Purchasing a 4-plex to live in

[Jesse Holmes]

We are looking at purchasing a brand new 4-plex to owner occupy while we are stationed in the middle of nowhere, Missouri. Each unit is 2 bedroom, 2 bathroom, and the average rent on units like these is $875. The electric is divided, but the water, sewer, and trash will be our responsibility.

Elsewhere in the forums, I read that one investor would bump up to a %60 rule for expenses if he was paying the water for all units. Using that as a rule of thumb:

$3,500 monthly rents
$2,100 expenses
$1,600 debt service

This property would cashflow at -$200 per month.

Now, I did run this by the 2% rule:

3,500 / .02 = $175,000

I know that it's a rule of thumb, and I know that I'm not going to get this place anywhere near $175K. The $1600 debt service was calculated conservatively by our lender based on the asking price. The builder needs to move this property, but as you might imagine, it is taking him longer than the duplexes he built in the same area. In other words, I'm fairly certain my debt service will be less than $1,600.

I'm currently leasing a house for $750 in a town across the valley. Because we share a vehicle (until the ice goes away for good and I can ride in on the motorcycle; wee!), this means $20 a day for gas and eighteen hour days due to our schedule overlap. The 4-plex is only 5 miles away from where we work.

Tell me if I'm thinking straight or over justifying purchasing this place (with %100 financing) as a residence for the next two years.

[Orest Omeliach]

I'm pretty new and I have no answers for you haha.. sorry, but I have a question. Are you renting out all 4 units or are you planning on staying in one?

[Jesse Holmes]

Welcome to BP, Orest! Go introduce yourself:
New Member Introductions

We will be living in one of the units. Owner occupy. You know, some of this REI language sounds like dog show language (e.g., bred by exhibitor). Even when it says what it means, it looks a little Greek at first!

[Eric Knapp]

Well, here is the thing. After two years you have to either sell it, or make it profitable. What is your plan?

[Orest Omeliach]

Thanks for welcoming me!! Haha I guess you have a point! So wouldn't your negative cashflow be more than -200 since you're not collecting from the 4th unit?

[Jesse Holmes]

Orest Omeliach, that is a great question that I didn't know how to answer. I assumed that as long as I was responsible for my portion ($875 in this case), the rule still applied to 4 units. I found this discussion to help with an answer. I bet @joel owens has posted the answer somewhere I haven't looked.

Also, I noticed that I double-dipped with my tax estimates, adding them to both the 60% and the debt service.

Eric Knapp, I had the same thought. With what I just stated above, 4 units is 4 units, the cashflow technically won't change when I move out. That makes this a -$200 deal, period, right? In that case, when it comes time to move, I would either need to add income or reduce my payments just to break even.

There are many duplexes here that are sold in halves. Maybe I could lease option the individual units as an additional exit strategy—which would surely involve dividing the water mains. That's not my best idea!

In two years, I may be in the same position as the builder—attempting to unload a 4-plex.

[Jesse Holmes]

Eric Knapp, I just realized I didn't really answer your question directly. My plan would be to hang on to the property for a good while. It's new, and it looks far better than some of the one- and two-year-old duplexes that were built by another builder here in town. Those left us feeling very concerned about some of his choices!

I would have two years to figure out how to make it positive, depending on where we end up on price.

[Jesse Holmes]

I fell asleep reading the BP forums last night (isn't that what you want to hear, Joshua Dorkin?). This is what I've learned so far:

The 50% rule is a guide, not necessarily a rule. It's meant to evaluate the potential performance (or potential risk) of an investment long term. A brand new property that is still under warranty and is filled with appliances under warranty, proper tenant screening by an established property management company … all these things should help to mitigate risk in the first 7–10 years.

Joel Owens, a MFH master in the ranks, reccomends the use of 60% when responsiblity of the water bill falls to the landlord.

Some have suggested that a number closer to %40 can be used when considering new construction.

If I stick with 50%, the property cashflows $150—but certainly not per unit.

I'll keep working these numbers as I gather more information throughout the week, but any additional input would be appreciated.

[Joshua Dorkin]

Jesse Holmes - That is exactly what we're hoping for . . . I've done it more than a few times myself!

[Brian Morgan]

HI Jesse,

First, Thank you for your service! I wish best of luck finding a place that will work for you.

That being said, I hate the 50% rule! As you already mentioned, it is a guideline. Using 50% or 60% on this property will throw the numbers way out of whack.

Do you know what the taxes and ins. will be? Does your debt service number include these as part of a PITI payment? Or are you separating them out? The 50% rule is including taxes and ins.

The biggest factors are going to be:

Management (10%), which you will likely manage on your own to start, then need to contact out when you need to move on.

Vacancy (5%-10%) depending on area. Even if you are renting at 100% all the time, I would never go below a 5% vacancy factor.

Maintenance (10%) probably lower for new construction, but I would budget this in and build up a reserve.

The other expenses are going to be the water, sewer and trash which you should be able to get from the town/county as well as the seller.

If you have the Tax and insurance #'s you should be able to come up with a more accurate number based on the actual expenses instead of the 50% guideline.

All the Best!

[Jesse Holmes]

Brian Morgan, the taxes and insurance will be counted in the debt service. That means I've double dipped, and in the end the numbers should work a little more in my favor because of it.

When I bought my first property, I wasn't thinking of an investment. I was thinking, "This place is litterally 700 meters from the post gate." I didn't buy it as a deal.

This time, I speak a new language—fledgling or not—and I want to do better by myself. I'll keep everyone posted!

Thanks for your help!

[Al Williamson]

Jesse Holmes good job tapping the collective know-how of your BP family. As Brian Morgan suggested, at this point in your analysis, it is time to put real numbers into a spreadsheet. Sounds like you've decided to proceed.

Time to do the heavy lifting needed to get actual numbers?

[Jesse Holmes]

That's right, Al Williamson. I'll know more about the taxes and insurance on Thursday, I hope. As for the FMR, I've asked three PM companies in the area so that I can get a better idea.

[Jesse Holmes]

Aside from all the discussion above, I wonder if someone would consider this purchase differently if they were doing it with zero money down the way we are.

[Elliot Mendoza]

Hey Jesse, just some friendly advise since you're looking at a quad and you're military.

Don't go for this deal.

You're getting a loan for a negative CF property. Even if you do pull 150 net from all 4 units, you have very little wiggle room for vacancies and everything else. Will you be doing the management yourself while you live in it? If not, then when you leave and use PM, the amount you lose per month will be even greater.

So, when it comes time for you to move in 1-2yrs, you'll still have a negative CF property, but you'll also be looking for a place to live and stay in. If you're looking to get more loans in the future with which to invest in, having negative CF properties is the wrong direction to go as banks will see that on your tax returns.

Hope that helps put things into perspective. Something I have to consider myself since I'm also military.

[Jesse Holmes]

Elliot Mendoza, noted, and that actually brings up an interesting point.

I wasn't looking for a deal when I bought my first property. Now I'm replenishing my cash reserves from all the pitfalls involved with an Army PCS that goes tragically wrong, including a house that sat vacant for a quarter while unexpected repairs and a bout of bad PM kept tenants away. I miss that place. I loved living there when my mortgage was so much less than rents, and the location … ah! The location!

Now it's a liability that is cashflowing $25 a month—the wrong way. If I had only known then … . Looking at that property from an investor's standpoint, it's a 62 year old property that is negative cashflowing $500 a month. I need a serious exit strategy for that thing!

The flip side is that if I had never developed an interest in REI, I might have looked at this property the same way. $1900 a month in passive income is half of my paycheck! I'll take two!

Your advice is dead on, as no one wants to buy something that is going to suck them dry when they know their job will move them again in 20 months (who's counting?). Tomorrow I'm going to put in an offer with numbers that work, and if they think they can move it without my help, I'll just keep looking.

Where is that point that I thought was so interesting? Oh! From the lips of our former Commander in Chief, "Fool me once … ".

Thank you for your service!

Also, for anyone else that is keeping any eye on this thread, I may have some interesting news tomorrow about the rents in that subdivision.