Is this a good investment opportunity?

Question

Hello,

I'm new to the forums and was hoping to get some advice about an multi-family investment opportunity.  In general, I'm curious if this is a good investment opportunity long-term and what other information I should know to help make the decision.

Here are some of the numbers:

Property Value: Estimating ~$800,000, but it hasn't been officially appraised since it was purchased 10 years at $500,000.

Taxes: $4,000

Insurance: $2,100

Year Built: 1912

5 Total Units: 2Br/1Ba, 2Br/1Ba, 2Br/1Ba, 1Br/1Ba, Studio

Utilities: Owner pays only water and trash.

Mortgage: Despite being zoned as a 5-plex, the property has been approved for residential mortgage previously (one unit classified as storage during appraisal).

Previous Gross Rents: $45,480 (previous owner was very generous with rent to family/friends)

Estimated Gross Rents: $69,600 (based on market value)

Previous Annual Expenses: $12,500 = 27% of gross rent. (including: water, maintenance, repairs, insurance, taxes, licenses, etc.)

Estimated Annual Expenses: $45,240 = 65% of gross rent. (including everything mentioned above).

Other: All units have been routinely occupied and the location is excellent.

I plan on managing the property myself and living in one of the units, but may ultimately live elsewhere and use a management company.

Thanks,

Jakobe

Justin Frank · Answer

@Jakobe Smiff

Are you purchasing for $800k or just think it’s valued at that? I would be certain and identify whether it is a 4 unit or a 5. This could potentially give you very different values. If you are purchasing for $800k, rents are guesstimated to come it at $69,400 annually, and expenses are a whopping 65% of your income, I would say this is not a good deal. You would hardly have $2k/mo to cover your mortgage on the property. Also, take into consideration if you come in and try to bump up the rent several hundred dollars on existing tenants they may up and leave. This  will leave you with a high vacancy period until you fill the units. Can you cover the note on the building alone? Why are your expenses so high? Especially if you are self managing. Also, the structure was built in 1912. I would make sure you dig into that building; plumbing, electrical, paint, etc...... I’m sure it’s a cool old building but it could also come with a handful of problems due to its age and depending on how past owners have kept up with it. You may want to be more clear on your purchase point. If I were looking at it, I would purchase based on the current income and my projected expenses. I do my best not to purchase at the price of what the property COULD produce in regards to revenue.

Corey Chonsky · Answer

@Jakobe, what are you basing your approximate valuation on? The property is 5 units so it’s valuation is based of the money it makes not comps. So you need to know what the local cap rate is to determine valuation. Also, are the expenses from the agent marketing data? It seems light for a property built in 1912 and owner paid utilities. Make sure you verify the expenses to include getting actual financial data from the owner from tax returns and bank statements to verify actual rent collected especially since they were “generous” with rent.

Marlen Weber · Answer

@Jakobe Smiff Welcome to BP. This thread has great information on your investment opportunity. Best of luck and keep us posted,

Jenny Roman · Answer

@Jakobe Smiff  @Corey Chonsky Agree with Corey, make sure the actual rents are mirrowing the executed leases and of course in their past taxes. Get an executed current roll to look at your income. Confirm what type of income is generated; long term lease, short term, month to month, Air BnB etc. If you have a 5 unit property under one tax lot it is considered commercial therefore Multifamily. Make sure the zoning and the current highest and best use concurs. However you living there as your primary residence is definitely convenient but might not be accepted by a commercial lender. At the end of the day an appraisal will confirm all these items.

Grayson Spittel · Answer

@Jakobe Smiff there are certainly different goals with owner-occupied multi-unit housing. If you are able to cash flow while still renting the 4 other units, of course that is the desired approach. Secondarily, if you can live for free due to the other units covering the mortgage and expenses, this is a great house-hack. However, a negative cash flow each month where you are "making your money" through "hopeful" appreciation in the future, isn't a solid investment in my opinion.

Jakobe Smiff · Answer

Erik, thanks for the info. That definitely helps clear some things up.

Part of the reason we're interested in the property is that we are currently renting one of the nicer units and love the location of the home. Our thought was, why continue to rent the property if we could own it and be paying a mortgage rather than rent?  In this sense we could "house hack" and have the other rental units help pay for our mortgage.That being said, we're fairly certain we would move out of the property in ~5 years and keep it strictly as an investment, so we'd like to know if it's worth it from an investment standpoint rather than just a house-hack.

I guess part of my confusion is if the goal of an owner-occupied multi-unit house should be to have the annual net operating income cover the annual mortgage + interest costs (i.e., positive cashflow), or if just the annual rent income should be greater than the annual mortgage + interest costs (i.e., positive debt-service-covergage ratio).

Erik W. · Answer

@Jakobe Smiff, hi and welcome to BP!

Typically, any property that fails the 1% Rule will not cash flow positive.  The 1% Rules states that the monthly rents must be at least 1% of the purchase price.  To meet the 1% rule, the equation for the property above would look like this:

Est. Rent = $70,000 (I rounded)

Est. Purchase Price = $700,000 ($100K below your estimate of market value)

$70,000 / $700,000 = 1%.  It would pass the test (barely), if you could buy it for $700K.

But.....BUT!  All that means is you are probably breaking even.  On a 100+ year old property, maintenance is going to be horrendous.  The owners who were "nice" to family and friends with below market rents most likely also left a lot of deferred maintenance items.  Think 20+ year old HVAC systems and water heaters....roofs patched with tar instead of shingles, etc.

I didn't see Vacancy or Capital Expenses included in your budget affecting cash flow.  It is correct not to include them as operating expenses.  Some people do include CapEx as operating expenses but I split them out.  They are more like Reserved/Retained earnings.  Regardless, they impact cash flow.

Let's say all your numbers are correct and 65% covers everything (Vacancy, OpEx, CapEx).  Estimated rent ($70K) - Estimated Vacancy & Costs ($45K) = $25,000 cash flow.

What's your debt service?  If you purchase for $700,000, put 20% down, and amortize over 20 years at 5%, your annual debt service is $44,300 and change.  But you only have $25,000 cash to cover that.  Your cash flow will be negative $19,300.

In summary: you're taking $140,000 cash out of your pocket for the privileged of losing $19,300 per year for 20 years.  CAVEAT: Yes, I realize a portion of the debt service goes toward loan amortization, so you're not "losing" that portion per se.  But you are tying it up in a highly illiquid form for a long time.

Bottom line: I'm not seeing how this property is going to make you money.  Maybe I missed something, but I'd need more detail for why you're excited about this....."deal."

Jakobe Smiff · Answer

Thanks for the quick replies. The seller provided all previous expenses and rents for multiple years. The previous annual income and previous annual expenses are accurate. The owners were generous with rent and did very little maintenance.

The $800,000 value is an estimate - just based on the current annual income and an estimated 5.6% cap rate. I'd be interested in knowing what you all think the maximum value to consider purchasing would be. I'm not sure if the 5.6% cap rate I've chosen is accurate for the exact location.

I was also under the impression that the basic rule was to estimate that expenses would be 50% of the income, and up to 65% of the income if owner pays trash and water. The building is old and may need bigger repairs in the future. But it's also registered as historic, so >$10K repairs have a 20% tax credit.

Is this a good investment opportunity?

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