Yes, she’s ugly.
She has purple windows and a dull gray paint job… but I love her anyways.
Today I want to tell you about my newest purchase, a triplex, and walk you through the step by step process I took to get this property. Although it’s easy to get small pieces of information here and there regarding the process for getting into small multifamily properties, sometimes the theory is just not enough and you want to see the real thing – the whole picture. That’s what this post is going to do – give you the exact, step by step process I took to acquire my newest investment property.
Keep in mind that every real estate deal is different. Every one has unique challenges, problems, benefits, advantages, and strengths. However, a success investor finds ways to navigate those treacherous waters and come out dry on the other side! That’s what this post is about: my ride – and I want to take you with me on it!
How to Find Multifamily Properties
Before ever taking a glance at the MLS, there are a lot of little steps that are important to take. Education, of course, is key – which is why I helped to write the Ultimate Beginner’s Guide to Real Estate Investing, and why we made it free. If you don’t have a basic understanding of what makes a good real estate investment, the rest of the game is just luck (and luck is not on your side!)
Following the education, I believe it’s extremely important to make a plan. You’ve heard me say it before: you wouldn’t embark on a road trip without a map, so why embark on a real estate investment without one? While I think an overall plan is great for your investing business (Like “I want to buy 10 units per year that provide x amount of cashflow for the next 10 years) I also think it’s smart to have a plan for the next property you want to buy. Specifically, I’m talking about having very carefully defined requirements for properties.
It would probably be silly to say “I will only buy a property that has four units, each with one bedroom, and with a new roof” because you probably won’t find that property, or you might pass up a lot of other good deals while waiting for it. However, it would be okay to say “I want to buy properties between 2 and 10 units that would provide at least $100 per month, per unit in cash flow assuming 100% financing” – which is pretty much my criteria. I’m not saying I ONLY buy properties that I can get 100% financing on… but I make that part of my requirements because it’s always my goal. If I can get $100 per month per unit with 100% financing, I know I could get even more cash flow with a down payment.
Additionally, I also know the neighborhoods I want to buy in and the neighborhoods I don’t, so I stick to that. I don’t want to buy in a war zone, so why even look there?
Having defined characteristics about a potential property enables you to “screen out” potential properties and only focus on the ones that matter to you. I like to think of it like a water filter – each layer of requirements will trap the stuff you don’t want. As a property makes it’s way through the funnel, only the one’s worth pursuing come out the other end. The more “automated” you can make this, the better.
For example, my real estate agent knows that I’m looking for small multifamily properties in certain areas, so I had him set up “automatic alerts” so that as soon as a property that has two or more units pops up on the MLS within the areas I’m interested in – I get an email notification. In a hot market, good deals can be snatched up in just minutes, so speed is everything. My agent also knows what makes a good real estate deal, so he keeps an eye out for properties that are especially interesting and will call me about them, encouraging me to act fast.
This is the case with my most recent purchase.
I received a call from my agent letting me know that this triplex was going to be coming on the market, but because it was a HUD property (it was taken back in foreclosure by HUD), there was a minimum time where investors could not bid on the property. However, I knew the location was great and the price HUD listed it at was exceptional, so I watched it closely. It hit the market at $68,000 and I was sure a homeowner would snatch it up, because of the unique characteristics of the home, which we’ll get to in a moment.
The property had three units, but not evenly split. I believe originally it was just a huge house with a basement and a garage. At some point in the past fifty years, someone added a basement apartment and another apartment above the garage. Let me give you a brief description of the property:
- The main house had 4 bedrooms and 3 bathrooms, including a totally remodeled (though slightly outdated) master bathroom complete with Jacuzzi tub, natural gas furnace, hardwood floors, and probably remodeled in the early 1990s. Potential rent: $800-1000 per month (we’ll talk more about this in a few minutes.) Total square feet: about 2,000.
- The basement apartment has one bedroom, one bathroom, tile floors, and newer kitchen cabinets. Total square feet: about 600
- The garage apartment has one bedroom, one bath, and laminate flooring.
The basement apartment and the garage apartment were virtually rent-ready, needing only a small amount of cleaning. The main house, however, had a roof leak near the chimney that ruined an area in the upstairs bedroom about 15′ x 8′. Although the roof was actually new within the past five years, it looks like whoever installed the flashing around the chimney did so incorrectly.
Furthermore, as you can see in the photos, the paint is atrocious. Purple windows… I don’t know what they were thinking.
My total estimates for repairs are about $5,000, most to fix the chimney leak, fix the drywall, paint the windows, and clean. This might be a little light, and I’m prepared to spend up to $10,000 if needed, but $5,000 will get it rented now.
The Main House: $800-$1000 per month. Yes, this is a wide range, but honestly I’m not entirely sure. Typical 4 bedroom, 3 bath homes might rent for $1000 around here, but the outside of the home is REALLY ugly (and I can’t paint until the rain stops next spring) and because it’s a multifamily property, I may have a little more difficulty renting this. So I’m estimating $895 for rent for now, though I’m willing to drop the price quickly if needed.
The garage apartment and basement apartment should both rent for around $500 per month, so I’ll advertise them at $495.
Total potential income: $1885.00
Additionally, there is a one car garage on the property. I may be able to rent this garage out to one of the tenants for an extra $40 a month – which would make my income a bit higher, but I won’t assume that yet.
How I Lost the Property… but Still Got It Under Contract
As I mentioned earlier, this was a HUD house that restricted investors from offering on the property for the first two weeks. With the large, main house and additional income units, I was sure this home would sell before I ever got a chance to offer and I was right… the home was quickly snatched up by a homeowner. Good for them… but sad for me.
However… two weeks later, I got another call from my agent. He just heard that the buyer was going to be backing out of the deal and the property would be coming back on the market the following morning, still at $68,000, and the bidding would be open for investors. He also knew several other investors that were going to be offering on the property, and I knew this would go quick. For the first time in my entire investing career I decided to do something I had never done before:
I offered above asking price.
The next morning my agent submitted my offer for $70,000 and we waited. By the end of the day, we received word: we had won the contract and the property was ours.
How to Analyze this Triplex
There are a lot of ways to analyze a potential rental property, and we’ll look at most of them here, so you can see the different methods. I’ll also share a video below on how I used the new Rental Property Calculator to analyze this property.
The 2% Rule
The first rule a lot of folks like to look at is the 2% rule. This “rule of thumb” is a quick way to look at a property’s price in relation to the monthly rent to see how awesome the deal is. I mentioned earlier the idea of a filter – and the 2% rule is a very early filter to see how good a property might be.
The 2% rule (of thumb) states that a properties total monthly rent should be 2% of the purchase price (including repairs and closing costs.) In other words, a property for $100,000 should rent for $2,000 per month. In this case, with a purchase price of $70,000 and roughly $10,000 added for closing costs and repairs, the property should rent for $1600 per month. As I mentioned earlier, the potential rent was $1885, which is 2.35% of the purchase price.
In most areas of the country, the 2% rule is impossible to find, and most of the properties I own don’t meet this rule, but this property actually surpasses this requirement. So should you use the 2% rule?
That’s hard to say. Would this property have been a good deal at 1%? 1.5%? Or even more importantly – what makes a good deal?
This is why the 2% rule is nice to look at, to quickly look at potential cash flow, but it is only a rule of thumb. I like to think of the 2% rule as a sort of “certificate of approval” – if it meets it, great! It doesn’t mean it’s not a good deal if it doesn’t, but it is definitely awesome if it does.
The 50% Rule
The next rule of thumb we talk about often on BiggerPockets is the 50% rule, which is used to quickly analyze potential cash flow. This rule basically states that half of your income is going to be spent on non-mortgage expenses each month, so whatever you have left (called the Net Operating Income) will go toward the mortgage payment and cash flow. If you want to learn much more about the 50% rule, check out this post and video.
Again, the potential income on this property was $1885 per month. The 50% rule (of thumb) tells us that half of that will go out in expenses, which included everything except the mortgage payment. So…
$1885 x 50% = $942.50.
So how much will the mortgage be?
My initial assumption was a 25% down payment, meaning a total loan amount of $52,500. (because $70,000 x .75= $52,500). Using a quick online mortgage calculator, I determined that a $52,500 loan, at 5.5% for 30 years would be $298.08 per month.
$942.50 – $298.08 = $644.42 in monthly cash flow, or an average of $214.81 per month per unit.
If you want to take this one step further, let’s look at the cash on cash return on investment, considering the 50% rule. With 25% down payment, we know we put in $17,500 for the down payment. I’ll also add $5,000 for closing costs and another $5,000 for repairs, bringing my total investment to $27,500 for this property.
$644.42 per month in cash flow X 12 = $7,733.04 per year.
To determine cash on cash return on investment, simply calculate: $7,733.04 / $27,500 = 28.12%
Therefore, according to the 50% rule, I could expect to earn $644.42 per month in cash flow which equates to a 28.12% cash on cash return on investment. Doesn’t seem to terrible to me – but what do the REAL numbers say?
The Actual-Number Analysis
Rules of thumb are good for quickly analyzing the potential, and for helping you avoid underestimating expenses… but it’s also important to run the real numbers and see what you’ll actually be looking at. This section is going to do just that. However, for this analysis I’m going to save a ton of time and use the new BiggerPockets Rental Property Calculator to run the numbers. The following video will walk you through my step by step analysis of this property, and below that I’ll show you the PDF report that was generated.
So for those too lazy to watch the video 😉 let me give you a quick breakdown of how the numbers look:
Total Monthly Income: $1885
Total Monthly Expenses: $1434.58
Total Monthly Cash Flow: $450.42
Total Cash Needed: $27,500
Cash on Cash Return on Investment: 19.65%
How I Paid For the Ugly Purple Rental Property
Easy, I whipped out my wallet, pulled out $70k in hundred dolla’ bills, and slapped it down on the counter.
Okay, that’s not how it went down. So let me tell you the story behind this deal.
As most people here on BiggerPockets know, I’m a big fan of using partners, for a variety of reasons – but mostly because I’m not rich. I know – shocker! However, when I use partners, I’m able to share the load and sometimes get into a deal for no money down. This triplex wasn’t quite “no money down” but in the end, I hope it to be close.
I reached out to a local couple of folks I know who had bought their first rental property a few years ago and have been very excited about doing more when the home came on the market the first time. I simply mentioned that I was working on getting a new property and wanted to know if they were interested in partnering on it. They jumped at it, and we began to take steps toward acquiring the property.
We decided to split everything right down the middle – down payment, closing costs, everything. As the video showed, we would need about $27,500 total out of pocket to make this deal happen, which means just a bit less than $14,000 each. Had I wanted to bypass this, I could have used a private lender for a year, refinanced the entire thing into a fixes rate loan, and done the whole deal with no money (Like I’m doing in this story), but I’m just a bit concerned about interest rates rising so I thought I’d lock it in right now, and I still may refinance and pull my cash out in the near future, depending on how things look six months from now.
We approached a local bank that does Portfolio loans (because I’m over the limit on the number of mortgages I can have through Fannie Mae/Freddie Mac) and obtained a loan through them. The loan is a thirty year loan, but fixed for 5 years at 5.5%, and variable after that. Although I’m highly against variable-rate mortgages (It’s one of my “6 Dumbest Mistakes You Can Make as a Buy and Hold Investor“) the rising rate was guaranteed to never rise more than 2% per year for a maximum of 11%. Worst case scenario, if the rate jacked up to 11% in 5 years… my payment will only rise by $200 per month… something I could live with.
My Plan Going Forward:
As I mentioned earlier, I plan on getting an average of $450 per month in passive cash flow. However, although I accounted for property management in the numbers, I will be managing myself – so I will actually be receiving an extra $226 per month, for a total monthly cash flow of $676.00 per month. Additionally, I hope to pass on a “Water/Sewer/Garbage” surcharge to the tenant in the large 4 bedroom house for approximately $75 per month. This will bring the total cash flow to approximately $750.00 a month after accounting for all of the possible expenses.
With the partners I am working on this project with, we have decided to pay this property off as fast as possible with the cash flow we get. Using an online early payoff calculator from Dave Ramsey, I can see that by paying this $750 per month toward the mortgage, I will be able to pay off this entire property in just 4 years, 10 months.
Yep, under 5 years and I’ll own this property, free and clear.
Although there are a lot of reasons why mathematically this might not make the most sense, it makes the most sense in this scenario because of the goals my partners have for their retirement. Additionally, because my loan is only fixed for 5 years, I’ll hopefully have the entire property paid off before the variable factor kicks in.
So I closed on this property yesterday. I’ve got contractors fixing the minor issues in the next several days, and will hopefully have this property fully rented by January 1st, 2014 – when my first mortgage payment is due.
On to the next!
Alright, I’m done rambling now. What are your thoughts or questions? I hope you don’t make me write 3,000 words without even leaving me a comment below!