I have a 5 unit under contract and have inspection questions!
Rich SomersPro Member
Investor · San Diego, CA · Member since 2019 · 131 posts · 116 votesSo I currently have a 5 unit Multi family under contract in Louisville, Ky with a 21 day inspection contingency period. The building is over 100 years old, seems to have somewhat updated plumbing & electrical and seller claims roof was replaced in 2017. My question is this: In addition to just the typical home inspection & pest inspection, would it be wise to have a HVAC specialist, plumber, electrician, and roofer come out to dig a little bit more thoroughly into this property? I plan on flying out there to be present during this inspection, and also intend to have a couple contractors out to the property to give me itemized estimates for the rehab that I intend to do. To give you guys a better idea of the rehab: I plan on doing mostly cosmetic items (new cabinets, counter tops, shower, vanity, flooring, appliances, ect.), along with cleaning out the basement to add coin op laundry, additional storage spaces, ect.
Thanks guys, I look forward to hearing your responses!
Commercial lenders do not have seasoning periods, I work for a large bank and do commercial loans. 2% early prepay for 3 years is actually reasonable. Some lenders do a 5-4-3-2-1 structure: 5% in year 1, 4% in year 2 and so on. Your lender will most likely not waive the prepay, but ask them for "customary yield protection" instead of the early prepay they mentioned. If rates go down, you pay the change in the rate x balance x time remaining on the note (it is a very long formula that I can't really explain) but basically if rates drop you will have a penalty, if rates go up then you do not have a penalty. The bank wants to protect its interest income if rates drop, if rates go up they are happy for the early payoff because they can lend money at a higher rate.
Banks lend on multifamily based on Debt Service Coverage of 1.25x. when building is stabilized. Gross rent less vacancy (5%), less reserve budget (5%) less property management fee (5%) minus all operating expenses = Net Operating Income. Operating expenses are anything it takes to run the property: taxes, insurance, landscaping, utilities, repairs, legal fees, marketing fees, etc. Put NOI in the numerator and divide by Annual Debt Service, must be greater than 1.25x.
Costs for repairs really depend on how much asbestos you have (you might not have any) and cost to replace K&T wiring (depends if the wiring is accessible from a drop ceiling, in an exposed basement, open attic, or behind plaster walls that will require some cutting and patching. On older buildings, I pop off the electrical plates when I look at a building and look for K&T. It looks like thick brown string.
The home inspector should be able to break everything down for you and check all the utilities, but while you have other Contractors there for your work, why not have those contractors look at those items for another opinion. A building that old, you need to expect at some time you will need to do work, you will not get a price lowered because utilities are not new and up to date.
@Rich Somers - I agree with @Patrick Liska.
Additionally, since you're going to be there for the inspection, you have the opportunity to pull in an electrician (or HVAC) IF the inspector finds major issues. No need to spend on those professionals until you know you need them.
It can't hurt to have extra inspections, but your home inspector should be qualified to look at the roof, HVAC, plumbing and electrical. If he sees issues, you can always hire more inspectors/contractors to investigate further. I bought a 5 unit building that was built in 1909. It had asbestos on the heating pipes in the basement, which I saw myself. And I saw knob and tube wiring as well. I consider myself a fairly experienced investor so these items did not bother me, rather they got me excited to offer a low price! If you are getting a loan you can pack in the construction costs to your loan, called a "construction loan". You will get about 90-180 days interest only and be able to make draws to pay your contractors. Then at the end of the draw period, your loan will convert to permanent financing at a fixed rate of interest. By financing the construction, you lower your out of pocket cash outlay.
It can't hurt to have extra inspections, but your home inspector should be qualified to look at the roof, HVAC, plumbing and electrical. If he sees issues, you can always hire more inspectors/contractors to investigate further. I bought a 5 unit building that was built in 1909. It had asbestos on the heating pipes in the basement, which I saw myself. And I saw knob and tube wiring as well. I consider myself a fairly experienced investor so these items did not bother me, rather they got me excited to offer a low price! If you are getting a loan you can pack in the construction costs to your loan, called a "construction loan". You will get about 90-180 days interest only and be able to make draws to pay your contractors. Then at the end of the draw period, your loan will convert to permanent financing at a fixed rate of interest. By financing the construction, you lower your out of pocket cash outlay.
Thanks for the advice, I plan on using cash to finance to property, then using my primary residence HELOC to fund the rehab costs. In regards to the asbestos, knob, and tube wiring, how much can this typically cost to have removed by a licensed professional? Also, in your experience with commercial lenders, how much of a seasoning period do they look for once you get the building turned around, and operating at the higher NOI for before they will allow a cash out refinance? My commercial lender I'm using said the early pay off fee is 2% for the first 3 years, for a 5/1 arm.
@Rich Somers My experience with 100 year old plus properties always cost more than expect for the reasons already stated. If you can get second opinion to the home inspectors from licensed contractors I’d go for it. I assure you things will be pricey on that old of a property. In Louisville area is key to making such a rehab even worth the effort. West end I wouldn’t be interested. Highlands or Old Louisville May be worth it. Again more eyes you can get on it the better to me. Good luck.
@Rich Somers I'd get as many eyes as possible on this project. Some will try to screw you, some will inadvertently screw themselves, and a couple will actually be a good fit. You have to go through a lot of people to differentiate between the three though. I'd pack your days with as many contractor walk throughs as possible.
@Rich Somers My experience with 100 year old plus properties always cost more than expect for the reasons already stated. If you can get second opinion to the home inspectors from licensed contractors I’d go for it. I assure you things will be pricey on that old of a property. In Louisville area is key to making such a rehab even worth the effort. West end I wouldn’t be interested. Highlands or Old Louisville May be worth it. Again more eyes you can get on it the better to me. Good luck.
Thanks for the advice, the building is actually in Old Louisville. The building is not being efficiently managed, and current lease agreements all expire this summer. With a $70,000 rehab budget, I think I can conservatively double the NOI. Hopefully the repair costs don't get too expensive. One concern is this: No other owners in Old Louisville have modern, trendy, updated units so theres no proof of concept. However, one of my good friends and co workers here in San Diego went to UL and rented there for many years. He believes there is a market for these types of units there, especially for the graduated kids that are into their careers but still want to live in Old Louisville. I also made friends with some various groups of residents who currently rent there, I showed them pictures of what my rehabs will look like and asked them how much they would be willing to pay, I was actually very impressed so I think I'm going to go for it and deck these units out. What are your thoughts?
Commercial lenders do not have seasoning periods, I work for a large bank and do commercial loans. 2% early prepay for 3 years is actually reasonable. Some lenders do a 5-4-3-2-1 structure: 5% in year 1, 4% in year 2 and so on. Your lender will most likely not waive the prepay, but ask them for "customary yield protection" instead of the early prepay they mentioned. If rates go down, you pay the change in the rate x balance x time remaining on the note (it is a very long formula that I can't really explain) but basically if rates drop you will have a penalty, if rates go up then you do not have a penalty. The bank wants to protect its interest income if rates drop, if rates go up they are happy for the early payoff because they can lend money at a higher rate.
Banks lend on multifamily based on Debt Service Coverage of 1.25x. when building is stabilized. Gross rent less vacancy (5%), less reserve budget (5%) less property management fee (5%) minus all operating expenses = Net Operating Income. Operating expenses are anything it takes to run the property: taxes, insurance, landscaping, utilities, repairs, legal fees, marketing fees, etc. Put NOI in the numerator and divide by Annual Debt Service, must be greater than 1.25x.
Costs for repairs really depend on how much asbestos you have (you might not have any) and cost to replace K&T wiring (depends if the wiring is accessible from a drop ceiling, in an exposed basement, open attic, or behind plaster walls that will require some cutting and patching. On older buildings, I pop off the electrical plates when I look at a building and look for K&T. It looks like thick brown string.
This is definitely not true - I'm curious what leads you to make this statement? What are the rents you are projecting when completed?
One problem you will run into if doing a $70K cosmetic renovation on a 5-plex in Old Louisville is that tenants who are attracted to the area and are willing to pay top dollar want the following:
-Original historic charm (No covering up original wood floors, trim, etc)
-Central heat and air (their own system, not shared)
-Newer electric
-Laundry and off-street parking
If this happens to be the 5-plex on Ormsby, you may want to do some more digging on whether it is actually a 5-plex and if the basement unit can be legally used as an apartment or not. PVA has it listed as a boarding house. We renovated a property like this several years ago and were forced to turn it back into a SFR due to zoning restrictions.
From experience renovating several of these properties, I can tell you that $70K will not go very far on something like this if you're expecting to be at the very top end of the market when finished.
Happy to provide additional feedback and/or answer questions if you have any!
Richard,
Welcome to Louisville. I think there is a market for updated upscale rentals in Old Louisville. With that being said I would offer the caution that all of Old Louisville is not the same. Street by street and block by block have very different characteristics that could significantly impact your ability to command premium rents.
For your inspection make sure that your contractors and inspector are knowledgeable about Old Louisville specific requirements as it pertains to the exterior of your property i.e. box gutters, wooden windows etc. as this is a designated historic neighborhood those items will need to remain and be maintained. I would for sure have an electrician and plumber come, most houses in Old Louisville have had multiple generations of renovations, not all of them by licensed and competent tradesmen so you can quickly get into trouble with wiring and plumbing issues.
@Rich Somers
Congrats on your property! In my experience, I usually keep it simple at first and do the main 3 inspections, Home, Pest, and Roof.
The home inspection report and your inspector should give you more detail about the deficiencies on your property and to what extent they are. From there, you can decide whether you want to schedule other inspections.
Remember, however, home inspectors usually just inspect and observe what they see. They don't get into the bones of a property. Seeing that this property is pretty old, sounds like more inspections might be needed.
But if you plan to rehab the entire property anyways, you could wait until after closing to get additional inspections and estimates done.
I hope that helps! Good luck!
Scope the drains. a sub $500 cost to avoid tens of thousands in repairs. High ROI
@Rich Somers. Is this for your first deal? If so, I guess you can probably get hvac done but in reality it’s probably not worth the hassle. I’d maybe get a plumber to check the plumbing if you want
@Rich Somers. Is this for your first deal? If so, I guess you can probably get hvac done but in reality it’s probably not worth the hassle. I’d maybe get a plumber to check the plumbing if you want
Yes, this is my first deal. I actually was able to schedule an inspector that has been working in this particular neighborhood as a contractor and as an inspector for 30+ years. Turns out he blew out the attic 20 years ago and added the 5th unit there for a prior owner. Anyways I got him scheduled, an HVAC specialist scheduled, and Ive asked the seller if she can provide documentation for remediated asbestos, if not I want an asbestos examination.
@Rich Somers. Is this for your first deal? If so, I guess you can probably get hvac done but in reality it’s probably not worth the hassle. I’d maybe get a plumber to check the plumbing if you want
I think this is all good for your first deal but understand most sellers probably won’t account for all this going forward. Some may, I’m just saying some may not.
@Rich Somers
As previously stated, in Old Louisville due diligence is your best friend. Plumbing, Electrical, and Structural issues needs to be tip top of your list. Keep in mind new toilets doesn't mean new plumbing that just means new toilets. Please let me know if you need any contractor referrals for additional inspections and I will help you best I can. I have seen a lot of money made and lost in that neighborhood. Beneath all that hidden charm there can be some hidden nightmares but as always there is money to be made.
As far your comment on there not being modern units, I'm not sure where you heard that information. There are updated units everywhere and more going on as this is being typed.
I agree with the block to block and street to street statement that was made if you were flipping. You want to use this to get the best deal but if this is a long term hold I would not be nearly as concerned. My experience in rentals as been if you have a high end unit but at a slightly lower cost then market (for the same apt in a better neighborhood) you can pull these tenants into areas that normally don't command rent that high. This would be even more true for students as some won't be from the area and thus will not have some of the local street stigmas ingrained yet.
Good luck on your first deal, first one is the hardest and then it gets way easier.