What next, BRRR, wait for FHA, or 2nd base hit?

Question

My story so far: I bought a duplex in MA and sold after 5 years and made enough to take larger strides in real estate.

I’m trying to figure out what to do next.

I just bought a 3 family owner occupied that pays for itself while I live there. I have to live there 6 months to satisfy my loan requirements before I can buy an FHA.

My options:

I am looking at a quad plex that cash flows at COC 8% or about a 3.5% cap rate with 25% down. I can buy now.

I’m considering waiting six months and buying an FHA with low money down and saving my capital for other projects.

or, I have an opportunity on a 16 unit that cash flows close to my goal, and is under rented. But it uses up all my capital. I could buy now.

- Do I save capital (FHA) and stay in the game longer, go for a base hit (quad plex), or go into unknown territory (for me) with the 16 unit?

Thanks,

Chad

Chad Kirchner · Answer

@Jaysen Medhurst thanks for the tips. I ran the numbers on the 16 plex, and although a B neighborhood, the property does closer to a 10-12% cap rate which is closer to my real estate goals. And after thinking about it I really like the idea of all the units in the same location.

Next steps, shop around the local credit unions for loans.

Thanks for the guidance. I’ll send updates as I progress.

Dan O'Neill · Answer

@Chad Kirchner I always hear advice to get 7 or 10 year reset on commercial loans especially now that we are a long way into an up-cycle but it seems like 5 is the more common which would also make me nervous. Coronavirus aside which is a freak thing, we have been on a long growth period and I'd be worried whether I could find a new loan when I needed to.  Sounds like you didn't stand still after moving on from the 16!  Are these all in the TC area?

Chad Kirchner · Answer

@Dan O'Neill Well, the numbers didn't turn out like I expected with the City Taxes taking up a sizable chunk of the pie. I didn't fully understand the ramifications of a commercial loan. Especially the pros and cons of the automatic 5 year rate reset, that scared me. Or the mindset of why someone would want to live in any of the units. That was a big hangup for me too. If I couldn't see myself living there, then I don't really understand the investment, and if I don't understand it, then don't do it.

I also wasn't quite ready mentally. 16 units felt like too much, too many tenants, more repairs than I was prepared for, too many unknown issues, and I had a full time job. If I had the same opportunity now, I would take it because the scale is not really a problem with a PM, it would have been a good learning experience for me, and you can still get some significant tax advantages with commercial loans. However, I went in another direction instead of waiting for another one of those to come along, or to do a long distance version.

I knew I wanted to hold at least some 30 year fixed loans in this low rate economy. So, I purchased a 4-plex that cashflows well, a short term rental, a foreclosure for a BRRR to keep me busy this summer while I learn to manage more rentals, and some Fundrise shares. This will give me 9 doors to deal with and plenty of problems to solve.

So, I'm using this year to learn what works best for each investment, and to understand the pros and cons first hand.

Dan O'Neill · Answer

@Chad Kirchner Good to see another investor from my area.  How's your exploration of the 16 going?

Jaysen Medhurst · Answer

@Chad Kirchner, you really need to shop around some local/regional banks and credit unions. Typically, I see 5.5-6% for 20 or 25 years and a rate reset at 5, 7, or 10 years.

If the loan will be $1MM+, it's worth looking into a Fannie Mae small balance loan. That will have terms closer to what you're looking for. Their underwriting can be stricter: they only go with stabilized properties, they want experience borrowers, and you need to show net worth equal to or greater than the loan amount (you can get around this by bringing on a rich friend). Worth looking into though, for sure.

Chad Kirchner · Answer

@Jaysen Medhurst , thanks for the feedback. Nothing like learning trial by fire.

Agreed on the quad: I want a higher margin, but I also want to be actively investing instead of sitting on a money market account.

For the 16, my understanding is that it will need a commercial loan. Do you know if there any way to get a 30 year payoff on something like that, or would I be restricted to the 5-7yr commercial loan requirements?

I'm still learning about commercial loan options, and am wondering if it's better to get a few 3-4plex's under a typical 30 year bank loan before venturing down the commercial path.

Thanks for your help!

Jaysen Medhurst · Answer

@Chad Kirchner, this is a no-brainer for me: the 16 unit. Far more potential upside.

The returns on the quad are nothing to get excited about (BTW: cap rate doesn't change with the amount of down payment). I'd want a CoC ROI of 1.5-2X that before even considering it.

You'll still have the FHA arrow in your quiver very soon, since it requires so little capital.