Profit/Cash Flow ratios and requirements on multi-family investments

11 Replies

Hi All

Forum Noob here, just curious what are your rules or requirements for profit/cash flow prior to making an investment on a multi-family unit? I'm currently looking at an opportunity to buy a 2 family for $260K. I plan to put $10K down on a 30yr mortgage at 4.5%. I estimated the mortgage/tax/insurance/water will total about $1750, Currently both units are rented with a total rental income of $2350, although I may decide to raise rents slightly. That would mean a profit of $600/month or 34%. Thats without putting any estimate for additional required maintenance. Would you pull the trigger on this deal based on this info and what other considerations am I missing?

Look forward to hearing some of your feedback!

@Peter Vuong

A couple of issues I see:

-- Only $10K down on a $260K property is about 3.5%, so I'm assuming you're counting on an FHA loan, but according to their website, you must be an owner occupant so you either won't be able to rent both units or you won't be able to get that loan. As an investor, your interest rate will probably be a point or so higher and you'll probably need 20% or more down. (If you have another loan source, please share with everyone).

--I think you are probably underestimating what the true expenses will be. Read up on the 50% rule that says, over time, expenses will average about 50% of rent. That's for everything except principal and interest payment. You mentioned insurance, taxes and water, but is the property separately metered for all other utilities? Not accounting for vacancy, maintenance and capital expenditure funds each month is being shortsighted: sure you might make a few hundred dollars each month, but when there's a vacancy and you need to spend money to replace carpet and repaint and then the roof needs to be replaced, you could end up losing big for that year, so you need to be preparing for those things and accounting for them in your projections. Also, most people would say you should account separately for property management even if you're gonna do it yourself. Some day, you might want to hire a property manager, so you should plan for the property to still be adequately profitable when/if you would do that and you should also pay yourself for the time involved in managing it yourself in addition to your pay as the investor.

-- Finally, I'm not sure how you were calculating your return. IF your cash flow was, in fact, $600/month (and I explained above why it won't be) that would be $7200/yr or 72% return on your down payment, not 34%. That would be amazing, but, again, your cash flow won't really be that high.

You need to figure out how you would actually be able to finance this property, what all the expenses would be including budgeting for less frequent, but still very real expenses like vacancy, maintenance and capital expenditure and then see what the cash flow would be.

Good luck.

Here is my worksheet for "sniff test" on a property.

Cost
DP
Loan
MP
MP Yearly
Taxes
Insurance (get a quote)
Utilities (for water, sewer, & garbage, I use $1500 per unit)
Vacancy & Maintenance 10% of rental income

Add last 5 items to get your yearly expenses and subtract that from projected income. See how you do. I agree with Peter about your loan plan. If you can pull that off, let us know how.

For an investment loan you're going to need 20% down. Assuming a 5% 30 year fixed loan here's how it looks to me:

Down: $52,000

Loan: $208,000

P&I Payment: $1117

Rent: $2350

Expenses, capital, vacancy: $1175

NOI: $1175

Cash flow: $58 per month

Cash on cash return: 1.3%

Originally posted by @Jon Holdman :
For an investment loan you're going to need 20% down. Assuming a 5% 30 year fixed loan here's how it looks to me:

Down: $52,000

Loan: $208,000

P&I Payment: $1117

Rent: $2350

Expenses, capital, vacancy: $1175

NOI: $1175

Cash flow: $58 per month

Cash on cash return: 1.3%

I couldn't even find a 80% LTV loan for multi-family. Not saying it doesn't exist, but I had multiple lenders point out the Fannie Mae rules limiting LTV of non-owner occupied 2-4 units at 75%.

402-965-1853

Thanks for the responses everyone.

Well I figured I could get a first time home buyer loan, there are some specific ones that the state offers that doesn't require 20% down. I figure as long as I'm paying my mortgage, not sure how much the bank would care?

@Brett Russell Yes, everything is separately metered. What is your rule of thumb for determining vacancy and maintenance? Is it 10% like Ginny's? How do you determine capex for larger expenses typically like a roof fix?

@Ginny Watson what is MP?

@Jon Holdman Thanks for the reality check, wow now this opportunity doesn't look as rosy as when I first looked at it.

Peter, to sign up for an owner occupied mortgage and to not live there is mortgage fraud. It is best to not start on the wrong foot in thus business. It is simple to find good deals for the first couple properties because of the ease of financing options so if you feel you need to cheat now, you really won't make it going forward. I recommend buying your first property as an owner occupied and then actually living there and renting out the other section of the duplex. This will lower you living costs and get you some experience in landlording. Good luck

Do not lie to a lender, or deceive them, it's a federal matter.

Also, a duplex is a single family dwelling (1-4 units) multi-family is 5 units or more. So, no you're looking at residential rules on a commercial building or visa versa need to identify what you're looking at first.....single family dwelling. :)

@Kyle Hipp

@Bill Gulley

You're right, thanks for being so candid, I need to do it the right way and making sure I get my financing in place first, if I'm to do that deal. I'll definitely look into the owner occupied duplex option.

@Giovanni Isaksen Yes, MP is mortgage payment. For my first investment property, I was required to put down 25%.

On another issue, Loopholes of Real Estate by Gary Sutton uses the assumption of 7% vacancy in his property analysis. I guess I should clarify whether the 7% includes the cost of turnover maintenance which always goes hand in hand with vacancy. Perhaps my 10% figure is a bit high. Does anyone know?

Originally posted by @Ginny Watson :
@Giovanni Isaksen Yes, MP is mortgage payment. For my first investment property, I was required to put down 25%.
On another issue, Loopholes of Real Estate by Gary Sutton uses the assumption of 7% vacancy in his property analysis. I guess I should clarify whether the 7% includes the cost of turnover maintenance which always goes hand in hand with vacancy. Perhaps my 10% figure is a bit high. Does anyone know?

Ginny,

8.33% (1 month in 12) to 10% is usually a fine allowance for vacancy. It is to your advanatage to be conservative when forecasting revenue. If the property cash-flows to your specifications with a higher vacancy allowance, then you will be smiling.

As an example, we are in a government/university town with a historically stable, if not a little tight, rental market. Vacancy rates for more than a decade, were <4%. We have always used 8.33 - 10% when modelling a new acquisition, but in reality have experienced an effective vacancy of <3% across our portfolio. In the past 18-months more than 400 new units have come on-line in the are and the vacancy rate rose last year from 4.2 to 6.8% (62%). As a result, there is a downward pressure on rents and it is taking a little longer to fill units.

Relate to this is the fact we have submitted bids on 3 REOs in the past month - fallout of folks who did not use conservative enough revenue projections (vacancy rates); overpaying and not being able to sustain the property when reality changed.

When modelling properties, it pays to be as conservative as you can - take the lowest revenue estimates and highest expense estimates applicable to the property.

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