Duplex purchase 100% financed - Is this worth it?

Question

I am looking to go from 3 single family units to 9 units total by purchasing these 3 duplexes down the street from 2 of my other rentals.  They were listed for sale at $155,000 each and did not sell.  He has since cancelled the listing and agreed to sell them to me for payoff of about $140,000 each - $420,000 total.  They were built in 2003 in comparison to my rentals down the street from the fifties.  They are 3/2/1, about 1200 sq ft each.

I have a bank that will lend me the money with 15% down.  I don't have all the needed cash, but I have one house free and clear that I could pledge in addition to some cash to meet the banks requirements.  Even with that route, I would be almost 100% leveraged on this deal.  Additionally, I have a father in law that wants to lend more money to me and will put up the $65,000 down in return for 5% interest payable quarterly.  So again...borrow from father in law or borrow more from the bank along with pledging one of my rentals....I will be at about 100% ltv....and I prefer to pay money to father in law instead of the bank, especially when the rate is the same.

In my past deals, I bought them and rehabbed them like a flip and felt comfortable with the numbers but never really analyzed them.  I am trying to get smarter in my old age and want to know if I am paying too much for these....even though they appraise at $165,000.  (they did not sell at $155,000 after being listed for 4 months).  Also...I am having trouble comparing apples and oranges.  My rentals down the street, 3/1/1 each about 900 sq ft, built in the 50's, vinyl siding, original single pane windows with storm windows on them....I have about $55,000 in each of them.  One rents for $750 and one rents for $825.  These duplexes are from 2003, built by the seller...larger, all brick and vinyl siding, modern electric etc.  Considering the size and age, along with the fact that I don't have to upgrade the electric, replace windows and vinyl siding in next 10 years like on my two rentals....I don't think it is a stretch to value these at $70,000/side.  That said...the numbers don't look great so I am wondering if I need to pass on this deal or if the issue is going in so leveraged.  We plan on contributing capital to pay down the debt and likely refi them to 30 year fixed rates in the next 24 months or so.  Anyway, here are the numbers.

First set of numbers at current rent average:  below market rent

And the COC return is useless since I really don't have any of my cash in it day one.

And here are the numbers after I have raised the rents to the MINIMUM market rates of $825/month.

Sam Sendgraff · Answer

Chris,

I also looked at these duplexes several months ago when they were on the market, and although I only did a quick analysis, I decided that it wasn't a deal I was interested in. However, they were listed at $155K when I considered them. Basically, they are nice and they are pretty new, but they just don't cash flow as well as the older properties in the surrounding neighborhoods. I also have two 3/1/1s in that area and I have about $55K in each. They are pretty nice in my opinion, and they rent for $795/month.

I noticed a lot of dirt work is being done across the street from the duplexes. Do you know what/if something is going to be built. If so, I would really want to know what it is and how it may effect the value/rents of your properties. Perhaps this is why the seller is selling. At $70K/unit, I do not think this can be considered even a "good" deal based on your analysis. If they were priced at $60K/unit I would probably get excited about the deal, but I understand the seller probably isn't going to sell for less than what he owes (assuming he actually owes $70K/unit). Also, I see anything about closing cost. Was the seller going to pay for these?

Patrick L. · Answer

Using the 50% rule to estimate expenses I come up with a 6.6 CAP with your current rent estimates.  That's too low of a return unless you're talking about a class A property.

Ben Leybovich · Answer

God knows I'm all about 100% financing.  But, just because you can finance 100%, doesn't mean that you should.  The DSCR measures the strength of you CF.  In this case it's not good enough.

Pay less or finance at much better terms :)

Chris Simmons · Answer

Is my problem with this property that I am paying to much for it, that the rents, even once raised aren't enough or simply that I am borrowing too much money to purchase this property?

The bank won't budge on the 15% down on purchase price of $420,000.  But let's say my father in law becomes more of a partial owner that gets an annual dividend of x amount and we agree that I will buy him out at the end of 4 or 5 years.  I am curious if and how that changes things.  Or, lets say i cut him out and I pony up $10,000 or so of my own cash and use my free and clear rental as additional collateral in lieu of the 15% down.  I am still borrowing close to $420,000 and my payments will even be higher since with the bank, on the 20 year amm, I am repaying principal as compared the interest only private note with my father in law.

I just want help understanding if this is a terrible deal all around....or if it just sucks because of the debt load.  If it is the debt load, when do you figure in your global debt status or do you not do that.  Do you ignore your free and clear properties to avoid re-leveraging them and risk never owning anything?

Is the specific cash flow issue on this over leveraged deal simply a managed risk that can be tolerated in the event I am successful in raising rents?

If I could pay cash and not have to service debt with this deal, would that change things?

Ok, I will shut up now.

Thanks

Chris Simmons · Answer

@Ben Leybovich

Please do.  I would love to learn more about this.  I am curious about ways other finance deals when they may prefer not to pony up the cash if needed.  Also, because of my "global" cash flow with other properties, liquid investments etc, I have a bank that will do this deal at the 100% ltv provided they are in first position.  With the above mentioned items and two healthy incomes, I am able to get more than enough rope to hang myself.  Additionally, I am a commercial lender that in the special assets department of a good sized bank, so I am a conservatively aggressive investor.  My only interest in this property is based on my belief that i can raise rents over the next 6 months to a year.

@Ron Averill

As mentioned above, I have cash reserves if needed, in addition to my heloc on rental 2.  Again, I look at the global level.  My total rental revenue vs my total debt and global DCR.  I have to admit, that looking at these numbers, even with rents increased....they don't blow me away.  I figured going from smaller, older houses to modern structures for not much more/unit purchase price I would see great numbers.  Maybe i bought my first 3....average about $55,000 total invested in each house is too much and I have had weak numbers all along.  I am just now starting to analyze the numbers vs sticking my thumb in the air and saying, yup, that sounds good to me.

Chris Simmons · Answer

@Christopher Covell

Rental #3 is still too new from a seasoning standpoint to access the equity that was generated by the rehab.  Throw in the costs to access that equity, and I might as well just get 1 bigger loan for the duplexes @ 5% interest than pay to get 1 small loan ($60,000) from the rental and 1 slightly smaller loan to buy the duplexes.  My thought process is on the global level, such that I look at my cumulative picture vs an exclusive property by property.  If one property has great cash flow due to no debt and another has worse because it is loaded down....what real benefit is achieved by shuffling numbers around to the various properties if at the end of the day I still have the same amount of debt and rental income?  I am not trying to be rhetorical, I am actually asking if my rationale is flawed?

@Patrick L.

Yes...the cash/door/month is terribly low.  I get that.  That is something that makes me doubt this deal.  But at the same time, day 1 I have $0.00 invested in this.  I have three other rentals that generate $2375/month and contractual debt obligations of just over $420/month.  One is free and clear at $750/month.  One has a HELOC on it at 4.5% fixed for the next 3 years.  Current balance is about $30,000....with another $22,000 available.  The 3rd one just had a cash out refi done for 30 years at 4.75%....p&i is $273/month.

This is another area I need to know if i am shooting myself in the foot, or if this is an ok way to manage.  Rather than strictly adhere to the 50% rule and accumulate cash reserves per property that will eventually be needed, I simply use the line of credit on the rental mentioned above.  My wife and I work and have healthy incomes so the rentals kind of pay for themselves along with us contributing capital on occasion.  I simply advance the line of credit for all expenses, taxes, insurance, repairs, improvements etc and then crash the line of credit with all rental revenue not used to service other debt.  When the line is paid off, I can then move on to another debt to pay down....or advance the line for an acquisition.  Additionally, we will finally have one kid out of day care starting next year and can start diverting that cash outlay from the day care to debt.  This way we can start working to undo the leverage this duplex deal will put us in since we will buy into it at 100% ltv....assuming we actually do this.  This keeps me away from having to budget some amount per property and sit on the cash.  Is this flawed?  I have only been at this for a few years now and need insight from some long time landlords to know if this is a bad idea or an alternative that is actually ok?  This way I can rely more on actual, historical data for budgeting purposes.

Thanks for all the input.

Ron Averill · Answer

This is not a slam dunk deal by an means, but there may be some ways to make it work, some of which have been suggested by Chris.

If you had the cash to make the downpayment and you could definitely increase the rents to $825 or above, then the deal would be just ok based on your numbers.

My main concern is that you are seriously considering a borderline deal that will leave you cash-strapped and at great risk if anything goes wrong. I make this assumption since you are short on the downpayment. Without sufficient reserves, I would not be willing to take on this much additional risk, especially when OPM is involved.

You might consider other ways of financing the deal that would reduce the overall risk. For example, is the seller willing to do a land contract at terms that would make the deal less of a personal strain, at least for a few years? Are you willing to take on a partner (perhaps your father-in-law) and also share in the profits?

Ben Leybovich · Answer

Chris,

Your costs don't include CapEx.  But, this is a great thread - thank you for posting it. Actually, would you be at all willing to consider letting me write a post on the blog around this.  This case is rather interesting IMO, and would be good for more folks to read...

Having said this, you have the most important number at the bottom of your analysis.  I suppose it being at the very bottom is indicative of your opinion that it is not so important - the DSCR.

The fact is, you have no NOI and you have no CF in this deal unless you can get the banks on board.  The banks need a minimum of 1.2, more preferably higher.  I know they are saying to you that they will lend on this, but they won't in the end.  Moreover, you should not be interested in this deal, or any other, at anything less than 1.4+ DSCR.  All the rest of it is noise.  I know they are sexy and new, but you don't want to live on the edge...

Thoughts, Chris?

Patrick L. · Answer

I think your maintenance/repairs number is WAY too low.  $50/door/month?   That has to cover every item in the units that can and will wear out (flooring, paint, cabinets, faucets, lighting, appliances, etc)  as well as capital reserves for big ticket items (roof, HVAC, siding, windows, plumbing, electrical etc).  Your low figure for this one is what's keeping your expenses so far below the 50% rule and you could easily be in the red on this deal.

Even with your very optimistic expenses you are talking about $24/door/month in cash flow with the 2nd mortgage.  I don't know many people that would touch a deal for under $100+/door/month.

Christopher Covell · Answer

I’m surprised no one has chimed in yet. I’m curious to see other responses, analysis & opinions.

I’ll qualify all of this by saying I’m new and just applying what I do know (so feel free to correct me where I’m wrong – I’ll learn something new!).

On a first glance I thought "no", but giving it a closer look and for having no skin in the game I don't think the numbers are too terrible to consider. One thing I didn't see you mention is it looks like the primary loan is amortized over 20 years. This immediately reduces your cashflow by $439.59/mo and makes the numbers look worse than they really are since more of that mortgage is paying down equity than it initially appears.

I wonder if the below-market rent assumption is too conservative? If you’re renting a 1950’s 3/1 that’s 900 SqFt for $825/mo and the market rate for a 2003 3/2 that’s 1200 SqFt is around $850 - $900/mo is $875 a fair number to use?

It does not break even with the 50% rule until rents are right at $875 / mo. Taking the expenses approach at $875 provides an NOI closer to $39k with a DSCR of 1.24. With the same assumptions ($875/mo) and primary amortized over 30 years the DSCR is 1.5 with a cashflow of ~$1077/mo.

Bottom line (which you hinted at): This looks significantly better once you get into a 30-year fixed.

Just a thought; if you own a house free and clear could you do a cash-out refi or a HELOC at a lower rate to get down-payment funds that would also help you get a 30-year fixed up front to reduce your total debt-service?

Duplex purchase 100% financed - Is this worth it?

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