All Forum Posts by: Matthew Drouin

@Kerry G. very smart to engage an architect.  Some questions I would ask before engaging them officially.

What are the building code requirements for adding this second unit?

Can you give me some example projects you’ve done where you got Zoning Board approval in this same jurisdiction?

Then take the general information you get from that meeting and ask a general contractor about a general budget. Based upon those conservative costs, what's the ROI on adding that second unit from a cash flow and value standpoint? If it costs you $200k to build it, including soft costs, and it adds $200k to the value and $6000 a year in cash flow considering financing costs (Assuming 80% LTV) at a 15% ROI. That to me would be a no brainer.

If it’s much less than that, I would think hard on what your opportunity costs are.

And then make sure that the architect you do engage is experienced on getting variances approved within that jurisdiction.  Oftentimes there is a Zoning Board Of Appeals that is comprised of volunteers who need to review and then collectively approve the variances you are asking for.  An experienced architect will know what to anticipate.  And also having an architect with expertise in your area means that they should understand the zoning code like the back of their hand.  Sometimes complying with one part of the zoning code by making a slight change will trigger another part of the code.  For instance, sometimes they will have a parking requirement for increasing density.  If you have to add another spot, it might trigger max lot coverage or set back requirements from lot lines.

You may pay more for an experienced architect but it’s worth it

@Steve Mitrano this thread got bumped up in my feed and looks like you found a resolution but just to add.  Another work around that isn’t discussed much is working on a strategy with your insurance company to protect your other assets in the event of a claim.

But also, it wouldn’t be a bad idea to consider getting the financing into your LLc name with a community bank and pulling cash out if you have substantial equity.

Right now, since the loan is in your name, it shows up on your personal credit report.  Once you start stacking more and more property loans into your personal name, it can bleed into your personal credit worthiness.

This bit me in the butt when I wanted to refinance my own house when rates were in the 2% range.  Since I had a couple million in mortgages in my personal name, I couldn’t do it.  The banks thought I was a dead beat because of my debt to income ratio.  Plus no matter what I did I couldn’t get my credit score above the high 600 range.  Once I did a portfolio refi, I got all those loans off my credit report and my credit shot up into the 800s very quickly.

@Van Lam I had a client just run into this recently.  Many community banks will give you credit for proforma rents.  The best way to do this is to renovate a unit or two to the specifications to bring it up to market.  This ensures you have a proof of concept to show the commercial appraiser.  You can then get financing either through refinancing the entire debt stack or getting a second mortgage with the same bank that did the first mortgage.  Many times they will hold back the renovation costs in escrow and release once you’ve shown the renovated unit and leased it.  My client bought a 22 unit building and used this strategy and walked out of closing with a check for $800k to perform the rest of the renovations, paid himself back his already expended rehab costs and his entire down payment.  Hope this helps!

@Robert Quiroz I think all of the factors you have listed might contribute.

So I’m not going to comment on that but I am going to comment on an assumption you made.

If 85% of rents are below market on deals you underwrite then those contract rents are probably THE market rent.

You can’t just go based upon area median income to rent ratio.

First off urban areas are oftentimes street by street, block by block. So relying on 1, 3, 5 mile radius can be misleading because circles can be sloppy.

You also have to go on rent comps.  Perform this research by using the rent comp tool on BiggerPockets as well as FB marketplace, Zillow, Craigslist, etc Also for those 15% of units that are “at market”. How is physical occupancy?  More importantly, how’s economic occupancy via delinquencies? If you are going to test the market with a new standard, be patient.  Sometimes there is value to be unlocked in capturing a discrepancy between AMI to rent ratio but don’t leave yourself over exposed.  Pilot a unit or two with this renovation spec and see how much demand you get from QUALIFIED applicants.  Once you get some market feedback, you can perform accordingly.

@Tayvion Payton I don't care about price.  What about the location?  Is it desirable?  An 80% occupancy rate indicates low demand.  And this low demand could be a couple of factors, either a rural location with low population density or the area incomes are not high enough in order to prevent a rent burdened scenario.  If you look at the one mile income radius and you see median household income at 45k, then take 30% of that or $13,500.  Divide that by 12 months.  This would mean that generally the households in that area wouldn't be able to afford more than $1125 per month.  If the proforma has the rent roll at $1400 a month, there is a discrepancy that could lead you into a bad assumption on your business plan.

Also one caveat, be aware of physical delineations around the area like bridges or railroad tracks or a canal.  The 1 mile income radius could be misleading in either way to the positive or negative if the property is on the right or wrong "side of the tracks" so to speak.

The 80% occupancy, if it's solely due to the mismanagement of the current owner could be an opportunity.  Many banks wont touch deals that are sub 90% occupancy, so you could negotiate short term seller financing to help give you runway to make the building bankable for a refinance while you reposition it.

@Tayvion Payton to get a better understanding of the loan products, it's best to have a conversation with a commercial loan officer at a local community bank or credit union.

On commercial, the number one rule is a deal meeting their DSCR loan covenant, which is typically 1.2 to 1.25. How to calculate DSCR is NOI divided by Annual Debt Service. Also asking them how they calculate DSCR and whether its on Pro Forma or trailing 12 financials or tax returns.

A lot of times you'll see properties that don't make DSCR on tax returns because the owner might have booked capital expenditures or major maintenance to repairs and maintenance. Most lenders I work with go off of the Pro Forma income expense on calculating DSCR.

The terms can be all over the place. Some banks will do 80% LTV but only on a 20 year amortization schedule or 75% LTV on a 25 year AM. Balloon payments are very prevalent in commercial financing. Most banks will do a 25 year amort but only a 10 year term, which means you either have to sell or refinance the property at the end of the term.

Also be aware of prepayment penalties.  Most community banks in commercial lending will have a pre payment penalty if you refinance or sell.  They usually have a step down on that penalty like 3% year one, 2% year two, 1% year three and so on and so forth.

So if you are buying a deal with the intention of rapidly increasing it's value in less than 24 months in order to refinance it and pull your cash out, you might want to go with a credit union for the acquisition financing because FCUs are barred from charging pre payment penalties.

I could talk about this for hours about all the nuances but my fingers don't type that fast lol

@Leslie L Meneus you are trying to find a tribe of super freaks.

Let me explain…

Only 6% of Americans own one or more rental property.  If you own one rental, you are part of the exclusive 6% club. A freak.

Those who own larger commercial deals, I would venture to say 1% or less maybe? 🤔 

Anyway my point is you need to surround yourself with likeminded people.  Obviously you are trying to go down that track.

So go to as many meetups as you can.  And start feeling people out and figure out who’s real and which one of those you vibe with. And start the tedious process of building those relationships.

Or you could skip all that and find a mentor that also has the community of likeminded people.

It will take you less time but is likely going to require an up front investment.

Btw have you done a deal yet or would this be your first?

@Tayvion Payton if I were starting out again I would follow the “DDD” rule.

Just “Do a Deal Dammit!”

Newbies starting out get all spun around with:

😵‍💫 Do I do a single family rental?

😵‍💫 Do I buy for cash flow or equity?

😵‍💫 Do I do LTR MTR or STR

😵‍💫 House hack?

😵‍💫 In my backyard or out of state?

By the time they research and go down all the rabbit holes of different strategies, never sticking to one in order to gain traction, they get exhausted, throw their hands up and never take any real substantive action.

Pick something and go with it, all the way to its conclusion.  Remember, the first deal is not meant to make you money, it’s meant to get you into the 6% club (only 6% of Americans own one or more rental properties)  Get into the club and figure out which direction you want to scale.

If I were to start all over again, knowing what I know now, and assuming I had some good cash to work with (I was broke as a joke when I started), I would have done small commercial all the way.  And bought a stabilized value add 5+ unit deal.  Something that didn’t need a complete overhaul but something that I would do light cosmetic cleanup in a good area.

Reason being is that let’s say I bought a 5 unit building for 500k and put $100k down.

Let’s assume that building has $100k in annual gross rents. And where I could boost the rents 20% over a four year period.  Or $20k.  Commercial is valued differently than residential.  In residential (1-4 unit), you are hamstrung by what your neighbors property sold for down the street.  In commercial you are valued based upon income.  So assuming your subject property is in an area where the income capitalization rate is 7.5%.  You divide that $20k by .075 and you get a boost of $260k to the valuation.

Allowing you to take the property back to the bank, get a new loan with $208k of additional debt on the property, pay yourself back that investment and now you have enough cash to buy a $1M deal and use that strategy over and over while scaling exponentially.

Welcome @Tayvion Payton!

• Analyzing Deals: Typically 50% of revenue is going to go right to operating expenses on small multi family.  Could be less on newer construction but you’ll pay more for the property.  This is a quick and dirty way to quickly make heads or tails of the property very quickly to understand if it’s insanely over priced.
• Lessons Learned: I should have transitioned to larger commercial deals sooner.  It took me 11 years, 25 properties, and 76 doors just to replace my income.  It took me 1 property and 1 deal to replace my wife’s.  Every other mistake I made was valuable and part of the journey.  And you’ll make mistakes too.  When you make a mistake, 99% of them will not be fatal.  The only bad mistake that should be avoided is buying a bad location.
• General Tips: I could spend hours talking on this one.  Happy to connect one on one to dive into this and give you some clarity.

@Rebecca Cho I’m going to be a heretic here.  Even though your market might prove expensive, I would exhaust all options before ruling it out.

Truth is, you have a unique competitive advantage in your market.  You have relationship infrastructure and knowledge that took a very long time to develop.  And once you change to a new market, you throw all that out and have to rebuild it.

I love expensive markets.  They might not be great for cash flow but might be great for long term capital appreciation especially when you use leverage.

I’d rather own a $1M asset that breaks even but appreciates consistently by 3% than own a $100k asset that cash flows $3k per year.

There’s power in investing in or near your backyard.  Happy to talk further.  Cheers