Rent by the Room Approach and How that Affects Appraisal

Lauren Cutchen · 2021-09-10T09:09:18-07:00

I am looking to purchase a single family home and turn it into a rent-by-the-room situation. PadSplit is suggesting to take away common spaces like the living room and dining room and turn them into bedrooms. I think this is an interesting concept, ran the numbers, chatted with the company, and it all seems good so far. I've identified a property that I can comfortably do this with. I need to install hard flooring throughout (probably vinyl), paint, and put up walls in a few rooms turning this 3300 sq ft, 4 bed, 3 bath house into a 9 bed, 3 bath house. I also need to expand and create access for parking. My question is the best way to finance this property. I do not qualify for a traditional loan...yet. Our goal would be to eventually refinance and take some money out for another project. So I have questions about the appraisal. Details: Purchase price $250,000 ARV (assuming cosmetic updates only) $300,000 - not a great ARV Traditional Rent $1500/month - it was a rental house for years Rent by the Room @ $150/week (1 month min) $5400 - assuming fully occupied and before padsplit fees, expenses...Cash flow: $2500/month Estimating $50k for rehab - extremely conservative and we plan to frame and do the drywall, and painting ourselves. Large house = large budget. I'd prefer to finance construction costs, but can do this out of pocket if we needed to. 1) Hard Money Loan - I would need to refinance after construction costs and updates. How will this kind of property be appraised considering we eliminated a living room, dining room, and bonus room? Would we refinance this into a commercial loan? 2) My MIL is willing to finance this with 20% down and do an investment loan. Could we roll this over into an LLC or refinance into an LLC? I don't mind having a partner with this project, but I want part ownership of the property. 3) See if a bank wants to keep this in house? Would I show them a business plan for this project? I've contacted 2 banks that have said no. How would this property appraise after construction? I want to put an offer in ASAP. I prefer to do this myself without the help of my family. And if we did go the family route, what's the best structure for that?

Brad L.

Rental Property Investor · Manitowoc, WI · Member since 2016 · 178 posts · 186 votes

5y

I've never attempted what you're doing, so take this with a grain of salt:

1. Start with commercial lenders at local community banks/credit unions and definitely have a business plan or at least something for them to review showing you have a plan in place and aren't just flying by the seat of your pants. From my personal experience, these local institutions have so much flexibility and if it's well thought out and makes sense you'll definitely find one that will finance it. I've been able to get some unique financing over the past couple years and know other rental property owners who have financed properties no bigger institution would ever touch. Local guy got a credit union to finance a 17-unit apartment building purchase in which 13 units were vacant for years and 3 of those had fire damage. They allowed him to fix up the units on his own time and dime. So they essentially financed a 17-unit property with only 4 livable units and no immediate plan to bring the remaining 13 units up to habitable standards. Sounds crazy but true.

2. In your initial conversation with these lenders, mention that once you've stabilized the property you'd like to re-appraise and pull cash out. The only thing that would make sense in this situation would be to appraise using the income approach, so if they won't do that they either don't understand what you're doing or they don't understand what they're doing. The problem you'll have is that it will be very difficult for you to estimate ARV on your own close to what the appraiser's value will be on the back-end. Who knows what kind of vacancy rate and cap rate they'll factor in on a property like this.

Summary: This will very likely never be anything more than a commercial loan at a small community bank or credit union, and there's nothing wrong with that. Get in touch with them to explain what you want to do and what they need you to do to make it happen. ARV is anyone's guess, as I'm sure there's not a "standard" vacancy rate or cap rate used for appraising rooming houses since they're not super common. Maybe it is in your market though. Wouldn't hurt to try to call a few appraisers to see if they have any thoughts.

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Lauren CutchenBusiness Member

OP

Real Estate Agent · The Woodlands, TX · Member since 2019 · 185 posts · 79 votes

5y

Thanks for replying. I have another meeting with PadSplit today and we are going over market analysis and all the income, costs -including vacancy rates, and such for our area. This is not common here, so I think it will be difficult to find an appraiser who may know how to use the income approach for this property. I may need to reach out to appraisers in college towns nearby and see if anyone has experience with this. My risk tolerance is pretty high, so I'm okay with being the only one in the area to do this. I just want to make sure I can pull money out after a little while. I'll keep reaching out to banks in the meantime and making an official business plan. I'll also try and get this property under contract (with a longer period to back out) just to secure it.

[email protected]832-406-4239

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Joe SplitrockPro Member

Moderator

Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes

5y

@Lauren Cutchen you better check with the city regarding zoning and occupancy laws. You are taking a single family home that would normally have 2-3 cars and you are going to have 9 cars to deal with now, so parking spots will be a big issue. This also puts substantial wear on the bathrooms and plumbing system. A typical water heater may support 3-4 adults, so you will need to add another water heater. You will need 2-3 refrigerators so people have a place to store food. There are also potentially insurance and fire safety concerns. Make sure every bedroom has sufficient square feet, closets and fire egress offering two escape routes (window outside and door).

As far as appraisal, odds are good that the modifications will reduce value. There is far less demand for 9 bedroom houses without dining or living rooms, than there is for 4 bedroom normal houses. The appraiser may also use the income approach for valuation, but since it is single family, the primary valuation will be based on comparable single family home properties.

This could be difficult to finance through a bank. This is going to be a lot of work to manage, so be prepared. You are not going to have 9 people sharing a space without conflict. I would also hire a cleaning company to come in once per week to clean the kitchen and bathrooms. Lots to consider here. Don't get starry eyed by the cash flow and forget all the other details.

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Lauren CutchenBusiness Member

OP

Real Estate Agent · The Woodlands, TX · Member since 2019 · 185 posts · 79 votes

5y

@Joe Splitrock

Appreciate your input! Yes, parking is something we are working to resolve. Fortunately, this property has a road in the back, so we're thinking of turning the backyard into additional parking. We also ran the property by a legal team too regarding HOA. I am checking the zoning as there are some mixed use lots adjacent to this neighborhood.

I think by using the company PadSplit, they take on liabilities with tenants. The other details like supplying an additional fridge, maid service, utilities, mail, have all been thought of. You bring up a great point about the water heater and gives me the idea to research more about the life expectancy of the current AC unit. The house has been a rental for many years, and has a lot of wear and tear on it already. We anticipate a higher maintenance budget for that reason.

This is a huge house at 3300+ square feet. The rooms are going to be a very generous size, each with a window and ceiling fan. Any walls we put up, can be taken down if we convert it back. It's an ugly box of a house, which is why no one wants it (on market for 45 days which is unusual here). I will talk to an appraiser about the potential of a "highest and best use" for this house and see if they will do an income approach for this property. If it can't, then I may reconsider the financing of it so I wouldn't need to cash out.

[email protected]832-406-4239

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Joe SplitrockPro Member

Moderator

Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes

5y

Originally posted by @Lauren Cutchen:

@Joe Splitrock

Appreciate your input! Yes, parking is something we are working to resolve. Fortunately, this property has a road in the back, so we're thinking of turning the backyard into additional parking. We also ran the property by a legal team too regarding HOA. I am checking the zoning as there are some mixed use lots adjacent to this neighborhood.

I think by using the company PadSplit, they take on liabilities with tenants. The other details like supplying an additional fridge, maid service, utilities, mail, have all been thought of. You bring up a great point about the water heater and gives me the idea to research more about the life expectancy of the current AC unit. The house has been a rental for many years, and has a lot of wear and tear on it already. We anticipate a higher maintenance budget for that reason.

This is a huge house at 3300+ square feet. The rooms are going to be a very generous size, each with a window and ceiling fan. Any walls we put up, can be taken down if we convert it back. It's an ugly box of a house, which is why no one wants it (on market for 45 days which is unusual here). I will talk to an appraiser about the potential of a "highest and best use" for this house and see if they will do an income approach for this property. If it can't, then I may reconsider the financing of it so I wouldn't need to cash out.

The air conditioner is a good point too. Keep in mind that cooling capacity is affected by number of occupants. Humans generate a fair amount of heat. Changing the back yard to a parking lot will require a permit. It may not be an issue, but some cities do limit how much of the lot can be parking. You mention HOA. If there is an HOA in this neighborhood, you will want to reach out to the board rather than just review the bylaws. You don't want the board to give you a hard time.

As far as the appraisal, the challenge is you don't pick the appraiser. Lending laws require the bank to pick them from a pool, so not even the bank gets to select who is doing the appraisal. It is a bit of a crap shoot how the appraiser will react to your modifications. Some may see it as highest and best use, others may see it as hard to sell if you default on the loan. Really that is the bottom line for the bank is, "what is this property worth if we are left holding the bag". Of course if you work with private lenders, the may be more flexible and even let you pick an appraiser.

I have never used PadSplit or heard people share their experience. It would be great if you keep posting in the forums about your experience with them. It would be good to hear the good and bad after you go through it. Renting by the room is the best way to maximize income, but it does increase expenses and risk. It sounds like you have thought it through. Good luck, keep us posted on your progress!

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Wayne Brooks

Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes

5y

@Lauren Cutchen This whole idea just seems crazy….9 bedrooms, no living room/common area…..straight up "boarding house". This will be an odd tenant pool looking for this. I see Real issues with zoning/code enforcement and absolutely issues with an HOA.

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Jason OberweisPro Member

Atlanta · Member since 2018 · 13 posts · 6 votes

5y

@Lauren Cutchen I own a Padsplit in ATL (over 2.5 years) and about to convert another rental property into one. Made both into 8 bedrooms. For the most part, the appraiser will lower the ARV because of a SFH not having a living room. If possible, I'd recommend doing the rehab in 2 phases. Everything in Phase 1 with Phase 2 being adding the walls for more bedrooms.

If that's not possible then you need to stage the old living room as best as possible to be a living room. Also, definitely be there for the appraisal so that you can tell them about the temporary walls and you're doing this so a family can have the flexibility to use the room as they want.

Feel free to DM me if you have more questions.

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Lauren CutchenBusiness Member

OP

Real Estate Agent · The Woodlands, TX · Member since 2019 · 185 posts · 79 votes

5y

@Jason Oberweis

I will message you. I have a couple other questions if you don't mind.

[email protected]832-406-4239

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Frank Chin

Investor · Bayside, NY · Member since 2017 · 1k+ posts · 1k+ votes

5y

@Lauren Cutchen

Have you checked to see if it is permitted under zoning restrictions in the area. Hate the see you get the loans, spent it all on renovations, and you're ordered to convert it back.

I'm putting my "city planning" hat on, and zoning in most jurisdictions is under the city planning department. Usually there's a master plan for the area that allows for so many properties, of a certain size, for a certain population, that requires certain size power grid, sewer, water, roads, parking etc. The rule is if you allow one property to do this, you'll have to allow everyone. In my area, such drastic changes requires a variance, a public hearing, and even a public vote.

Usually, a visit to the planning department to ask about it will give you a good idea. My dad rented an apartment back in the old days was two railroad type apartments, 8 rooms total, to a family of 4, with the tenant saying it's great that each kid can have it's own room, and they can have rec rooms, offices etc. What happened? They were Vietnamese refugees who made it into 6 bedrooms, with two bunkbeds to a room, and rented out by the bed. That's 24 people. Neighbors were complaining about all those people coming and going, taking up all the local parking spaces. What a nightmare.

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Lauren CutchenBusiness Member

OP

Real Estate Agent · The Woodlands, TX · Member since 2019 · 185 posts · 79 votes

5y

@Frank Chin

Yes, zoning keeps getting brought up. The house I identified wasn't easy to find. But zoning, HOA, is fine. PadSplit also has a legal team to run this all by. They are responsible for tenant screening and tenant liabilities. Many factors of the house have to fit a particular criteria. Theres also an acquisition team to make sure the house fits all the criteria. My concern was being able to get refinanced and that would shape my strategy of how I initially finance the property.

I expect a lot of pushback with this type of living situation and can appreciate any and all concerns brought up.

[email protected]832-406-4239

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Matthew Paul

Severna Park, MD · Member since 2013 · 7k+ posts · 7k+ votes

5y

Padsplit doesnt sound right to me .

I would love to see their agreements between the owner and then the tenant .

maybe some others would read this and give their opinion https://medium.com/swlh/the-at...

They have a "membership" for tenants . Sounds a bit fishy .

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David EdwardsPro Member

Houston, TX · Member since 2019 · 88 posts · 97 votes

5y

@Lauren Cutchen

Lauren,

I have a PadSplit in Houston I can help you with anything.

My PadSplit is 8 rooms pulling in $5500'ish in revenue. I have met and managed much of what you are asking about and I routinely have discussions with the PadSplit team here in Houston.

Give me a call, heck I am free now.

917-482-5894

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Lauren CutchenBusiness Member

OP

Real Estate Agent · The Woodlands, TX · Member since 2019 · 185 posts · 79 votes

5y

@David Edwards

Susan, is it? I'll definitely give you a shout. I got your number.

[email protected]832-406-4239

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David EdwardsPro Member

Houston, TX · Member since 2019 · 88 posts · 97 votes

5y

Hello all,

A bit of a case study on PadSplit.

I purchased a 5 bed , 2.5 bath home in March of this year and converted it into an 8 bed 3 full bath home.

The home has 3 room types:

1) Shared bath with private entrance (former living room with sliding glass door) that rents for $170 a week

2) Shared bath bedroom that rents for $150 a week

3) master bedroom that rents for $200 a week

I also rent out garage parking for $25 a week.

Parking is handled in a few ways, by having a corner lot, by having. Home in an area with abundant street parking such as across from a cemetery, or by turning your Packard into parking with "minimalist landscaping" or paving.

In order to account for all costs including PITI, utilities, cleaner, landscaper, maintenance, etc you want to have 6+ bedrooms but really not much more than 9 though I have heard of some with 10+ units. I have actually started looking to possibly build duplexes with 6 bedrooms per size rather than a single family with this many tenants.

Padsplit does manage the drama, they deal with the people. What you need to do as the home owner is manage the place which yes it will wear out faster but your cashflow is 10x that of what you would expect of a sfh, at least in my case it is. If you want a more passive experience there are property services companies you can find as partners on padsplit's website under vendors. They will take care of the place for you.

If you start thinking of getting into padsplit, one metric is $30k per bedroom. Plenty of hosts state this is their target all in price for a home including aquisition, rehab, and the slight furnishing (bed, mattress, bed cover, lamp, side table, place for clothes if there is no closet) you have to have.

917-482-5894

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David EdwardsPro Member

Houston, TX · Member since 2019 · 88 posts · 97 votes

5y

@Lauren Cutchen

Ha I just zoomed in on your picture :-) yes, talk soon!

917-482-5894

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Rent by the Room Approach and How that Affects Appraisal

Rent by the Room Approach and How that Affects Appraisal

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