as my current rent, as I am going to move into this - if I rented it out externally, I would predict $1200 -$1250 in rent based on comps.

Expenses

I'm assuming all other expenses are in the mortgage. I'd like to save approximately 10% to cover unforeseen repairs, etc. Given the new floors, new electric, new kitchens, new bathrooms, new windows, new HVAC, new roof, etc, I do not anticipate too much for this, but prefer to be safe than sorry.

The Financials

So... upon first glance, things look "ok". I'm cash flow positive (assuming I account for me own cost of living, or rent all 4 units). I've got a cap rate of 9.23%, which is not too bad, and a cash-on-cash of 23%. As a complete newbie to this (I've been reading BiggerPockets for about 1 week), this sounds like a green light for the project. Could I be missing something? ...what scares me the most is that I created this spreadsheet based on reading a post on BP linked to the beginner's guide. I am not 100% sure that this is correctly calculating everything. Also, the numbers change dramatically if my assumptions change about the project. What if I get higher vacancy rates? ...what about having to reduce rent? What if my common space utilities end up costing more than $100? ...are there costs I am not calculating? ...and so many more questions!?!?!

According to the Rules

[Cory Binsfield]

Alex, do the tenants pay utilities? $100/mo seems extremely low. I'm thinking water, heat, sewer, garbage, lawn care and or snow service, etc.

Also, I'm assuming the taxes and insurance are zero since you rolled that into the loan.

At first glance the numbers seem ok. However, if your dropping $400,000 on a property with only 3.5% and it's cash flow positive I feel it's a good deal.

My biggest concern is the after repair value. What are similar fourplexes selling for that include a garage? Unlike multi family income property (5 units or higher), 4 unit properties are based upon comparable sales and not cash flow (NOI and Cap Rate).

Lastly, is their a higher and better use for a FHA loan? As a newbie investor, your not only buying in a distressed area, you are also taking on a major construction project.

Is it possible to spend $300,000 to $400,000 on a turn key property that's in a great rental area without the hassle of living in a construction zone? As you work on the units and bring in tenants, some of the tenants will become annoyed over the construction activity.

Just some thoughts. I like the deal but it looks like a major time suck for a new investor. It seems like a sweet deal for a well capitalized and seasoned investor. If my thoughts get you more worried, perhaps you could sell the deal to someone else at a profit and take the proceeds and use it to build up your reserves.