Landlording & Rental Properties

(VIDEO) Why I Backed Out of this Fully Occupied Renovated 4 Plex

Expertise: Real Estate Investing Basics, Personal Development, Flipping Houses, Real Estate Marketing, Real Estate News & Commentary, Business Management
60 Articles Written
Four Plex Analysis

I wrote a blog awhile back about the shoe being on the other foot when looking for property here in Phoenix, AZ. I’ve been searching for a juicy cow (can that be a new phrase for a cash-flowing property that’s a great deal?) and will share my experience here.

Want more articles like this?

Create an account today to get BiggerPocket's best blog articles delivered to your inbox

Sign up for free

In any case, I went under contract on a 4 plex and was ready to move forward. Here’s the play by play

  1. I found this deal on the MLS, and it caught my eye for several reasons. It was fully occupied, appeared to have been updated in the last couple years, and was in an area of town that I really like.
  2. Details: asking price, $175,000, rents $495 (with potential to be $500+), NO HOA, all 2 bedrooms, 1 bath, parking in rear, each unit was individually metered for electric and healthy rent market in the area. The one thing that jumped out at me though was listed in the Income/Expenses section was an exorbitant water allotment. I inquired about that and the listing agent said he wasn't quite sure about it but they could provide all paperwork during escrow. Fair enough.
  3. I pulled comps and saw similar properties going for $160-$170k, so inquired if there was wiggle room, which there was. I drove the property, liked what I saw, drove the neighborhood several times, and felt good about the location. I checked in with my lender, got the A-OK, and moved forward to go under escrow. I was willing to go near market value for several reasons, so long as the numbers made sense from day one.
  4. Within a few days I received the leases, title report, and management expenses. I was planning on self-managing, as management companies can really eat up costs if you don't really comb through what you're being charged for, when, and how.
  5. I called up the utility companies to verify water costs, since the owner (ie me) would be the one responsible for this expense. I was nearly in disbelief when the customer service rep let me know there was an annual expense of nearly $6,900, which had gone up this year, based on a 2 year average. So, the listing had in fact been pretty close to the truth.
  6. The annual gross income was $23,760 but with a 10% vacancy rate, making gross operating income to $21,384. With all the other operating expenses (maintenance, common area electric, Repairs,Advertising and promo, and rental tax,)… and a monthly water bill of approximately $575, the income is nearly eaten alive.
  7. This puts the annual operating expenses at $11,000. So, my net operating income is around $10,000. In this scenario we're approaching it at a 20% down payment, 30 year fixed mortgage. (PLEASE NOTE – in the video I had the interest rate too low at 4.5% so the projections are actually slightly worse!) So if you factor in the debt service (ie the mortgage payments on the loan) the cap rate becomes anemic, my cash on cash return nearly made me vomit, and cash flow becomes nearly non-existent. And, you have to pay taxes on any cash flow. My hopeful juicy cow had turned skeletal hag.

Check out the following video for the complete story:

Where’d it All Go Wrong?

During the escrow period, the Seller provides all paperwork showing the actual expenses, income, leases, and agreements relating to the property; It’s like reviewing a tiny business.

When I began reviewing the leases, it started to make sense. In 2 of the units, there was a families of 4. In the other two units, there were 5 people living in each unit. My god, I would be paying nearly $600 a month for 18 people to shower, do laundry, wash their hands, give baths, and use the restroom. I shuddered at the thought.

Digging further, the units had been listed in MLS for rent for quite some time, and the management company had gotten them filled. This then became a fully-occupied 4 plex in good condition, an immediate draw for any investor. The catch is quality, over quantity…and there really was quantity, in this case.

Let’s Just Be Friends

I did it, I’m guilty. I did the “How, but if, well we can..” game. What if we install low-flow fixtures, change the commodes, charge a monthly water usage fee, cycled out these tenants? The catch is, if the 4 plex is predominately occupied by families, single people and childless couples are less likely to want to live there. (and, there are Fair Housing laws that you must abide by). Point being, the problem is the high occupancy, but you can’t just solve the problem by kicking people out, trying to only rent to couples, or charging fees. So, there really wasn’t much room for me to try to lower the water bill creatively or otherwise to have it makes sense, now, if ever. I couldn’t commit to this, and decided to break it off.

I quickly emailed the escrow officer, my loan officer, and the agent and simply let them know after reviewing the breakdowns, this did not make financial sense, and to please cancel the escrow. The listing agent was very kind, but understood.

The better news is, another opportunity popped up nearly immediately from a different source. Because I didn’t need the cash to close on the 4 plex, we were able to jump on a better, more profitable deal to make some quick cash and keep the money moving.

What do you think? Please LIKE or SHARE if you find this info helpful, thanks!

Photo: Kansas Sebastian

    John Thedford
    Replied almost 7 years ago
    So, the moral of the story is: investigate investigate investigate. Know all the facts before you sign on the dotted line. As to the juicy cow theory: there is nothing better than a big thick ribeye off the juicy cow:)
    Tracy
    Replied almost 7 years ago
    Hi John, correct, but I couldn’t have known all the details without being in escrow. Luckily, I didn’t lose money or much of any time though. All hail the juicy cow! 🙂
    Sheikh Rahman
    Replied almost 7 years ago
    Awesome reinforcement of the need to fully analyze the deal using all available information. +1 for the Ren & Stimpy reference!!!
    Tracy
    Replied almost 7 years ago
    Thanks Sheikh, although I’m not sure of what reference you mean? I probably did it unknowingly, oops!
    Sheikh Rahman
    Replied almost 7 years ago
    The horse with the quote “No, Sir, I don’t like it” is from a Ren & Stimpy sketch.
    Tracy
    Replied almost 7 years ago
    I figured as much once I watched it again…I had to look it up online though!
    Bill S
    Replied almost 7 years ago
    Ok, glad you found a better deal. For me, I would look harder at the water. It is my guess that there is a leak that is undetected after the meter. You were surprised by the cost of water. That says to me that something structurally is wrong. I would look at the amount of water used and compare it with four single family homes of similar occupancy. Know this, the largest used of potable water is outside irrigation. I have an interest in a 6 unit property with probably 11 occupants that uses less than 20,000 gallons per month and the water and sewer bill is less than $125 per month. I know Phoenix is not in Colorado and I know AZ is a dry state and water is a premium so there is a possibility that it is just high use. I would use the water bill to lower the offer price if I knew I could correct the situation after I was the owner. Reply Report comment
    Bill S
    Replied almost 7 years ago
    Ok, glad you found a better deal. For me, I would look harder at the water. It is my guess that there is a leak that is undetected after the meter. You were surprised by the cost of water. That says to me that something structurally is wrong. I would look at the amount of water used and compare it with four single family homes of similar occupancy. Know this, the largest used of potable water is outside irrigation. I have an interest in a 6 unit property with probably 11 occupants that uses less than 20,000 gallons per month and the water and sewer bill is less than $125 per month. I know Phoenix is not in Colorado and I know AZ is a dry state and water is a premium so there is a possibility that it is just high use. I would use the water bill to lower the offer price if I knew I could correct the situation after I was the owner. Reply Report comment
    Bill S
    Replied almost 7 years ago
    Ok, glad you found a better deal. For me, I would look harder at the water. It is my guess that there is a leak that is undetected after the meter. You were surprised by the cost of water. That says to me that something structurally is wrong. I would look at the amount of water used and compare it with four single family homes of similar occupancy. Know this, the largest used of potable water is outside irrigation. I have an interest in a 6 unit property with probably 11 occupants that uses less than 20,000 gallons per month and the water and sewer bill is less than $125 per month. I know Phoenix is not in Colorado and I know AZ is a dry state and water is a premium so there is a possibility that it is just high use. I would use the water bill to lower the offer price if I knew I could correct the situation after I was the owner. Reply Report comment
    Bill S
    Replied almost 7 years ago
    Ok, glad you found a better deal. For me, I would look harder at the water. It is my guess that there is a leak that is undetected after the meter. You were surprised by the cost of water. That says to me that something structurally is wrong. I would look at the amount of water used and compare it with four single family homes of similar occupancy. Know this, the largest used of potable water is outside irrigation. I have an interest in a 6 unit property with probably 11 occupants that uses less than 20,000 gallons per month and the water and sewer bill is less than $125 per month. I know Phoenix is not in Colorado and I know AZ is a dry state and water is a premium so there is a possibility that it is just high use. I would use the water bill to lower the offer price if I knew I could correct the situation after I was the owner.
    Tracy
    Replied almost 7 years ago
    Hi Bill, did you read the rest of the post and see what the issue was?? And what I would have had to offer to even make this start to make sense? Even at a severe discount, it wouldn’t have even tapped into the water issue, every pun intended. Hence, why I backed out. Thanks for your comments!
    Jim Pratt
    Replied almost 7 years ago
    Doing a comprehensive search as you did saved a lot of money and future problems. The muti-plex I used to own, I had each unit metered to cut my expenses. Good work.
    Tracy
    Replied almost 7 years ago
    Thanks Jim, its common for owner to cover water, although, I wish each tenant could cover their own utilities in entirety.
    Randy Phillips
    Replied almost 7 years ago
    My question is, why buy at retail or near retail prices? Why not target distressed properties and or distressed sellers? And not having to deal with tenant issues can be worth every penny of a good management company’s fees.
    Tracy
    Replied almost 7 years ago
    Hi Randy, because the appreciation and cash flow made sense. I do target distressed properties and continue to buy and sell those as well. I don’t mind paying a PM company, but this one wasn’t what I considered worthwhile. Great questions, thanks for you comments!
    Dennis
    Replied almost 7 years ago
    I agree with Bill S. there is most likely a few bad toilets running the bill up. I bought a SFH I own two other SFH on this same block, the tenants are responsible for all utilities. I had no complaint on the others but this one house had double the water bill every month. I assumed the W/D and 2 teenage daughters were the reason. Later the tenant asked to install low flow shower heads, still no appreciable change. I even read the meter each week for a month to see if I could see some spike in water usage. Last week the tenant mentioned she is bothered by always needing to jiggle the handle to stop the toilet from making noise. I had a low flow toilet installed her bill is now less then half of her last bill. It might pay you to low ball the seller and have a plumber give the place an inspection as part of the due diligence.
    Tracy
    Replied almost 7 years ago
    Hi Dennis, I’m with you. I’d have to have a low-ball price, low flow toilets, and low water bills to make this make sense. The Seller wasn’t willing to come down to a price I’d even be interested in to get into the inspection phase. Thanks for the comments, great insight.
    Dennis
    Replied almost 7 years ago
    I agree with Bill S. there is most likely a few bad toilets running the bill up. I bought a SFH I own two other SFH on this same block, the tenants are responsible for all utilities. I had no complaint on the others but this one house had double the water bill every month. I assumed the W/D and 2 teenage daughters were the reason. Later the tenant asked to install low flow shower heads, still no appreciable change. I even read the meter each week for a month to see if I could see some spike in water usage. Last week the tenant mentioned she is bothered by always needing to jiggle the handle to stop the toilet from making noise. I had a low flow toilet installed her bill is now less then half of her last bill. It might pay you to low ball the seller and have a plumber give the place an inspection as part of the due diligence.
    Kyle Hipp
    Replied almost 7 years ago
    I agree with others at looking into additional causes for the high water bill. Even more for that price Just split up the water and separately meter them and then the tenants pay for their own usage. This allows you to let each unit pay for their specific usage and if the current annual bill is $6,000+ then the cost to split and separately meter should not be a problem.
    Tracy
    Replied almost 7 years ago
    Unfortunately if they cannot afford the rent plus the water, tenants will seek other places where the water is included. I’m not sure how many other rentals in that direct area include water, but it would be worth looking into if I was actually considering purchasing the property.
    Kyle Hipp
    Replied almost 7 years ago
    I agree with others at looking into additional causes for the high water bill. Even more for that price Just split up the water and separately meter them and then the tenants pay for their own usage. This allows you to let each unit pay for their specific usage and if the current annual bill is $6,000+ then the cost to split and separately meter should not be a problem.
    Owen Hogarth
    Replied almost 7 years ago
    Wow, this really shows just how important it is to go over all the available data when you plan on buying real estate. I was in the market a while ago but have since moved on, traps like this is one reason why many “real estate investors” gets eaten alive.
    Tracy
    Replied almost 7 years ago
    Right you are Owen! Many people still buy to break even, banking on prices going up. That may work for some but I can’t imagine not having any wiggle room from month to month.
    Aaron Yates
    Replied almost 7 years ago
    Hi Tracy, Great story to share. Our blogs this week could go hand in hand. These types of blogs are exactly what newbie need to see. Real experiences instead of personal preference of what’s the best type of real estate investing. Just to give a little insight of my market, these numbers are what I get from a SFR with all-in-costs averaging $25000 cash. cash flow of $500-$600 per property and rents from $750-$850, so I would have walked away from the deal also. Reply Report comment
    Aaron Yates
    Replied almost 7 years ago
    Hi Tracy, Great story to share. Our blogs this week could go hand in hand. These types of blogs are exactly what newbie need to see. Real experiences instead of personal preference of what’s the best type of real estate investing. Just to give a little insight of my market, these numbers are what I get from a SFR with all-in-costs averaging $25000 cash. cash flow of $500-$600 per property and rents from $750-$850, so I would have walked away from the deal also.
    Tracy
    Replied almost 7 years ago
    Hey Aaron, I read your blog and thought the same thing. And, I’m liking the numbers in your neck of the woods much better. Thanks for sharing your story as well, good stuff.
    Ian Kuchman
    Replied almost 7 years ago
    I love the Ren & Stimpy reference in your slide show!
    Tracy
    Replied almost 7 years ago
    Hi Ian, haha thanks, but I didn’t realize I did it!
    Ian Kuchman
    Replied almost 7 years ago
    I love the Ren & Stimpy reference in your slide show! Reply Report comment
    Robert
    Replied almost 7 years ago
    @Tracey, I am surprised of such high costs of the water even in a 4 unit building occupied by 4-6 people per unit. I own a 4 unit apartment building that sounds identical, and have an average water/sewage bill of $170 a month. However there is an average of 2 per unit. One thing to mention is that I get anywhere from 50-75 back due to my coin-opp laundry. Did the building have a coin opp facility, or the potential to install one? I noticed my water/sewage bill jump almost 50% when installed. I bet that is where most of the money went. @Kyle, One thing to mention about utility bills is that in some states they are leanable. In PA, regardless what the lease says, if the tenant doesn’t pay the water bill you could lose your house. It’s common practice in PA to estimate operating expenses and include in rent.
    Tracy
    Replied almost 7 years ago
    Hi Robert, thanks for the insight. The washer/dryers are in each unit and there wasn’t anywhere on-site for coin-operated laundry. I’m not sure if taking out the W/D would help as much as it might detract tenants that would much prefer to have laundry on-site, paid or not.
    ThosMN
    Replied almost 7 years ago
    If it hasn’t sold yet (under greater fool theory), I’d offer less in a couple weeks, plan a closing by Dec. 31, or after Jan. 1. You’ve already analyzed its numbers, why not? Seller may have tax reasons to find either closing date appealing. And with rents that low, I’d seriously consider, as others suggested, getting it metered separately for water. It’s their water, not yours.
    Tracy
    Replied almost 7 years ago
    Hi Thos, I thought about it, but the price would need to be basically what they currently owe. Even if I took it sub-to, which they won’t do, I’m still stuck with the high-occupancy and water bills and trying to make it manageable.
    ThosMN
    Replied almost 7 years ago
    If it hasn’t sold yet (under greater fool theory), I’d offer less in a couple weeks, plan a closing by Dec. 31, or after Jan. 1. You’ve already analyzed its numbers, why not? Seller may have tax reasons to find either closing date appealing. And with rents that low, I’d seriously consider, as others suggested, getting it metered separately for water. It’s their water, not yours. Reply Report comment
    Mary B
    Replied almost 7 years ago
    Soon as I saw 2br 1ba for slightly under $500/mo with not much room to raise it answered the reason why you walked because the numbers just won’t work. Doesn’t matter if it was a 10unit building fully occupied. If the numbers don’t make sense the deal is a dud. Thanks for sharing. Kudos, Mary
    Tracy
    Replied almost 7 years ago
    Thanks for reading and taking the time to comment Mary! Reply Report comment
    Tracy
    Replied almost 7 years ago
    Thanks for reading and taking the time to comment Mary!
    Roger Rouse
    Replied almost 7 years ago
    I’ve owned five 4-family buildings, and in my experience they represent the worst of all worlds for residential real estate. On one hand they have all the negative aspects of an apartment building — public areas, grounds keeping, utilities, and more transient tenants. On the other hand they lack the economies of scale that makes larger buildings work. The only real advantage I can see is that they qualify for conventional financing (>4 units and you are talking about commercial loans). We’ve had better luck with smaller properties (single family or duplex) where the tenants can be responsible for lawn care and there are no public areas to maintain. They also tend to stay in the unit much longer. The other option is larger apartment buildings (say 10+ units) where you can achieve some economies of scale.
    Tracy
    Replied almost 7 years ago
    That’s really great insight, thanks Roger. There’s so much value in the threads after the actual article, particularly because of real-world feedback from investors like yourself. Appreciate you sharing your take!
    Barry
    Replied almost 7 years ago
    Hi Tracy. Enjoyable article. Maybe I am missing something but from where I come from, California, your deal doesn’t look all that bad. Obviously, the $25,000 price reduction would make it a whole lot better. What kind of deals are you finding? Cap rate? Cash on cash % return? Thanks for the good work.
    Tracy
    Replied almost 7 years ago
    A lot better than this, Barry! Cap rate on these smaller ones is less important to me than cash flow.
    Barry
    Replied almost 7 years ago
    Hi Tracy. Enjoyable article. Maybe I am missing something but from where I come from, California, your deal doesn’t look all that bad. Obviously, the $25,000 price reduction would make it a whole lot better. What kind of deals are you finding? Cap rate? Cash on cash % return? Thanks for the good work. Reply Report comment
    Tiffany H.
    Replied almost 7 years ago
    What about sub-metering and charging the tenants for their own water?
    Tracy
    Replied almost 7 years ago
    Hi Tiffany, I talked about that in the video. Tenants wouldn’t be able to afford the markup, nor would I want to take on the expense. A 20%+ hike in their expenses isn’t a solvent on this one.
    Jeremy Reynolds
    Replied almost 7 years ago
    Hey Tracy, Great post/video! Thanks for showing your analysis and detailing for us your train of thought. It really helps us newbies! 🙂 Any good books you can recommend that would help in performing the financial analysis on properties like these. I’ve bought some single-family homes before but I want to break into multifamily and I’d like to learn how to properly perform the due diligence and analysis. Thanks again! Jeremy from Atlanta Oh and I really liked your podcast interview as well! I just found BP about a month ago and I’ve been listening to all the past podcasts. Thanks!