Real Estate Ride Along: Fourplex Multifamily Property Tour & Deal Analysis
Welcome to episode No. 2 of “Real Estate Ride Along”! We will be taking a look at a fourplex that is located off of West Colfax, four blocks from Sloan’s Lake—one of Denver’s up and coming trendy neighborhoods.
A few of the reason’s we really like this location are:
- It’s quickly transitioning and seeing large growth and development.
- Location! It’s in Lakewood, Colorado, which recently passed a proposition in early 2019, limiting the amount of development. This means demand will increase for this area, as there will be less supply with the development restrictions.
- Due to a shortage of affordable housing, this property will have high demand from tenants and is positioned very well for a long-term buy and hold investor.
This property has actually been vacant for close to 10 years. We initially walked the property in 2018 and tried to put a deal together at that time. We found out that the property was going through the court system, as there were multiple liens on it from two previous investors who had tried to develop the property and were unsuccessful.
We finally were able to close on it in April 2019, pulled the necessary construction permits in July, and are currently finished with all of the rough plumbing, electrical, and mechanical work. The next phase of construction will be covering up all of the walls and leveling the floors. We are on track to be leasing in late June of 2020.
Read on about our business plan from the beginning of the project.
Fourplex Rehab Game Plan
- Renovate the entire building while it is vacant.
- Lease at market rate to tenants once construction is completed.
- Allow the leases to season four to six months.
- Sell to an investor looking for a turnkey income-producing property.
Funding the Fourplex Purchase and Rehab
This property is a full-scope construction project that entailed architectural drawings, permits from the city, and a GC on site every day in order to execute. This is a larger and more in-depth remodel than we are used to, so we had to seek out some alternative financing in order to make the number’s work. Due to the condition of the property upon purchase, we were not able to use bank financing, and traditional hard money would have been far too expensive for the amount of time we would have to wait until the property is cash flowing.
So, we went with a private money lender that is local to the Denver market and is familiar with our business model. He was willing to lend us money at 8%, along with extending some additional funds for construction. Once we were past the rough permitting stage, we were able to refinance that lender out with traditional bank financing at 4.5%.
We purchased the property for $405K. Construction costs will end up totaling between $200-$250K. Part of the reason for this higher construction cost and hold time is the fact that we had to pull full permits for electrical, mechanical, plumbing, and exterior work.
When you do a project that is contingent upon architectural drawings and city approvals, always expect delays and longer hold times. This is just the nature of the business when dealing with municipalities and other third-party service providers. So, we underwrite these kinds of projects accordingly with longer hold times and conservative expenses from the beginning.
While the holding time and costs may be a little higher than our desired timeframe, we are confident that the end product of four high-end apartments with condo-grade finishes in this “cool” and growing neighborhood will be worth the extra time and money.
Securing 8% interest on private money is a really good rate, especially with no closing costs or points added on. The key to sourcing this kind of private capital is building great long-term relationships. We've done hundreds of deals with this individual over the years, and our track record has allowed us to lower our capital costs considerably year over year.
This lender, in particular, is always looking for ways to conservatively deploy capital to produce monthly cash flow aka “mailbox money.”
Pro Tip: Build relationships and a strong track record to lower your borrowing costs and get more favorable terms. No bank or hard money lender can come close to these terms from a private money lender. Private money lenders, although willing to lend at lower rates than hard money lenders, are looking for established and proven operators in their local markets.
When we first purchased the property, the exterior was in pretty rough shape. The building itself was stucco and had cracks all up and down the exterior walls. It also had foundation issues and poor drainage around the crawl space, so any rainfall or moisture was getting directed toward the foundation and causing more and more issues.
- All new exterior brick
- New brick trim around the windows
- All new windows with added black trim. The black trim is an extra $100 per window, but we felt that it would attract the right “high-end” tenant due to the area.
- New concrete for sidewalk/walking path and parking lot in front and rear of building
- Stucco trim around exterior doors and entrances
Since Atheena Brownson with Compass Real Estate joined us for the last episode and was able to ask great questions and give us a Realtor’s perspective, we asked her to join us again to ask more questions and identify some of the differences between this four-unit property and the previous six-unit that we discussed on the last episode.
The first item Atheena noticed is how different the inside of this property looked from the previous property. This project was a lot more involved than some simple cosmetic upgrades and interior improvements. With this project, we will do all the cosmetic work we normally do, but on top of that, we will be taking this project all the way down to the studs (foundation) and rebuilding it from ground zero. This includes running all new sewer lines, plumbing lines, electrical wiring, and venting for heating and cooling.
This may seem like a lot to take on but there’s a reason we were so patient and waited two years to acquire it—LOCATION! Atheena was able to confirm that this neighborhood is probably gaining 10-12% annual appreciation, as this is one of the hottest areas near Denver right now. There is also lots of new development like Edgewater Marketplace, shopping centers and amenities all within a short walk or drive. All these factors will hopefully demand higher rents.
- Three 1-bedroom/1-bathroom
- Units will be a little smaller: 600-650 sq. ft.
- Marketed toward a young couple or single professional
- One 2-bedroom/1-bathroom
- Unit will be 800 sq. ft.
- Marketed toward a young couple or single professional with a roommate
As we walk the property and think about the updates, we always try to keep the tenant’s perspective in mind. We are always asking ourselves…
“What will a tenant in this area renting at this price point what in their unit to get excited about living in this building versus one of our competitor’s properties down the street?”
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When it comes to heat, we talked in the last episode about how having a boiler system that services the entire building can be a pain for tenants, because there is much less control over the temperature for each unit and the speed in which it can heat up or cool down the unit. With the ever-changing “moody” Denver climate, this becomes even more important.
With this property, we will be adding a brand new furnace and AC system and a NEST thermostat system in each unit, so that tenants can control the temperature of their own unit. We are hoping that this could increase rents by $150-$200 each month per unit.
Another great amenity is an in-unit washer and dryer system. This can increase rents up to $75 per unit per month in most areas. For this property, we actually custom built a closet in the master bedrooms for the washer and dryer and ran new plumbing lines in order to make this happen.
For the bathroom, we had to work with a tight space, but we weren’t worried because the tenants who will be renting these units will either be single or a young couple that will prefer a stand-up shower and not require a bathtub. We will finish the bathrooms off with custom tile on the shower wall and floor to make it pop.
As we mentioned before, in our typical cosmetic remodel project, there is no need to hire an architect. But for this project, since we had to pull permits, hiring an architect was needed. When you are doing a project that requires building permits, you are most likely always going to need to hire an architect. I recommend hiring an architect that is familiar with that municipality’s set of building codes and guidelines.
Although most every city follows the same set of IBC (international building code), every city (like most government entities) has a way of interpreting them differently. So, having an architect on your team that is familiar with your local building department will save a bunch of time, money, and heartache.
Costs for an architect vary (as with any service provider). In my experience, going with the cheapest or the most expensive has proven to have its own set of challenges. I recommend finding one that has the time to make your project a priority, enough experience that he or she can speak confidently to how things at the city will work, and falls somewhere in the middle of the pack in terms of pricing.
Development and Rental Numbers
Now, let’s take a look at the numbers for this project. This property was originally bought two years ago for $525K and then was foreclosed on. We were able to get the property for $405K.
As we rehab the property, our numbers are shown below. Remember that no one had lived in the property for 10 years, so we were not able to collect rents during this time.
We are hoping that this project will be a total of 12 months. We bought the property in April 2019 and hoped to have the units rented out by June 2020. However, we are probably 4-5 weeks behind our desired scheduled. Our typical project isn’t normally 12 months for construction. But on this project, because the scope was so complex, it took several more months to get these units through city inspections and approved for CO (aka certificate of occupancy).
We have to have an inspection after each major installation. Plumbing in, then an inspection. Electrical finished, then an inspection. Furnace and AC units installed, then an inspection. Caulking and fire caulking, then an inspection. It was a lot of back and forth with the city to get everything finally approved.
An advantage to working with a smaller municipality, like Lakewood, is that once you are done with a section and ready for an inspection, the inspector usually comes out either the same day or next day. If we had been in Denver, it could take two to three days for an inspection.
Another advantage to a smaller city like Lakewood is that once you begin a project like this, you start to build a rapport with the city officials, so they can work with you efficiently as you move through the different phases of inspection. Having a good relationship with your local inspectors, regardless of the municipality, will make these inspections go a lot smoother.
Once we are able to get the building stabilized and each unit rented out, we are projecting the numbers below for rents and RUBS. As a reminder, RUBS are what the landlord bills back to the tenant for water, sewer, trash, and sometimes even parking per unit each month. Due to the area, we will bill back about $50-$75 per month for water, sewer, and trash to the tenants.
Each unit has separate electric and gas meters that are not included in the RUBS. Tenants are responsible for those utilities themselves.
The maintenance costs above are very low. But since everything is brand new, has been checked and approved by the city, and would still be under warranty if anything should happen, we feel good with this lower number—at least for the first few years.
For property management, we do have some economies of scale, so we feel comfortable with underwriting it at 7%. For landscape, we zero-scaped all around the property. But there are parking lots in both the front and back of the building, so there will be snow removal costs.
For reserves, we plan to put away $250 per unit per year. This will help with those major expenses like a roof repair or water heater replacement nine to 10 years from now.
For a fully remodeled fourplex, we hope for around 23-25% operation expense ratio, so we are right on target for that.
Overall we are cash flowing about $1,300 a month with an 8% loan. This is a reassuring number—if we have to hold onto the property for a few months, we feel that this will be very manageable.
As we stated in the beginning, our goal will be to sell to an investor looking for a turnkey property. We have run three scenarios below to see what our best exit strategy will be. Our goal for this property will be fairly aggressive at 5.25% cap rate. We think we can achieve this because for a fourplex, a lot of investors will self manage them. By not having a property management cost, it helps the numbers greatly.
We will plan to list this property right around $1 million, which we think is attainable because of the area, proximity to downtown, all the “cool” development around the area, and the fact that we did high-end finishes. It’s basically a brand new building.
While our actual profit isn’t a great return on our time spent on the project, we are happy that the deal will be profitable!
So, let’s look at the numbers from the investor’s perspective who we will sell the property to.
Chris was able to call a local credit union who quoted him a five-year fixed-rate loan with a 3.875% interest rate. This is a great rate! When we first started buying properties in 2013-2015, interest rates were at 5-6%.
There are four ways to look at how you make money in real estate. Visually, it's great to use the Return on Investment Quadrant™. It really helps show you that while cash flow is important, it's not the only way you are making money on the investment. This chart shows us that a typical investor who has put about $235,116 into the deal will receive a 25.32% return on that money, or about $59,536 return after the first year.
Let’s also look at the investor numbers after holding the property for five years.
Like we showed in the last episode, the compounding effect of real estate will remain the leading factor in why we continue to do these deals. The ability of rent growth year after year, the ability to have tenants pay down your debt, and the great depreciation and tax benefits from these transactions prove why this is a great investment for a buy and hold investor.
Tip for New Investors
We know that there is a section of the audience who might be at the beginning of their investing career. They might be a newer investor with less experience and less cash on hand. We encourage those of you who have $10K, $15K, $20K to reach out to your network or research the type of properties you want to be involved in (office buildings, retail space, industrial, residential, etc.) and start building relationships with people and companies like ours.
Find someone who is doing these types of projects at a high level and figure out how you can add value to their project. Find a way to bring a deal to the table. Some of the deals come from a broker, but many come from an individual who went knocking on doors or connected us to someone in their network.
This will take some time to build these relationships. Realistically, in multifamily, it could take six months to a year to put a deal together. Single-family transactions can be done usually within 30 days, but multifamily is a larger scope and larger dollar amount. If you put the work in, the upside can be rewarding and you can see possibly $15-$30K, depending on the size of the project.
Relationships are key. They take time to build but have a great payoff in the end if you stick with it. As with most investments in real estate, you have to be in it for the long game!
At the time of publishing this blog, the fourplex is weeks away from the construction being completed. Then it’ll be time to start leasing the units and then find an investor for this property.
If you’re in Denver or coming here, reach out to Chris Lopez to talk about joining us for an episode!
What are your thoughts on this deal?