Duplex in nicer area - deal too thin?

[Emily Weitkamp]

My husband are looking to buy a multifamily in an B class area for buy and hold. We know that the cash flow won't be as great for a "nicer" area, but we'd like to manage ourselves and start with a tenant pool that is less likely to be problematic. We have cash for a reasonable down payment but we are considering "house hacking" -- renting out our current single family and moving into one side of a duplex for a year -- to get an FHA loan and use up less cash.

There is a duplex we are considering is in middle class area outside the city in a great school district. Average household income in the area is about 70k-80k. The house is not that old by local standards (60's) and in good condition with some recent updates.

Offer: $240,000

Each side: 3 bed/2 bath, 1 car garage per side, all separate utilities

Rent: $28,800 ($1200/side/mo)

Vacancy: $2880 (assume 10%)

P&I: $1031 (assuming 20% down, 5% interest. would be ~$200 more with FHA loan I think)

Property mgmt: $3111 (assume 12% - we plan to do ourselves, at least at first)

Taxes: $5400

Maintenance & Repairs: $1000 (tenants do lawn care/snow removal themselves)

Capex: $2592 (assume 10% per year of rents)

Insurance: $1200

Total rents - vacancy: $25,920

Total expenses: $13,302

Debt service: $12368

Yearly cash flow: $250 (ugh!)

My questions:

1. What do you think of my input numbers? Too conservative? Not conservative enough? Am I forgetting something? The numbers line up pretty well with the 50% rule so I guess I'm not too far off...

2. I'm having trouble gauging whether improvements to the home could warrant higher rent and increase the cash flow. Rentometer says $1200/mo is reasonable for the area. The units currently look just ok - a bit drab and outdated. New flooring, paint, and maybe some updated appliances in the kitchen could go a long way toward making them much more appealing. However, I'm not sure I'd get a good enough return to warrant the updates. How do you know what upgrades are worth it? 

3. Is this deal too thin? That is my gut but I'm having trouble just letting it go. Should I just expect a thin deal in nicer neighborhoods where small multi-families are uncommon?

[Casey Miles]

I think you're definitely on the conservative side. Which is good but you don't want to be too conservative or you'll never buy anything :) 

In my experience, totally different market mind you, the 50% rule just doesn't hold true. Are you really going to spend $2500 in capital improvements each year or does it currently need work? I use a 5% vacancy rate and my actual vacancy rates are less than that. With your numbers it's a 5% cap witch I wouldn't do unless maybe it was in a high appreciation market and I had a 2-3 year exit. 

Using the categories I usually use when looking at property it's a 8% cap which most find desirable. I really try to be at a 10% cap but you have to hunt and hunt and hunt for that. If you think you can get slightly higher rents I usually run the numbers using the average of the actual rents and the anticipated rents.

I know I probably don't calculate the way everyone else does but it works for me and I consistently use the same parameters.

Hope this helps.

[Logan Hassinger]

@Emily Weitkamp

At 120k/unit purchase price you would need rents to be well over 1500/month.  Even with the amount of money you would need to improve the property and your market supports 1500/month, I can't imagine the added return would be worth it. 

Much to thin for me. 

[Logan Hassinger]

@Casey Miles @Emily Weitkamp

The allowance for CapEx is just that, an allowance for future replacement. If you aren't factoring that monthly amount you need to be setting aside for CapEx, then you are going to be well in the red when things go wrong.

I would look to significantly reduce your purchase price and value the property based on the expense estimates you have. Then back into the monthly cash flow you would like to achieve.  

[Casey Miles]

Originally posted by @Logan Hassinger:

@Casey Miles @Emily Weitkamp

The allowance for CapEx is just that, an allowance for future replacement. If you aren't factoring that monthly amount you need to be setting aside for CapEx, then you are going to be well in the red when things go wrong.

I would look to significantly reduce your purchase price and value the property based on the expense estimates you have. Then back into the monthly cash flow you would like to achieve.  

 We're probably slitting hairs and I'm probably wrong. I look at capex as improvements not r&m. Generally capital is used for improvements where an roi is associated with it. R&M is for roofs, leaks, AC repairs, etc. Capital would never be a regular category in my cap rate calcs.

I'd 've looking to spend low 190s on this one. What would be your # Logan?

[Emily Weitkamp]

@Casey Miles

Thank you for your feedback! I tend to be too conservative - and it keeps me from looking at a lot of properties. That is why I posted this to see if I WAS being unreasonable. 

@Logan Hassinger

Thank you! The "CapEx" I includedI am assuming is money saved for major expenses - roof, furnaces, water heaters, etc.

That said, I would love to get $100-$150 /door per month. With my calculations that would mean a purchase price of $165000 - $190000. I just didn't know if I was being too ambitious for a "nice" area. It seems that most duplexes in nice areas around here sell at retail prices and not investor prices. Is it even worth making an offer that is $50,000+ below list price? Seems like they wouldn't even consider it!

[Michael Noto]

@Emily Weitkamp In my opinion if you are going to live in a multi-family it is a completely different mentality as compared to when you buy it as a non-owner occupant.

The first thing I always recommend that my CT clients do when they are looking to "house hack" or live in a multi-family is pick areas you want to live in first and then be ready to pounce when a deal becomes available and fits your strategy.

Cash flow is certainly important, but when you are going to be living there that is a factor as well. Don't compromise that just to get a deal. Be patient.

[Logan Hassinger]

@Casey Miles @Emily Weitkamp

I would look to pay no more than 170k and offer around 150k. Is this likely to get you the property, no, they will actually laugh and move on.  Emily, you are right, duplexes in almost all areas are going at retail prices for reasons known; inexperienced, uneducated or need a place to park cash. 

Now on to the issue of CapEx. These expenses represent items that are not regular in nature, but are definitely apart of what it takes to run an investment property. Conventional methods don't include CapEx in the cap rate valuation method but I don't care. I also don't use cap rate to value a property. It's based on COC return, COC/unit and IRR. I know the building will have to be maintained with normal operating expenses and abnormal expenses.

My valuation will always come under that of what you would produce, and I'm fine with that. 

[Devan Mcclish]

I think your numbers are pretty good. Property management might be a little high. But look into your area for that.

The 50% rule holds pretty true. It's a good standard to follow. But the 50% is not only capital expenses as expressed above. It includes taxes insurance capital expenses (it is ALL your expenses). Don't forget that.

But if you're only making 250 a year on this thing. What happens if something unexpected happens like a tenant trashes the place or the furnace gives out. And your expenses go to 60% for one year? You're cash flow is gone. The truth is you're taking on a lot of risk for $250 a year.