Advice please! Should we proceed with this duplex?

Question

Hi BP community!I'd appreciate your thoughts on this. My wife and I are considering buying a duplex in a major metro in the South, in a rapidly developing and trendy in-town area close to downtown.  We have it under contract for about $400k and there are good opportunities to improve it and increase rents- both sides are currently occupied at below market. I know this area well and significant new development is underway nearby- restaurants, apt complexes etc.

We're planning to use about $200k to make a 50% down payment from one of our parents. I know this is an extremely high down payment but it will allow us to keep PITI a bit below the monthly income and to make improvements faster with our own cash.

We think we can increase the rents probably 20% over the next couple years, refi and pay back the investment with a chunk of the cash-out. This of course assumes interest rates aren't seriously higher then.

My main question is whether this is a dumb use of this much cash? Should I be looking for a larger property and make a down payment of closer to 20-25%, ideally one that cash-flows more out of the gate.

Another factor is that we're splitting the profits with our parent when we refi and buy him out, which will reduce how much cash we can pull out, in order to keep 20% equity in the property. The timeframe for this buyout is flexible - probably 3-8 years.

I love the BP community and would really love your take on this!

Scott E. · Answer

The simplest way to analyze this deal is to calculate your cash-on-cash return.

This means you need to take what the annual GROSS rent number, subtract out all expenses to come up with your NET rent number, and then divide that by your $200k invested. For example:

Monthly GROSS Rent: $3,000

Monthly NET Rent: $1,000

Annual NET Rent: $12,000

Cash-on-Cash Return: 6% ($12,000 / $200,000)

Do this same math on your deal. If the cash-on-cash return is north of 8%, then it's a good deal in my book (in today's market)

William Costello · Answer

@Derek Johnson congratulations on taking the step into real estate investing. Like what Scott mentioned measuring cash on cash is a great way to analyze the deal. Also what is your goal with this property. Are you looking for a long term hold? Also having comps in the area to make sure your rent is competitive enough for the duplex to be rented. Best of luck

Rick Baggenstoss · Answer

You should work with your parent's CPA on this.  This could be a note, a partnership, a gift, etc.

I think they are buying with you -- let's say a multi-member LLC.   You have the option to buy them out in 3-8 years for $200k plus 50% of the appraised value greater than $400k?.  Meanwhile, you will split the income?

I'd figure out how to structure this better to reduce the tax burden on your parents and improve your cash-on-cash.  Maybe they'd rather have the whole note and wrap the mortgage for you?  Better get some tailored advice.

Nicholas L. · Answer

@Derek Johnson I may not be understanding your plan correctly, but increasing the rents only is not likely to increase the value of the property significantly.  Small multi is valued using comps and not income.

So, there is definitely risk in counting on the value going up so you can refinance and get more cash out.

Now, whether or not it's a "good" investment is a different question that will depend on your goals, desires, cash on hand, other opportunities, etc.  I just wanted to make that one point so it was out there.

Nick Shri · Answer

I am sure you have heard the maxim 'cash is king'. 50% down is locking up your cash in a non or not high cash flowing property. Lenders may not like that. Cash out refinance, well with high interest rates in future you will not or continue to have reduced cash flow. And banking or counting on appreciation would be more like gambling, you don't know for sure what is going to happen. I like to invest the least possible as required by the lenders and have cash reserves.

Goodluck to you on your journey! And if possible, log your journey here on BP.

Alex Hunt · Answer

This is a tough debate. I would consider less down payment on the same location, as long as it passes the DSCR. Using the rest of the cash as down payment to purchase another location, as I believe it is better to diversify your holdings verse having a lot into 1. Figuring out the ownership structure will be important to

Derek Johnson · Answer

Thanks all for your input! Super helpful for us, and as we ran the projections more, decided there's probably a better deal out there for these funds. Your ideas will definitely help us find the right one.

Advice please! Should we proceed with this duplex?

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