Investment Info: Multi-family residential buy & hold investment located a 20-mile drive or 25-minute ferry ride from downtown Boston in the beach town of Hull, Massachusetts, also known as Nantasket Beach.

Purchase price: $550,000 in 2016

Cash invested: $137,500 from 1031 exchange (75% mortgage)

A 14-unit property on a corner lot, and it includes an adjacent lot as well (10,000 sq ft total lot size, double the town median lot size), giving an exceptionally large patio, yard, parking areas front and back, and a storage shed. The property is 1 of only 4 licensed lodging houses in the town. Topline was about $113,000 when we bought it. Backup alternative in this area is redevelopment to condos if an owner preferred that route.

*Note that we interchangeably use the labels: Lodging House = Rooming House = Single-Room Occupancy (SRO) = Co-Housing Property

The building has 3 kitchens and 4 full bathrooms, on 4 floors:

3rd floor: The 3rd floor is ‘off-limits’ to the 1st and 2nd floor tenants, so the two 3rd floor tenants enjoy the exclusivity of their own entrance, and a kitchen and bath shared only with one other unit, plus some distant ocean and Boston skyline views.

2nd & 1st floors: Eleven units share 1 kitchen and 2 full bathrooms, one on each floor. Since tenants are not all the same schedule, there are no bottlenecks for kitchen or bathrooms use.

Lower level: Large unit for the onsite-manager with private kitchen and bath (has windows in every room but is partly below grade), plus the common area laundry room, and managers’ tool room / storage room.

What made you interested in investing in this type of deal?:

Intriguing model – Fits the niche of offering a housing alternative that is cheaper than a studio apartment. The potential NOI and cash flows seem to be roughly double what a comparable ‘vanilla’ multi-family would be at the same purchase price (such as a 3-unit apartment building).

Many of the 14 bedrooms had not been fixed up in decades. Several had mint green walls with dark brown trim, and hardwood floors that hadn’t seen love in a very long time. About one-third of units have tile floors. The onsite-manager’s unit had a concrete floor which sometimes got wet from water coming over the sill in big storms. There was no laundry room. The grounds (patio, etc.) were usable but unkempt. About 8 satellite dishes hung off the outside all over the place, and many tenants each paid for their own cable internet/TV account. Appliances and fixtures were old and tired.

Basically, the core bones of the property were good, but there were a lot of things that seemed ripe for easy improvement.

The location was great, right next to the town’s primary commercial district, with a grocery store 100 yards away, coffee shop/bakery, Post Office, drugstore, hardware store, hair and nail salons, barber shop, dentist, bank, a half dozen restaurants, and a variety of other shops and services. And the wide sandy beach of Nantasket (3 miles long) is less than 400 yards away. It is right on the muni bus line, and there is no need for a car when you can easily walk a block or two to so many amenities.

For some people, co-housing is a lifestyle choice. They could afford their own 1-bdrm apartment, plus electric, heat, cable, snow-clearing, etc. But in a rooming house, they pay a much lower rent cost, and get the benefit of a professional cleaning crew doing common areas, kitchens and bathrooms, free high-speed Wi-Fi for their streaming devices, etc. Their only other bills are their mobile phone and car insurance, and with the rest of the money they save on rent, they can spend it on other priorities, whether it’s expensive toys, travel or paying down debt. The prior onsite manager lived there 15 years, and one tenant 10+ years; other tenants 8+ years, 5+ years, 3+ years.

We thought that it seemed like SROs fill a valuable niche, and that property owners who manage them stand to gain high-density cash flows commensurate to the high-density living.

How did you find this deal and how did you negotiate it?

It was on MLS described as "Investors' Dream". They neglected to mention that SROs (single room occupancy, aka lodging house, aka rooming house) also means likely very high maintenance, necessitating supervision and hands-on management.

The property had just dropped out of contract because the first buyers couldn’t get bank financing. Our 1031 tax exchange deadline was looming, so we didn’t try to negotiate and we simply offered the asking.

How did you finance this deal?

Bank mortgage with 25% down (probably could have done 20% down, but we had 1031 proceeds to put to work anyway between this and another property. The other property was even lower LTV.) We went with a community bank that portfolios the investment RE loans they do.

How did you add value to the deal?

After a thorough review of systems, we had plumbers troubleshoot and repair/replace a couple of small chronic bathroom leak issues, and electricians installed a number of end-runs back to the panels so that rooms could each have window A/Cs running without tripping circuits and other such issue. We also replaced quite a few old ceiling lights with new ceiling fan/light combos and replaced any cracked or suspect outlets, etc.

Kitchens got new stoves and microwaves and upgraded furniture in common areas. Room by room over several years (as they became available) we did complete makeovers: detailed prep work, painting ceilings/walls/trim, refinishing the old hardwood floors, etc. Outside common area space and furniture got upgrades too. Exterior didn’t need much – sharp new accent color for exterior doors, and other aesthetic enhancements, plus some upgrades on roof flashing and weatherproofing.

We discovered that the ground level water intrusion was because a huge crack in a sloping sidewalk next to the building was funneling all the stormwater right over the sill, into the onsite-manager’s unit. So we did a sidewalk replacement which immediately stopped the water intrusion 100%. We did use a high-grade vinyl plank flooring over the concrete floor down there, just in case, but years later we can say there have been no more water issues.

We also plumbed in and installed a laundry room, purchasing twin pairs of coin-op Speed Queens.

All of those renovations allowed us to go up-market a bit, from the prior $160/week to $180/week within the first few weeks on the incremental rehabbed units. And now it’s more like $200/week average. Multiply that by 52 and divide by 12 and it may sound uncompetitively high to you to compete against a studio? But remember that for studios, tenants typically would pay their own cable, electric and other utilities and maintenance, so the gap is bigger than just the base rent comparison.

Our tenants have the option of paying an extra $10/week to have a mini-fridge in their room, and $10/week for weeks they want a window A/C unit. We include free high-speed Wi-Fi and all other utilities, giving a huge savings for tenants, apples-to-apples compared to alternatives.

For both tenant and landlord peace of mind, the property had an extensive video surveillance and security DVR system already installed by the prior owner, which covers outdoor areas and indoor common areas and records 24/7/365, as well as sensors for excess dB noise levels.

We added a few more video cameras to expand the coverage. The property easily can be monitored from a mobile phone, tablet, laptop and/or desktop, and the software has screenshot and video capture capabilities, as well as the user being able to access and play historical footage from all or selected cameras simultaneously, if incidents need to be researched.

What was the outcome?

Rents: 14 units are currently rented for a $150,540 annual run rate. With historical vacancy factored in, that will likely be more like $143,000 rent topline, not including seasonal A/C surcharge revenue, plus about $1,520 in laundry revenue.

Expenses: Total operating expenses are running about $59,200, before depreciation or mortgage expense, and not including the offsite property manager role (me doing screening, etc). But those figures do include the onsite-manager, who basically just pays a discounted rent in exchange for doing the onsite-manager duties. Utilities $14,845, Insurance $13,530, Taxes $7,493, and on down the line items from there.

NOI: That yields $85,350 in current run rate NOI.

Lessons learned? Challenges?

Flood insurance: I’m all for being conservative on insurance policies. On another 10-unit mixed-use property in a nearby coastal town, we carry hurricane and earthquake insurance, in addition to O&L (ordinance & law) supplemental coverage. Most people in New England don’t bother with hurricane insurance, and even more people laugh when we say we have earthquake coverage (low likelihood?).

But for the Sunnyside Nantasket Lodging House we would not carry flood insurance if we didn’t have a bank mortgage requiring it. One tiny little corner of the building shows in the flood zone, but of course that drives the classification for the whole property. And actual major flood events in the last 45 years in reality have not come anywhere close to the elevation where this property is. The mapping models are constantly being updated for reality being different than prior modeling. So we think flood insurance on this one is a wasted expense each year, and can go away when we are no longer tied to bank financing.

Screening and vetting: As with every property, vetting good tenants is essential to success. But the intensity of that process becomes all the more critical when dozens of candidates are often interested in a rooming house vacancy. Most of them don’t qualify, but often they are not going to tell you the truth – you have to figure it out through your screening process.

Evictions for Cause and for Non-Payment: The frequency of needing court filings and eviction proceedings is higher than any other property I’ve ever managed. On the positive side, at least in Massachusetts, there is a special paragraph of the law that applies to rooming houses / lodging houses, which enables just 7-days’ notice to start an eviction for cause of an offending tenant when they are doing something that is creating significant issues for their neighboring tenants (or the LL). SROs are close-quarters living, and the law is written to help protect all the other tenants, giving the property manager a strong tool to manage problems.

In the five years we have owned the property, we have started 15 of these 7-day Notice short eviction processes. We have never lost a single case in court, and most cases don’t make it to court because the offending tenants know that we have well-documented evidence and understand the proper procedures to prevail. Minus the Covid-driven court closures and delays in 2020, we never had any issues with the process.

Overall we have vastly more “good” tenants, and the law allows you to get rid of the bad tenants and maintain a desirable place to live for the good tenants who you want to keep.

High-maintenance <=> High-Return: Those prior two points drive what I meant when I said the cash flows and NOI should be about double what they are on a “vanilla” MF (multi-family) purchase at the same price point, but it can be a high-maintenance proposition to manage the screening on the front end, the day-to-day management issues, the more frequent turnover and vacancies, and the frequency of needed court filings to get the keys back from a tenant when somebody is not being a good neighbor to your other tenants in the lodging house.

Bottom line: We think we were right on point five years ago when we identified that SROs fill a critical niche that is in extremely high demand. You don’t have to research very far to see the widespread housing trends toward more micro-apartments, co-housing situations, and all the other ways people are voting with their rent dollar in wanting a better value proposition at the affordable end of the rental spectrum.

Vacancy for an SRO can be kept quite low, and the density results in a very high cashflows compared to the same square footage of a triplex or 6-unit down the street.

Utilities bills are marginally higher with the SRO, because there is no incentive for tenants to conserve. Repairs and maintenance are higher with the turnover and harder use. We don’t bother with security deposits, so there’s no recourse against the outgoing tenant who destroyed the furniture that was ‘new’ (meaning great condition off of Craigslist) just a year prior. And don’t forget that your legal bills, process server fees, etc are higher.

But even after the expenses and the higher maintenance, the reward of the much higher NOI is there to be earned.

Compare: Put a 9% cap rate on an $85,350 run rate lodging house NOI, and compare what other multi-family properties you could buy for the same $948,000 purchase price? A nice 3-unit, with 2-bedrooms each? A decent 6-unit apartment building, with four 1-bedrooms and two studios?

Then look at the expected rent and NOI you are looking at for that 4-plex (or 6- or 3- or whatever) that you could buy for $948,000. Are you coming in more like $42,700 NOI on the comparison ‘vanilla' multi-family property?

And then take into consideration the higher time demand to manage turnover and screening applicants. Is this a model of investment you could take on?

Nota bene: all figures are intended to be accurate, but are not guaranteed or warrantied. Buyers looking at a property like this must do 100% their own due diligence.