My First Investment Deal w/ FHA Loan. Good or bad?

[Dan Rivera]

I am in the process of buying two 3-family properties. The first, I'll post here and provide updates along the way.

Property Info:

Unit 1: Studio basement apartment that is in good condition and was "somewhat" renovated. Kitchen is a little outdated, same with bathroom, but it commands a rent of $950.

Unit 2: Ground floor 1 bed/1 bath apartment. It has a very outdated, but spacious kitchen. It'll need about $12,000 to renovate. Bathroom is a little outdated (blue everything, yuck!) but is in good condition. It commands a rent of $1000 as is, but can get $1200-1250 if we pump $15,000 into renovations.

Unit 3: 2nd floor 2 bed/1 bath apartment. Well maintained and recently renovated, with the exception of the kitchen, which is outdated. It commands a rent of $1350 as is.

70% of population are renters and there is a steady demand for rentals.

Typical cap rate in the area is 5-7%. The property's current cap rate is 5.4%.

 The numbers:

Purchase price: 315,000

Closing Costs: 12,500

Down payment: 3.5% or 11,025

Monthly (current) Income: $3,100 (900, 1000, 1200)

Monthly Expenses:  $3,093.79

Water/sewer - $300

Insurance - $123

Taxes - $582

Electricity - $0 (separate, tenant pays)

Vacancy - $155 (5%)

Repairs and maintenance - $155 (5%)

CapEx - $155 (5%)

Property Mgmt - $0 (I will be managing the units, otherwise $217 or 7%)

The plan:

I'm considering this property because I see a lot of potential here. I will be moving into Unit 2, the 1 bedroom, in order to renovate w/o issues with tenants (then I'll probably move out after a year). In terms of renovations, I have two options: 1) renovate the unit with the current floor plan. It'll command a rent of $1200. Or, 2) renovate the unit and convert it to a 2 bedroom like Unit 3 (same sq footage). The spacious kitchen would be made a tad smaller and turned into a bedroom. The hallway that runs from the living room to the kitchen has a long, deep closet on one side and the bathroom on the other. The closet would be removed and the kitchen would take its place. There is ample room in the hallway for the kitchen. This would command a rent of $1350.

I believe the costs to convert Unit 2 to the new floor plan would be higher--however--not by much. I anticipate 50% of the labor will come from myself, my dad, and my uncle (who is a general contractor). Both of them have considerable experience taking down/ putting up walls, installing cabinets/fixtures. Plumbing and electricity will be handled by the pros. I have about $15,000 to spend on this reno project, and according to my calculations, this should be sufficient. Of course, my renovation calculations are based on research and not from any professional knowledge, so they could be wrong.

The verdict:

What do you all think? As guidance or advice is much appreciated. It seems to work because of my financing (i.e. FHA loan with 3.5% down, low interest rate). It's a bit risky in the beginning (CoC return of ~0.30%) but it provides the opportunity for a double digit cash-on-cash return after the first year if I raise the rent (10.78% w/ Unit 2 as a 1 bedroom, 14.76% w/ Unit 2 as a 2 bedroom).