Duplex in Lebanon, NH

[Drew MacDermott]

Good afternoon, fellow BP'ers!

My wife and I have lived in the area for a year now and I have interested in purchasing property due to two factors - 1) Dartmouth College next town over and 2) Dartmouth Medical Center just up the road, both supplying a high number of tenants. I have been watching the MLS and found one duplex that was listed at $200k several months ago and just came back on the market at $175k. I am not ready to put in an offer and have not confirmed the numbers yet, but here is what I have calculated for practice. The biggest issue I see in NH are the high property taxes - I'll have to offer much less than asking price.

Property is in good condition and would probably need $5k in cosmetic repairs.  I would love to hear your thoughts on the potential that this property has.  

Total Current Monthly Rent $2,400

Purchase Price: $140,000

Down Pmt: $28,000 (20%)

Closing/Holding Costs: $3,000

Morgage Pmt: $550 (4%, 30 yrs)

Taxes/Insurance: $625

Prop Mgmt: $240 (10%)

Repairs/Maintenance: $240 (10%)

Vacancy: $240 (10%)

CapEx: $168 (7%)

Water/Sewer: $83

Lawn/Snow: $42 ($500/yr)

Electric is subdivided. $0

Oil possibly one heater.  Current expenses are $7k per year, seems very high.

Current Cash Flow: -$371

I've done some research and it looks as though to install two separate propane heating systems is about $10k.  I could upgrade the units to a Rannai system in order to remove the current $7k oil costs.

Cash Flow with Tenants paying heat: $212

[Expenses per MLS Listing (Assuming annual)

Insurance: $2,033

Heat: $6,912

Water: $980

Snow Expense:350

Maintenance:1,650]

[Troy Zsofka]

Hi Drew,

I see that this one is off the table for whatever reason, but the following may still be a good exercise to look at for future purchase considerations.

Based on your numbers, if you spend the $10K to separate the heating (which is a good idea in my opinion because it incentivizes frugality; whereas a tenant who doesn't pay for heat has no reason not to leave it at 75 degrees all day),  you're in for $158K+/_ .

Purchase Price: $140K

Misc: $3K

Heating: $10K

Repairs: $5K

The NOI you propose, without paying for oil, comes to $9,144 per year (gross rents minus all operating expenses - NOT including the mortgage payment). This represents a CAP rate of 5.79% (NOI/AcquisitionCosts). I wouldn't necessarily jump up and down about that in the Upper Valley. Sure, Leb is arguably on the up. However, the numbers have to work without the prospect of appreciation, regardless of how hot the market is, especially if your initial exit strategy is to hold for rental.

Consider making some adjustments to your deal analysis:

1) In my opinion, you're beating up the expenses too much. Being conservative is one thing, but 37% for PM, Vac, R&M, and CapEX is a bit rough. First of all, if you're going to pay a professional PM 10% to manage it, they need to get better results than a 10% vacancy rate (especially considering that you can show an occupied unit to prospective replacement tenants with 24 hour notice to the current tenants, so there's really no reason to have a month vacancy between tenants). Also, in my opinion, if you can't keep the Repairs and Maintenance at 5%, and the CapEx at 2% or so, you didn't do enough renovations in the first place. (Disclaimer - I buy rehab properties with no tenants in them, so it's easy for me to bring everything up to par before renting. On the flipside, I can understand waiting to do some repairs that aren't really needed right away because you already have a stabilized property with established tenants and you don't want to remove them). For a quick analysis, consider using an Operating Expense Ratio. OER is the ratio of expenses to gross rents. Your numbers put it at 68.25% (meaning that 68.25% of your gross rents are going to expenses, not including mortgage). 40-45% is about normal. Let's go with 50% to be on the safe side (NH typically is a bit higher because our real estate taxes are so high, and the rents don't typically quite make up the difference, from my experience). At 50%, your expenses (Taxes, Insurance, PM, Vac, R&M, CapEX, Water/Sewer, etc) come to $14,400 instead of the $19,656 that you have estimated. The CAP rate then becomes 9.11%. Getting better.

2) Realize that if you convert the heat, you may have to decrease rents (unless they are below market right now). I don't know the square footage, beds, baths, etc, but you'll need to take into consideration what other comparable units in duplexes in Leb are renting for. 

3) Try a little value-add. If the units are side-by-side and have separate yards and driveways, and you're restructuring the leases and rent anyway to put the heating costs on the tenants, consider putting the lawn and snow on them as well. I mostly invest in single families, but we do own a couple duplexes, and the lawn/snow is on the tenants. 

4) When figuring cash flow, keep something else in mind. To get a commercial investment property loan, qualification will not be based on dollars of cash flow, but rather on DSCR (Debt Service Coverage Ratio). This is NOI (Net Operating Income as discussed above) divided by the mortgage payment (principal and interest. The taxes and insurance go into the operating expenses that you subtracted from gross rents to get NOI). It's been some years since my days in commercial banking, but I think a typical DSCR for a loan approval is around 1.25 or higher. Now, I know that a duplex will not be a commercial loan, and will not use DSCR (will use DTI instead with probably 75% of rents applied to wash the mortgage payment, or something along those lines). However, I still think it's a good idea to look at the DSCR as part of your own deal analysis, and to show the lender you have an investor mindset by providing them with a pro form income/expense analysis, including DSCR, when you submit the loan request.

Double-check my numbers if you want. I threw this together quickly so some of my calculations might be off. 

Happy investing,

Troy