Go Multifamily Right Outta the Blocks??

Question

Hi BP!

So I'm looking around my area for deals and was pretty much keeping my eye on small CHEAP (<$50k) SFH or cheap duplexes (<$75). The other day I decided to branch out for the hell of it and looked at multi-family properties in the area with a little higher price cap. I ended up coming across a nice 4 unit property going for ~$200k. I'd love to get some thoughts and feedback on the following:

LP: $200k

Units: 4 (all rented for $800/mo)

Bed/bath: All 4 are 3/1

Cashflow assuming mortgage payments of $1200/mo and taxes of $11k: Roughly $1,000/mo

Tenants pay all utilities. Taxes were about $11k last year. Nice renovation brought it current with rental-quality hardwood floors, updated fixtures, decent kitchen, and updated electrical. I consider rents to be low for the area and could be possibly raised to $1000 (after current tenants/over next 2-3 years).

Now I have considerable student loan debt (>$60k) but enjoy less debt-laden company, therefore I'm considering doing this deal with a friend of mine (possibly 2) to make it work and get this first piece under my belt. Questions I am looking to get addressed: General feelings and observations about this deal and the points I've made? Considering this sold for mid-$80's 3 years ago, what questions should I have for the seller? In regards to my partnership with a friend, I hear the best thing is to buy together as co-mortgagors, form an LLC, and shortly after closing use a quit-claim deed to transfer ownership to the LLC. Is that what BP would recommend? How do you see the best way to structure this deal since we would most likely have to utilize conventional financing? (If this deal looks attractive to any HML's I'd love to hear from you or if anyone wants to recommend someone PM me) What is the best way to get an accurate valuation for this property without a formal appraisal? I have a 5-year payoff as the standard for rentals in my head, is this right? Wrong, low, high? Thanks for everyones responses, I'm excited but nervous about making such a leap so fast and so early.

Andrew Stack · Answer

Absolutely. Luckily I work for a big ol' mortgage company and can pretty much run myself through and figure it out :) pretty convenient. My DTI is pretty high and I don't think it would go through no matter my LTV. I may have to investigate a few credit unions and smaller community banks. I hear they're pretty amicable when you come to them with a good, well thought out plan.

Paul B. · Answer

Hi @Andrew Stack ; I can't really advise on structuring a partnership. I've not had the opportunity to travel that road. I do know enough that you would need good legal counsel to work out your relationship properly and make sure you guys are each covered. I speculate your operating agreement or other legal items you draw up as partners (or members, if LLC) would govern how you pay for the expenses, how the note is treated, and who gets what and in what percentages. Banks always want some skin in the game - adding more down will do that, but they will still assess the borrower in terms of risk. If your debt to income ratio is good, you may qualify just fine. Even with student loans. So adding more down might help (not sure on that to be honest, but worth the question/conversation with a banker!) but it will cut into your cash on cash return. The mortgage will likely have to go in someone's personal name.The bank usually wants some "person" on the hook for the note! Then you transfer the deed to your entity later. Personally, on the partnering subject I would probably talk to a lawyer who is also an investor and is familiar with what you want to accomplish.

Andrew Stack · Answer

@Paul B. that helped enormously, thank you! I'm sure my agent can help with those questions. Seems to be experienced in the area so that's good. To address a big expense, I will be handling property management for the foreseeable future until we move away most likely. I suppose I'll probably recoup some of my cost by getting paid a little as a pm as well as an equity partner. I do feel $200k is high after your analysis and think I'll shoot for closer to $150k if I pursue this one. It has been well updated so I like it a lot and understand the expense involved in such a renovation but it certainly can't command $120k out of it. My new, seemingly more pressing issue/question is: How do I structure multiple investors on what will most likely be a conventional financing deal? I may end up with as many as 5 investors but cannot get financed under my name given my student loan debt. If I can secure a big down payment (upwards of 30%) do you think that would change the situation? If not, everyone I'm working with has excellent credit as well so we can probably put the mortgage under anyone's name. Do mortgages work like student loans where you can

Paul B. · Answer

@Andrew Stack I like your thinking. Buy low, add value/streamline ops, trade up. In my opinion, appreciation is "icing on the cake" for a cashflow mindset. (which is mine, so of course I like it! :^) It may or may not happen. Your market is going to be different than mine. We are definitely not appreciating like LA, Vegas or TX. What you will buy the property for is an interesting question. One way is net income valuation, which is NOI / cap rate. The realtor can hopefully give a clue on the cap rate for the area on this type of property. The NOI is predicated on knowing the income (which you have), and all the expenses. The REAL expenses, not the pro-forma happy-day expense numbers the seller will give. So that means figuring out from the pro-forma you have, what it will really cost - in ballpark terms - for: Property management (usually a percentage of gross rents between 6-12%. Call a few and ask), maintenance (tricky to nail down. I overestimate it. Some pro-formas go blanket 5% maintenance, but I don't believe that), insurance (get quotes), property taxes (which you have), landscaping, waste removal, and cash reserve. Let's say the cap in your area is 10%. Let's assume your NOI per year is $19,200. NOI is calculated without debt service. So divide that by 10%, your buy price is $192,000, +/-10%. In contrast, some say to start at 25% off the asking price and work your way up. If it's been on the market a while, this may be a good strategy. The net income method however does give me something tangible to take to the seller and show the actual value based on income, minus for deficencies, etc. The math does not lie. Hey, I hope this helped again and let me know how it goes! Paul

Andrew Stack · Answer

Hi @Paul B. thanks for the quick reply! I actually spoke to the listing agent yesterday and he told me that's low-middle on price for that type of building in the area. He also told me it's a little rough but a friend of his owns one of the apartment buildings in the same place. Thanks for the analysis! Based on what you found, what do you think I need to buy at? $150k? As for our goals, my friends aren't really versed in REI so I will essentially be making them investors. I think the first move is cash flow from a rental with improvements over the next 2-4 years and then sell with appreciation and 1031 into a bigger and better property. Probably a small portfolio of multifamily's up to a 50 or 75 unit apartment complex/building.

Paul B. · Answer

Hi @Andrew Stack Assuming all rented at $3200/mth gross, the 50% rule says $1600 to expenses, taxes, insurance, property mgt. Add $1200 in mortgage payments, this equals $400 cash flow. Assuming a conventional loan at 75% LTV, your downpayment would be $50k. Given that, your cash on cash return would be about 9.6%. If your seller is interested in holding the note, that could improve. There are definitely other creative ways to finance this stuff you can search on BP and check out Ben Leybovich's postings. Given that it's already upgraded physically, the rent increases may be the only upside potential to the property. That is, it's at the high end of sales prices in the area. But suggest digging into the operations of the building and see if there is any room for improvements there. Also get comps on other 4plexes in the area would be interesting. What is your collective friends goal for the property and exit strategy? Best of luck to you. Hope this helps.