First, I must congratulate my friend Brandon Turner on his latest acquisition of a triplex which he recently discussed in his article “How I Found, Analyzed, and Bought an Ugly Purple Rental Property.”
The numbers he provided looked great.
This definitely seems like a rock-solid deal for Brandon (except for the cash out of pocket), but I do see some elements of this acquisition that give me heartburn…
In fact, I wouldn’t have touched it with 10-foot pole and I caution you against it as well…
I want you to know that I asked and received permission from Brandon to write this article. I am writing this in the interest of all of you newbies out there, because while experienced operators like Brandon will more-than-likely do very well with this deal, there are structural elements here that represent a great case study of the less obvious things that can potentially be very problematic…
When we talk about a triplex, what we are really talking about as income investors are 3 units representing 3 revenue streams. It is important to realize, however, that not all 3-unit properties were created equal.
Did you take the time to view the video as part of Brandon’s post? I did, and I also read the entire post. I am not sure if you noticed this, but the video seems to be missing one vital piece of information which is contained in the text – the fact that this building used to be a single-family dwelling and was at some point converted into multi… In the world of triplex buildings, this one is indeed a Waldo; it does not conform!
“Who cares,” you say – “it’s three units and three revenue streams!”
Understand – the original design and functionality of all of the mechanical systems was intended as a SFR and not a multi-family, and while systems have obviously been adapted, we just don’t know how well and proper this was done, which can lead to significant headaches later on. Let’s look at some of the elements that could cause concern:
In the case of centralized municipal sewer system, the main sewer line from the house is connected to the main city line at the street level. Each connection is what we call a “tap” and its size is designated to accommodate a specific number of units, in this case 1. In order to add additional units, one would have to either pull permits and pay the fees for additional taps, which can be thousands of dollars in most municipalities, or the new lines could simply be tied into the existing plumbing.
Most people do the latter and the problem with this is that a line which was intended to handle waste from 3 baths, 1 kitchen, and 3 toilets is now handling almost twice that volume. This may be no big deal, or it may cause some stinky issues. Not to mention that if the work was done under the cover of night and without pulling appropriate permits, this means the work was never inspected. As such, Brandon bought a cat in the bag.
Now – even more serious can be a situation with septic sewer, and even though this is not relevant in Brandon’s case, some of you may run across a similar deal but with septic sewer system, so – listen up:
Government regulations regarding septic are stringent and become more so every day. Every septic system is designated to service so many units and so many people. If you buy a SFR and decide to convert it to duplex, you may be surprised at needing to replace the entire system – just saying.
And then there’s water and electric, which I’m not going to even touch at this time…
Size and Layout Of Units
There are a couple of issues that jump out at me with this investment relative to size and layout of the units. Let me begin by accentuating a general concept – in my understanding, successful income investing exists at the intersection of desirability to tenants and desirability to landlord. Put differently, while we absolutely must ensure that the unit is attractive to prospective tenants so that it rents quickly and stays full with well-qualified renters, we have to temper this with something I call ease of management; no matter how attractive and desirable the unit is to tenants, you will hate your life if this unit is difficult to manage and maintain.
With this in mind, a unit above the garage is just that – a unit above the garage. The staircase leading to the front door is in a lot of cases on the exterior and susceptible to weather, which creates additional liabilities on the owner. A unit like that comes with highly diminished desirability to tenants, as it for all intents and purposes precludes single parent with a stroller, retiree suffering from arthritis, or me – there is no way in hell I would ever schlep my behind up like that…
Then there is a basement unit, and I only have to say one thing here – this will not be rented to a single woman due to safety issues. Therefore, the market for a unit like that is single men. Depending on the demographics this could work, but…
The Big Unit
Now – this is going to take you out of the proverbial box a little, but stick with me. Here’s the deal – the nice, big, 3-bath unit is I am sure the sexiest thing Brandon’s future tenants will have ever seen. Who wouldn’t want that; Jacuzzi and all? Here’s the issue – the bigger the unit, the more people/larger family it can accommodate legally. Let me ask you: Do you want 2 adults and 5 kids in your rental unit as it relates to wear and tare? Do you want to clean out 3 sets of drains, and auger 3 toilets?
No problem, you say; I’ll just place occupancy limits into the lease. May be, or may be someone decides to sue you for discrimination under the Familial Status protected class of the Fair Housing Act of 1968 – and they would win in this case! You are going to have a hell of a time trying to prove to the feds that a family of 7 in a 1,000 sq.ft. unit with 3 baths is unsafe or unsanitary for the kids – trust me, they’ll have you…
As you gain experience, you’ll begin to figure out that it is very difficult indeed to control occupancy legally, and that the size and layout of the unit becomes the main tool. While it is reasonable to decline an application for a 2-bedroom/1-bath from a family of 7, it is not reasonable to decline them in Brandon’s big unit. So, when Brandon saw the nice, big unit with 3 bathrooms, he got excited; he still is excited. Me – I see nothing but liabilities in this; wear and tear galore and an inability to effectively limit occupancy. The last thing you want is HUD investigating you…
We get fixated on the numbers, and we should – numbers are important.
However, real estate is not about the numbers; it’s about people. All I’ve done here is look at the deal from a perspective of different people involved in the life-cycle of the asset. I suppose that none of the above is make it or break it, and one could learn to live with all of the above. But, in that we are looking for the cherries, we should try to see more than just the numbers…
[Note from Brandon, the Editor: I did indeed encourage Ben to publish this post, because he's right: there is more than meets the eye than just the math. The concerns that Ben addressed in this post are very important to understand going into a property.
That said, I also believe that there is no "perfect" property and by waiting for that one perfect rental, you may never purchase anything. Instead, do as I or Ben do ... and continue to educate yourself on these factors. The best way is by speaking with other investors and doing proper due diligence. Ben and I talked about this deal before I bought it, and I talked with numerous other investors about it as well. Yes, there are risks, and those conversations helped to identify them. Then, I factored those into the deal and made a decision based on my risk tolerance.
Yes, the sewer could be a concern (doubtful) and yes, these units will not appeal to everyone so my vacancy rate may be higher than average, and yes- I will be renting to a very large family with lots of kids. However, I will be going into this deal with full acceptance of those concerns and approaching the business and math with them in mind. If you do the same, I see no reason to avoid these properties with a 10-foot pole... just with eyes open and help from the BiggerPockets community!]
Photo Credit: jakedobkin