Converting a 4 unit to 5 unit

[Anthony Deringer]

I am considering buying a deal with the following numbers (provided by the seller):

Current purchase price 309,000

Sq. Ft. Actual Monthly / Actual Yearly

Unit A 1000 / 12000

Unit B 775 / 9300

Unit C 885 / 10620

Unit D 575 / 6900

Total Rental Income 3235 / 38820

Vacancy (5%) 162 / 1941

Gross Income 3073 / 36879

Management (8%) 259 / 3106

Insurance (estimate) 100 / 1200

Maintenance (5%) 162 / 1941

miscellaneous grounds, well, septic 50 / 600

Taxes 384 / 4603

Total Expenses 954 / 11450

Net Income 2119 / 25429

Cap rate @309,000 = 8.50%

25% down 5.5%IR 30 AM 1273 / 15276

Cash Flow 846 / 10153

Cash on Cash (ROI) 13.50%

Currently the property has the four units listed above and it has a large unfinished garage.  My plan would be to add value to the property by spending 20-25k finishing the garage and adding another unit - most likely an efficiency ($575/month).  Most of the money from the added until would fall to the bottom line each month, but lets just say only half would become net income.  If I sold the property at an 8.5% cap rate it would make the property worth $339,000.  So my questions are:

1. Do these number look reasonable?  Anything you would add?

2. My understanding is that going from 4 unit to 5 until allows me to increase the value of the property based on cap rate.  Is this true?  Are there legal issues I should be considering when increasing from 4-5 units?

3.  Would you do this deal?

Thanks in advance for your thoughts!

[Greg Baker]

@Anthony Deringer

Full Disclosure: I do not own any SFH or Multis at this point-

A few things I would consider though: 

Management 8% - Have you found someone to do this for 8% or are you counting your own time?  The PM may have additional cost charged every time a unit is turned, with 4 units, that could be costly on an annual basis.

Maintenance 5% - This seems low, I was listening to a few recent podcasts where Brandon Turner, Ben Leybovich  and some others were referencing their maintenance costs being much higher on multis, I think they said something along the lines of the "65% Rule" rather than 50% meaning only 35% was left for Mortgage.  I also do not see a "capital expenses" listed anywhere.  There is more plumbing, more HVAC, etc. to plan for.

Misc. Grounds, Well, Septic - $50 - May want to check on this, how often does the septic need to be pumped?  I assume grounds alone would be $50 a month.  Are there any common area utilities that you pay for?

Taxes - I am jealous, I pay that on my $90,000 personal home lol.

If I were doing quick calculations I would say 

Gross Income - 3073

Operating Expenses

35% - Vacancy, PM, Cap Ex, Maintenance - 1075

Insurance - 100

Taxes - 384

Misc. Grounds/well/septic - 50

Total Expenses - 1609

Debt Service - 1273

3073-1609-1273 = +$191 pre-tax cash flow per month with 25% down.

Cap Rate - 5.6%

Cash on Cash - 2.9%

Re- Garage - Any chance you can "rent" this quite simply as garage spaces or storage?  Maybe you offer it to your senior two tenants for an extra $50-75 a month or something along those lines they can park?  The other gentlemen addressed the city issues.

Once again, I'm purely in the learning phase here, so please provide feedback on my numbers.