Reader Question: “Should I Buy This Triplex?” (A Real Life Case Study)

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Today I received a private message from a BiggerPockets colleague (we’ll call him Jake) that asked a very good question about a potential property he was looking at. Rather than try to summarize, let me just show you the message:

Rental Property

I wrote out a rather lengthy response and then decided this would make a really good discussion here on the blog. So follow along with me as I analyze this potential property and show you how I look at something like this.

The Potential Rental Property Deal

Allow me to quickly sum up everything in the above question, just so we are all on the same page.

  • Jake owns a home already, with a mortgage payment of $734 per month. His home would rent for $900.
  • Jake is considering a Triplex that just came on the market in a good area
  • The triplex consists of a main house with two basement apartments.
  • The current asking price of the property is $250,000, but Jake is hoping to pay $210,000.
  •  Jake would move to the triplex, live in the main house, and rent his former house and the basement apartments.

So Jake’s wanted to know my thoughts. Would I do it?

Honestly, at first, I thought “Seems decent.”

HOWEVER.

Then I dug into the numbers.

(Watch the Video below, or simply skip the video and read the text explanation below it!)

The Analysis

When investing in real estate, you can’t rely on just gut feeling. This is a math game, and it has to begin there. After a few minutes of looking at the numbers, I could quickly see this wasn’t looking pretty.

To make things easy, I headed to the Rental Property Calculator here on BiggerPockets. I use this thing every single day to analyze potential deals, and it hasn’t let me down yet.

Here’s what I discovered:

Jake

A few things to point out:

  • Whenever analyzing a live-in multifamily property, I always run the numbers AS IF I were renting all the units out. This way, you can compare apples to apples. Also, an investor isn’t gonna live here forever, and it WILL become a rental soon enough.
  • Potential income, I estimated, would be around $2100 per month if all 3 units were rented.
  • Potential expenses, I estimated, would be around $2332 per month.

This shows a potential negative monthly cash flow of $232 per month. This should be enough to stop most investors, but just for the heck of it, let’s explore the issue a little deeper. In the following screenshot, I ran the numbers as if the main house unit was being lived in by Jake, so we could see what it would actually cost to live in the property:

Jake 2

As you can see, if Jake were to live in the property, he could expect -$872 per month. What this means is that it would cost Jake roughly $872 per month to live in this home (plus his own utility payments.)

Is this a good idea?

Well, let’s talk more about that.

When Would This Purchase Be a Good Idea?

No one wants to lose $872 per month in cash flow. That’s bad… right?

I think this depends on what Jake is currently paying in his real estate market to live. If the average home would cost him $2,500 per month to live … well, $872 is a whole lot less than $2,500 so it might not be such a bad idea.

It depends on Jake’s situation.

A second reason it may be advantageous to purchase this triplex is for appreciation. After all, check out the graph below, which also came from the Rental Property Calculator, that shows what 2% per year appreciation would look like over time.

Screen Shot 2014-03-14 at 2.50.15 PM

The green line represents how much equity Jake would have (assuming he starts with $50,000 in equity because he got his $200,000 offer accepted) over $200,000 in equity by year 15.

Now, personally, appreciation is NOT my game. I don’t invest for appreciation, and don’t generally recommend new investors do it either. However, it is a strategy that has worked for many people in the past so I need to at least bring it up.

To sum up the advantages: If Jake needs to live somewhere anyways, and he can live in this home for significantly cheaper than living elsewhere, and he can take advantage of a rising real estate market with minimal cost out of pocket (and he can learn how to be a landlord while doing it) it’s not necessarily a terrible decision.

Conclusion

So what should Jake do?

What would YOU do?

I just hung up the phone with my friend Ben Leybovich, and we spent a while talking about “perspective” in real estate. The mechanics are generally obvious and fairly black & white. However, it’s the “perspective” that is often difficult to grasp. This is why I believe discussions like this are so important.

Just like the post I wrote last Friday, titled “Let’s Get One Thing Straight About “Waldo…” (A Follow Up to my Debate with Ben),” I firmly believe the best way for a new investor to become a Pro is through opening your mind, and your mouth, in conversations like this.

So do me a favor and open yours below by commenting and letting me know your opinion. Should Jake buy the property? Why or why not?

(Also, if you don’t mind sharing this on your Twitter, Facebook, LinkedIn, Etc – I’d be very much appreciative!)

Happy Investing!

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About Author

Brandon Turner (G+) is the BiggerPockets.com Senior Editor and Community Director. He is also an Active Real Estate Investor (Flips, Apartments, and Buy-and-Hold), Entrepreneur, World Traveler, Third-Person Speaker, and Husband. Come hang out with him on Twitter!

31 Comments

  1. I’ll just nibble at the edges with two thoughts, and let you guys do the heavy lifting (is that a mixed metaphor?):

    1. Are the basement apartments legal? Often such units are not.
    2. Jake owns his current home? Unless they’ve changed this rule (along with so many others recently), if he lives there two out of five years, he can probably exclude most or all of the capital gain when he sells. So if he hasn’t been there for two years yet, he may be sacrificing a nice benefit if he moves out now.

    • Brandon Turner

      Frank, I hope you know how much I love having you jump into these conversations! As for point 1 – that’s a great question and I’m not sure. For this example’s sake, let’s say “yes, it’s legal.” Obviously, if they were illegal, and could not be “made legal” it would make this a 100% “No” deal. However, if it is legal, it’s only a 90% “No” deal. Thoughts?

      Your second point is something I never even considered (which is why I love these conversations.) That’s a REALLY good point, and one that could have huge ramifications for Jack. Right on! Thanks Frank!

  2. Ben Leybovich

    Nice job Brandon!

    I only watched the video cause I wouldn’t have time to talk to you on the phone if I took the time to read the entire thing :)

    The video is very good, though. Your follow-up perspective to the analysis was the most poignant. What we need to understand is that rent is paid with after-tax income. This means that in order to pay $2,500/month of rent we would have to most likely earn at least $3,500 – pay $1,000 of income tax, and then pay rent.

    In this case $900/month or so in this example would move us considerably in the right direction; and that doesn’t take into account depreciation…

    In Podcast 61 I made the assertion that analyzing a building is pointless unless said analysis can be placed within the fabric of the marketplace. This is no different. Since the property is not a pure investment, but a place to live, which means that we are not simply analyzing Passive Income but Earned Income as well, the DESIRABILITY has to be placed in context of impact on the entirety of our financial life and not just our investment life. Very nicely done my friend :)

    • Brandon Turner

      Thanks Ben. I agree 100%. (You and I both have been dwelling on this “perspective” and “context” thing for a while now. I think we’re on to something big!)

      And good thinking on the after-tax thinking. I hadn’t thought of that. So yeah, there definitely could be a reason this property might make sense given the right person and right circumstance. As my wife tells me a lot (when she wants some kind of home improvement task done) “not everything in life has to have an ROI.” She is a smart lady.

  3. Brandon,
    I agree with your analysis. The 2 big factors are the delta between Jake’s current and potential cost of rent, and where he stands with cash flow / appreciation needs and time.

    • Brandon Turner

      Definitely Adam. However, do you think it’s still a good idea- knowing he may move in a few years? That’s where I start to get nervous. Negative cash flow is fine when it’s something you live in (it costs money to live) but once it becomes an investment, it’s no longer cool! Thoughts?

  4. Gentlemen, an erudite, entertaining article and commentary. (Brandon, love the video, including the Rental Property Calculator). Now, as a member and fan of your gender, I appreciate all the numbers and incisive financial analysis. However, one critical question has yet to be asked, which is, “is Jake soon-to-be or already married?” Because if he is, I can assure you as a former practitioner of marital bliss, the final decision is very likely out of his hands. :D

    • Marital status and spouse’s W2 income was my first question too. We don’t know how much she makes or how much she could stand to ‘bleed’ to fund the appreciation. If combined income approaches the married cap of $155,000 then the tax strategy overrides just this one asset’s Cashflow. If the first asset can cover the $900 negative Cashflow and combined they break even, then depreciation is their best friend.

      We also don’t know liquid reserves situation. If monster appreciation is expected and they can bleed savings to cover the expenses, much as one would fund an IRA or tax-advantaged college fund, and still be six months liquid, then this triplex could make sense. I believe if they stay two years, they also avoid the gain. Here, the location would play a role, maybe they want to be closer to a certain school or grandparents, or the office.

      My gut tells me that the rents could be higher already and with upgrades in the units, another $25 to $50 higher.

      The other leg of the stool is anticipated capital expenses. How old is the roof. How old is the Hvac? Do I have to buy more appliances shortly? Has the plumbing been updated? Has the drain line been compromised.

      Economic factors to consider. Is this part of town in high demand for one bedroom apartments or are young singles flocking to a different neighborhood. Is the local major employer expanding or relocating? Are there new apartment communities coming online, with superior amenities? These millennials are paying $200 above market for new apartments that have weight rooms and pools.

  5. Brandon these case studies are awesome, I love the calculator too. Definitely my favorite kind of blog post. Also you NEVER blink lol.

  6. Sara Cunningham on

    Great analysis. Since it’s impossible to know all the personal details of Jack it’s a hard call. I think I might go for it, but that would be because I would be in possession of all the relevant facts needed to make a good decision.

  7. Has the neighborhood grown or declined in recent years? Homepath has a neighborhood characteristics link that says grows since 2000 in the area I’m looking. Not sure if it does the same thing everywhere. But I have compared growth rates of a couple areas I’m looking into and it will be a factor for my due diligence.

  8. Wow. I just watched the video and reviewed the numbers. I think we need a better grip in the taxes, insurance and capital expenses. These could make or break the decision. Also we need to know local income tax levels. We don’t know if this property is a hurricane state without a state income tax, like Florida, or in the Mississippi River floodplain, or if earthquake insurance is required. At least we know it’s in the US because it’s an FHA loan.

    My homeowners insurance is $2,400 annually, for my primary residence. Most of you would consider that ghastly. Taxes are $600 annually, on my primary residence. I do not have a state income tax. My point is: across this country, taxes and insurance vary widely enough for these decisions. We need more info.

    Using a low capex and swagging on the insurance expense produce a “no go”. (SWAG = scientific wild a$$ guess). The analysis then becomes intellectually flawed.

    My gut tells me that with a $250,000 ask, this must be in a location where income is less important than maintaining a high barrier to entry, aka an A or B location where schools are superior and the houses are newer or bigger than average. If “Jake” wants to be closer to his parents or on that particular side of town, then location location location would compel a closer look.

    Also combined asset strength should be a examined, in the view of overall tax avoidance strategy.

    I dislike being negative so let me say that this analysis and discussion is fantastic. Thank you Brandon for doing this. You and the commenters have demonstrated that one size does not fit all. There are nuances in this case study that cannot be read in a book or learned at the weekend seminar. This study is all meat and potatoes and I am starting to see that only one percent of people leave a comment.

    From me to you: keep doing this kind of stuff. You don’t know how much wealth you’ve helped me acquire these last two years. But more importantly you’ve served as a psychogist too. I am not crazy! I am elite! (Elite in that I’m actually in the game). Rock on!

    • Brandon Turner

      Hey Joe, thanks so much for the great comment! Yeah, you are 100% right: there are SO MANY nuances here, that could never be fully looked at in a post like this. However, hopefully that’s what people can learn from a post like this: It’s about a lot more than just “it seems cheap.”

      Thanks so much for reading and commenting!

  9. I agree with others there’s a ton of info we don’t have, but if Jake can rent his current house for $900 and only pay $872ish for rent in the triplex, then theoretically that’s an almost lateral move in terms of “his” monthly housing costs.

    However, from an investment perspective, I’m concerned no one is thinking about the house he’s left behind. The first house will most definitely not cash flow at $900 rent w/ a $734 PITI and other additional expenses.

    Also, even if he has this triplex fully rented (i.e., he doesn’t live in any of the units), it is cash flow negative. For these reasons, I just don’t think it’s a good overall move for Jake and his life, finances, and investing career.

    • I was pondering Jake not needing to work because he’s financially independent and needing a tax shelter to offset dividend income. Unlikely. But maybe he can get a tax benefit by providing “work-force” housing. For example maybe a ten year tax-free period.

      Or maybe the triplex is next door to a family member and he could eliminate daycare expense and go down to one vehicle if he moved there. Say $400 monthly for each expense when including car payment, gasoline and insurance and annual registration, and personal property tax in some states. Jake wins and his life is simpler. And his kids spend quality time with relatives.

  10. I guess it depends on cost of living elsewhere and how long s/he plans to stay in the home. If it’s cheaper to live there, and s/he will be there a while, then it probably makes sense. If not, not.

  11. This is great, Brandon! Thanks for sharing the thorough analysis and calculators. I’m considering a dive into the rental market at some point, so there’s clearly a lot I can learn from you.

  12. To me its pretty easy, find a situation where he is making money not losing money, I believe Warren Buffet has a saying somewhere that says never lose money. With the real estate markets still slowly coming back up in value I believe there are better properties then the one he has. Also by living with his tenants his headache potential and ratio increases significantly.

  13. it sounds like you dont do many properties. no where will you only pay 1800 per year in taxes valued at 250,000. please advise if you think im wrong. thanks carson

    • Brandon Turner

      Hey Carson, sounds like you must live in an expensive area for taxes. Or you are just a troll. Or both. Yes, $1800 a year on a $250k purchase is low, it’s not unheard of. It’s actually pretty normal for my area, and a lot of areas. Some states/counties are really high, some are really low. Besides, I chose the lowest amount that it might possibly be, to emphasize how bad the deal was no matter what I chose. Had I chosen $5,000 a year… and the actual taxes were $2,500 – a person would say “Well, he overestimated taxes, so it probably is a good deal.” However, by estimating on the lowest end of the spectrum, I show that even in an area where taxes are crazy low… it’s still a bad deal. Sheesh.

  14. A few things come to mind:

    – if you were to run the calculator again on his CURRENT house, it would be far more negative than this deal (there is NO income), so moving from paying for his entire house to this one that would pay for most of itself is a step in the right direction
    – did he/could he consider living in one of the basement apartments and renting out the upstairs? This would again change the numbers drastically, and combined with my previous point would put him in a good situation/give him a good start.
    – You have to live somewhere. Why not live somewhere that is subsidized and that allows you to take deductions on your primary residence…
    – From there he can focus on building a portfolio of non-owner-occupied rentals, and the numbers for those would be different (and would need to work better than these numbers…).

  15. I think in it would be a bad decision just because it seems that this scenario would have too much risk involved. The reason I say that is for one Jake plans on renting out the studios which in my point of view they usually attract short term tenants there for he is likely to have a high vacancy rate. The second reason is because if his personal residence on would “cash flow ” around $200-$250 after the mortgage it seems like too little especially of he has to cover for some of the utilities as well. My answer I say he let’s this on pass because if he doesn’t he is likely to have smallerpockets instead of Biggerpockets. (Pun intended)

    Abel

  16. Barry Gysbers on

    I think that if you are going to invest in multiple properties, the most important consideration is only buying those properties that will allow you to continue playing the game, and preferably, enhancing your ability to play the game.

    In this scenario, you have less ability to buy the next property, and so, you would reject it, or modify the terms until it worked (which might then be rejected by the seller).

    Several decades ago, I bought my first two mobile homes in Colorado, and lucked out. Everything was a “go” financially, cash flow, etc., but then, I ran out of the ability to land financing (I now had two loans to cover) with the local banks. I didn’t want to stop “playing”, so I started in what seemed to be the next most logical step. I only bought mobile homes that were financed by the owners. Unfortunately, these were so undesirable, and needed so much work, that I soon was unable to maintain all 6 mobile homes in the condition necessary to keep them all rented to helpful tenants. Yup! Overcome by greed… When I bailed, at the end of 3 1/2 years into the game, I was a total “don’t wanter” and was relieved to simply transfer the mobile homes to anybody else for basically whatever I owed on them. Hard to get rich that way…

    The situation in this article reminds me of how I encountered my initial, primary failure in real estate. My second mistake, of course, was in buying mobile homes without also owning the land that they were located on. Interestingly, at the time, I “reconstructed” the facts to say that since I didn’t actually lose any money on the deal as a whole, and even made a little, I came out a “winner”. We have SO many ways to delude ourselves. Hopefully, I will choose more skillfully on my next set of real estate deals.

    Great article, and clever strategy, asking others to decide how to proceed!

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