First off I apologize for the crazy long post, but I don't post a lot of these, so I want to have some meat and potatoes in here when I do!
Investment Info: Buy and hold duplex in Minneapolis, MN
Purchase Price: $300,000
Remodel Budget: ~$73k
Actual Cash Invested (outside construction loan): ~$22k
After Repair Value (via HELOC appraisal): 495,000 (460k on initial construction loan appraisal)
Monthly cash flow: $664 (when I move out)
What made you interested in investing in this type of deal?
I own two other duplexes in South Minneapolis where I implemented this same strategy of buying a property that was clearly underpriced given its location. I had just fulfilled the owner occupancy requirements from refinancing my primary so I wanted to find the next househack ASAP to minimize cash outlay on my next investment and start that 12 month timer once more.
How did you find this deal and how did you negotiate it?
This deal was on the MLS. It had a steep price drop from 350k to 300k after just a couple weeks of being listed. One of the agents in my brokerage had the listing so I knew the sellers were motivated and wanted an easy transaction. I had no interest at 350k but when I walked through after the price cut I knew I had to have it. I didn't negotiate the price, gave them 305k with 5k closing costs covered.
I put in a 7 day inspection contingency but made it pass/fail so they knew I wouldn’t nickel and dime them. The house was not only vacant but also completely empty which was nice, so this was my first purchase where I didn’t bring in a professional inspector. I would still recommend getting an inspection done in almost all scenarios, but with it being vacant I had time to do a thorough inspection myself and unless there was some huge latent foundation damage that I missed in initial walkthrough there was no way I’d back out.
How did you finance this deal?
This was one of the coolest parts of the deal. My pre-approvals were for an FHA or 5% HFA preferred state of MN Conventional loan (higher income limit than HomePossible, but also higher interest rate). I think FHA inspection would have failed due to the condition of the property here and I wanted to save my FHA if possible, so I offered with the 5% conventional, which was accepted. But I remembered a conversation I had with an investor around 2 years ago about a construction loan specific for househackers that would work well here. Lender offers 85% of the ARV (based on scope of work you provide) to fund purchase, rehab budget, and closing costs. So we amended the contract with the new loan and it was all good.
To give an idea of the numbers, the initial ARV was 460k so they could fund 85% of that, 391k. My PA was for 300k and I had estimated around 50k for rehab (ended up being 61k), so even with closing costs I was well below the 391k number. So my new goal was refinancing at 80% LTV without bringing cash to close at the refi, so I'd have no PMI and a higher equity cushion in the deal. That would be purchase + rehab + closing costs all in at 368k or less.
This loan is awesome for fixer uppers that are going to be house hacks. The construction loan charges 5% interest only for up to an 11 month term.
How did you add value to the deal?
Every square foot of this place got new flooring and paint, that was a given. With this being a duplex, I ended up gutting 1 of the kitchens and 1 bathroom which wasn’t part of the original plan, but scope creep is inevitable with these old homes. All new trim save for a couple rooms, new light fixtures, stainless steel appliances, quartz countertops, yada yada. Pretty standard mid to high end remodel finishes, I added before and after pics at the end of this post, if you ever make it there! Haha
The major undertaking and something I hadn’t done before was a basement remodel where I added ~500 sq ft and an additional bedroom to 1 of the units, making it a 3 bed/1 bath. After the original construction loan and refi I decided to do this on the other unit (where I’m living) as well, though given the location of the furnace it ended up being around 325 extra sq ft on this side.
What was the outcome?
It felt like a 4 month sprint to get all the work done so I could close my refinance while interest rates were on their way up. I ended up closing the refinance on April 1st - if possible I always do the start of a new month, that way I don’t have a mortgage payment until June 1st, just another tidbit that most probably know, but if not then not ya know :)
My rate for an owner occupied duplex was 4.375% - locked on Feb 28. I spoke with my lender in April about what the rate would be in May and they mentioned 5.75% which might even be a little higher now.
My PITI payment on the 368k loan is $2501. I'm living in 1 unit, income for the other is $1975. My unit is also a 3 bed 1 bath and remodeled and I'm estimating market rent at $1925 for my unit given some slightly less desirables.
That puts total income at 3900. I pay the water/garbage bill for the house which typically runs ~$150/month for a duplex in Mpls, I'm allocating 15% expenses for vacancy/CapEx/maintenance, and I self manage so no PM fee here. Expense ratio may seem low but this place has a brand new roof, newer mechanicals (less than 5 years), and I just spent 4 months fixing the rest haha. With the PITI at 2501 that brings total expenses to 3236 for monthly cash flow of $664.
My initial rehab for the construction loan ended up costing 61k, so considering all closing costs and escrow on the refi my cash to close was ~10k for the refi (alas, the no money down deal eluded me). After I closed this I finished my side of the basement and spent ~12k on that for the additional bedroom and 325 finished sq ft.
The last step of this process was accessing some of the equity I built, which I did by utilizing a home equity line of credit at 90% LTV. The HELOC appraisal came in at 495k, so 90% of 495k minus a loan amount of 368k comes to a 77.5k LOC. I spoke with the appraiser and he said he went on the conservative side to make sure it would get through underwriting. I was optimistic that it might appraise in the mid-high 500s given that the 3 most recent duplexes in 55409 zip sold for 627k, 630k, and 720k, but they are definitely more desirable and in my opinion probably not worth their sticker price, so I don't have too many qualms over the appraisal. He did mention that it would be tough to justify my desired value given my purchase price in late 2021 and improvements that were made, which is fair. I don't think I deserve that high of an appraisal based on the work done, but if the bank was willing to give it to me I wouldn't say no to cheap money haha
Speaking of that, HELOCs are nice as they have an extremely low cost of capital - closing costs are only a couple hundred dollars and appraisal is the most costly part if you even need one (some lenders will offer desktop appraisals, or use a refi appraisal). HELOCs come with some risk, for sure, but you need capital to scale and it's a more advantageous way to tap into equity (on a primary residence) over selling and looking at a potential capital gains hit and other transaction costs. Given the fed's plan to raise interest rates, I would focus on using this HELOC in a short term scenario like a BRRRR or flip where I could pay it back with a sale or refi, because I don't want to have too much variable debt right now as most HELOCs are ARMs that track at some margin above prime rate. I've been paying 4% interest only (+ extra for principal) on a current HELOC, so even as rates go up it's still a far cheaper option than hard/private money.
Lessons learned? Challenges?
Lots of challenges here but they all boiled down to one common theme, trying to move too fast. When dealing with the city inspector for the basement remodel, the contractor I used did not draw up detailed enough plans which would have raised concerns over specific parts of code with headroom by stairs, landing requirements, etc. I was impatient and wanting to start so I didn’t ask my contractor to redo plans, hoping things would end up okay during rough-in inspection. We failed miserably and I ended up needing to shift the stairs back for headroom/landing requirements, bring in a structural engineer to sign off on work, redoing the plumbing rough-in for tub for fire wall separation between units, constructing a new 1 hr fire wall in basement, etc. Never a good time to hear this but it would have been a lot better during the plan submission phase, and saved time in the long run. Slow is smooth, and smooth is fast.
I definitely learned some lessons too and will give a few of the major ones. Conservative underwriting and stress testing deals is huge. In Fall 2021 my interest rate would have been around 3% on this deal. I underwrote at 3.25% because conventional wisdom was that the fed was going to raise rates starting in the spring but maybe around 25 bps per quarter (LOL). I closed at 4.375 but had I went a month or so longer on rehab that could have easily ended up a lot higher. At 5.75% my lender mentioned my monthly cash flow would drop down to $310/month.
I’m finally getting around to the importance of hiring more work out as this rehab really took a toll on me. I’ve thoroughly enjoyed most of my time spent these past 2 years rehabbing this project and others, but there’s always a cost to that time spent. Many weeks working 70-80 hours (that’s including 40 hrs from my W2 job) doesn’t leave a lot of time to grow elsewhere in my life. I’ve been able to work alongside my parents a lot which is awesome, but apart from that all the time dedicated does feel very one track minded towards trying to build wealth, for better or worse. Especially now with my real estate license, if/when I do take clients on I can’t expect to DIY rehab projects and represent them to the fullest while I still have a W2 job (maybe I just need to lose the W2? lol). Anyhow, no regrets on that time spent as it got me into a situation financially where I can even think about hiring this work out now. Just trying to leave a little more margin in my life for health, relationships, other hobbies, etc. I know this gets talked about all the time with entrepreneurs but figured I’d say my piece.
Lastly, I’m also slowly shifting my mindset from buy and hold to looking at the velocity of money. With how much home prices have gone up relative to rents it’s always good to look at your return on equity to see if you’re still getting a good return, or if you could generate a higher return elsewhere if you sold. With that said, it’s tough to find a good yield right now at higher residential interest rates, so I’m at least entertaining other asset classes now such as a small apt. buildings or investing outside my home market. Regardless, buy and hold with small multifamily is great but I’m always trying to grow and take on new challenges. I certainly wouldn’t say I’ve mastered remodeling duplexes after doing just 3 of them, but I think I’m ready to take on something bigger if the opportunity presents itself, or I hunt one down :)
Did you work with any real estate professionals (agents, lenders, etc.) that you'd recommend to others?
Agent: This was the first deal I closed with my real estate license :)
Lender: Falcon National Bank for the construction loan portion, Kim Peterson with Luminate for the refinance. Mike Kadier at TruStone Financial Credit Union for HELOC
Contractors: One I'd highly recommend for Egress Window is Doston Holdings LLC. But others include plumber, HVAC, electrician, quartz countertops, hardwood floor refinisher, carpet, drywall, etc. I worked with a lot here so just PM me if interested.
