My first Yellow Letter potential deal - downtown Sacramento

[Sergey Tkachev]

I wanted to share my first yellow letter potential deal and get feedback from you guys on this scenario...

I received a call in regards to a yellow letter I sent about 3 months ago, the caller is a close friend of the owner, who is 70yo, has power of attorney and is trying to help him sell the house.  The house is an old 1900 Victorian'ish house in downtown Sacramento, had a partial fire, has been gutted on the inside, work was partially started but then stopped due to lack of funds.  

Current condition: inside is about 80% gutted, has an illegal addition attached to it that is probably cheaper to tear down (it's in really poor shape and not built well) and rebuild than make legal, has a finished basement unit with kitchen but it's illegal, city wants it returned to basement/storage.  Most of exterior and structure seem ok but it pretty much needs a full rehab, from roof, to electrical, plumbing and so on.  Built in 1900, 1300sqft, has high ceilings (10ft?), can be brought to it's original character.  Garage can be added in backyard.  Rehab is at a minimum $50-60k without any additions, if I manage it myself.

Coming up with an ARV has been somewhat tricky - the property is in the Mansion Flats area of downtown, which as far as I understand, is not the best and not the worst area, but more of an improving part of downtown Sac. There are rental fourplexes in the same area, as well as condos converted from 4plexes. The owner may consider owner financing. There is a current mortgage of around $200k and they are looking to catch the existing equity above that 200k. They haven't really stated what they are looking to get.

The options I see are: 1) Tear down illegal addition and add a new one to expand the current 1300 sq ft to 2000sqft or so, add a garage in the back (there is alley access) and return downstairs to basement.  This has potentially more profit but more risk than (2).  2) Remove illegal addition and restore the original 1300sq ft, return downstairs to original basement and possibly add a garage in the back. 3) Turn it into a multi-unit, and either rent or sell - selling units individually would seem to make most sense (as opposed to renting) but this is higher risk for me as I have not had that kind of experience before.  Exit strategy in all cases is to rehab and sell.

Because I'm not confident on the ARV, my thoughts are to potentially work with the owner on sharing equity after rehab, i.e. - offering a low price and an equity share of profits at sale. This way I can potentially purchase at lower cost initially and have less risk of putting up too much money. At the same time, owner has a potential of making more on final sale of ARV (hope that makes sense).

I'm open to any other ideas and input, maybe from someone who knows the Mansion Flats/Downtown area well.  Pretty much looking at all my options.  Apologize for the long post, I probably missed something so if something doesn't make sense, let me know - I tried to summarize as much as possible to keep it short. :)

[Derek Daun]

I'm not super familiar with Mansion Flats, but based on my familiarity with Midtown and other surrounding neighborhoods, I'd think the most value in the property is going to be as a 2-3 plex (maybe 4). I don't think there's high demand for single families in that area, and the trend is going towards converting SFR into multis around downtown anyway.

With that in mind, it makes more sense to spend the money to jack it up to gain legal floor space on the bottom now, compared to later after the main floor has already had improvements. If you do a nice SFR improvements now, future investors won't want to pay a premium for your improvements if some of them need to get ripped out to convert the property to multifamily.

Jack it up, and put in two 1bds on the ground floor, ~100k.  Maybe another ~80k for the main floor.(That might be a little tight, since your talking a brand new kitchen, bathroom,  HVAC, roof....) You're probably going to be running new plumbing to the street anyway, so this way the entire house can be done right. Same with the electrical. Put in as wide a garage as the city will let you, with a 'workshop' on top, that could possibly get a variance for living space in the future. (~25k)

Rent it out, and sell it fully rented to someone from San Francisco with a bunch of 1031 money burning a hole  in their pocket. Now if you can still make money doing that...