Using a 7yr ARM for a non-warrantable condo

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Using a 7yr ARM for a non-warrantable condo

Gregg C.
Denver, CO · Member since 2013 · 7 posts · 0 votes

Hi All,

I am under contract on 2bdrm condo in the Park Hill neighborhood of Denver for $94,300. Having a difficult time finding financing since it is an investment property in a condo with the own-occ rate at 35% (non-warrantable number per FHA). I found a lender who will do a 7yr ARM (30 yr amortization), 25% down, 1.5% origination (unfortunately) at 4.125%. This is the best deal I have found of a handful of lenders who even offer a product in this situation. I don't want to bring more than 20% down and tie up more cash so I am using a HELOC from another property to get the extra 5%. I plan to pay the HELOC off in 3 years and have backed in a half a point annual increase in my analysis. The unit needs new windows ($2900 estimate) which I intend to use the HELOC for as well.

Factoring in the HELOC payments I still cash flow ~$800 per year (yes, not much). Once the HELOC drops away the cash flow is about $4200 per year. I would like to hold onto the property for a long time so in my modeling I am getting an average before tax cash on cash of 18% when looking out 20 years, which in Denver in this neighborhood right now I think is solid. But for the first 3 years cash-on-cash is 4% because of the HELOC payments. The cap rate without using the HELOC is 9% (again I think is solid in central Denver right now).

What scares me is what rates will be in 7 years. I can always sell the place of course and I think I am getting a good buy so even in 7 years think there will be some decent price appreciation. And the ARM adjustable rate caps out at a level that still cash flows.

Should I walk away from this deal? Too many moving parts? If I am paying a HELOC for three years and potentially need to sell after 7 years is this not even worth it?

Thanks for any advice, Gregg.

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  • Bill S.Pro Member
    Moderator
    Rental Property Investor · Denver, CO · Member since 2013 · 4k+ posts · 2k+ votes
    12y

    Run Forest Run. I know the Denver Market and I understand your needing to stretch to make something work but here is why not to do this deal.

    1) You are correct to be concerned about interest rates. I don't know anyone on the planet that doesn't think they will be higher in 7 years. The only question is how much. Might consider it if you could lock it in for full term.

    2) $800 annual profit for 3 years. That is so low you will be feeding this alligator out of your pocket sometime in those 3 years. You should have at least 10% in reserves for this property.

    3) Windows - why replace them? Usually windows are the responsibility of the HOA. Why do you need to spring for new windows? They never pay back either in energy savings or increase value or even considering both.

    4) HOA - Find a SFH, HOAs are just another moving part that costs you money that you can't control. If you insist, then ask What are the condition of the reserves? How good is the management? What are the outstanding maintenance issues going forward?

    5) Your price point is at the bottom of the market for the core of the metro area and the lowest tier for the surrounding area. Any way to get in the next higher price point? You will find a lot better properties.

    6) Not sure about your statement about CAP rate. CAP rate is not calculated by using any information from loans or interest rates.

    7) Thinking out 20 years for cash on cash is not advisable. Today and the day after today are what counts for me. You have to get to the 20th year or it doesn't matter.

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  • Gregg C.
    OP
    Denver, CO · Member since 2013 · 7 posts · 0 votes
    12y

    Thanks for the advice Chris. Every time I walk away something pulls me back to this place. It is in a great location and ready to rent without any work (except for the windows).

    Some clarifications to your comments.

    1. The rate is fixed for 7 years at 4.125% which is nice. After that I can lock in for another term of years and amortize at 20 years.

    2. Yep...not good. Decent risk there as you point out

    3. It is a small building so everybody is on their own for windows. They just need to look similar. The current windows are single pane metal frame. None of them are operational. Every crank are is broken. I can spend $500 to get them fixed and probably have to repair them each year so I am opting to spend the money now and not have that headache. Half the units in the building have replaced windows, half don't.

    4. Agree on HOA fees but this building has cheap HOAs relative to other places I have seen and some I own, and a decent reserve. The building is only 11 units so it is self-managed.

    5. I like cheap condos ;-)

    6. CAP rate is 9% not factoring into the NOI that there will be a payment on the expense side to pay for the HELOC payments.

    7. Good point.

    On the fence still but you have me leaning to one side.

    G

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  • Micki M.
    Flipper/Rehabber · York, UK · Member since 2013 · 895 posts · 453 votes
    12y

    This may not apply since this is not an owner occupy, but for non-warrantable condos I always work with Key Bank or Compass Bank they have identical programs. Are you staying away from private money? Resolvefunding.com in Boulder could get you into the property and then you can refi a non-warrantable more easily than purchase one.

    I also like cheap condos :) and they're getting harder to find here in Denver.

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