My First Multi-Family

19 Replies

Hey guys, I'm working on my first multi-family investment, and I'm hoping you all might have some advice. I am currently renting an apartment with a lease that expires at the end of January, so I'm in a bit of a time crunch, especially with the holidays, trying to find a deal. 

I came across a near-fully remodeled duplex here in Orlando, 2/1 on each side, total of 1390 sqft. It was recently renovated: (plumbing, electrical, appliances, kitchen/bath). I couldn't see the roof as it was flat, but it was not indicated as having been replaced.The property is lacking privacy fencing and is covered by trees that are in need of some major trimming or removal ($10k+ to remove the big guys).

I'm planning to owner occupy this property for at least a year, but for investment purposes, I'm looking at it from the perspective of me not living in it (I think this is fair).

I expect I can rent each unit out for $875. Rentometer confirms. Electric is metered separately, and water is not. I figured I'd charge a flat rate of $25/per unit for water to offset this.

Asking price is $190,000. I plan to do FHA 3.5% or Conventional 5% down. My bank quoted me an interest rate of 3.8%, however my mortgage broker quoted me a rate of 4.75% on the conventional. I was told this higher rate includes some lender credits to reduce my cash at close and to compensate the mortgage broker. I expect with the conventional loan my payment will be $937 (I think this includes PMI of $200). I was still told I would need around $14k cash to close.

So here are the numbers I am working with:

Income: Rent $1.750

Expenses: Pmt $937 - Taxes $135 - Insurance $100 (don't know where to get this number) Vacancy $140 - Repairs $87.50, CapEx 87.50

TOTAL Expenses : $1,487

This leaves me with $263 (not factoring in property management). 

Am I missing something? Do my numbers fall short somewhere? I plan to write my offer with contingency on the roof inspection showing it has 5+ years of usable life left. Once I determine the highest price I can pay for this property (hopefully with some help from here) I plan for my first offer to be 8% less than that price to leave negotiation room. I will likely offer close to $170-175k. Anything else I should be doing?

John

your numbers are not far off. The reason they are not making sense to you is because the return is a negative return. A good rule for an investment property return is the monthly rent should be at least 1% of the purchase price. So for a purchase of $190,000 you should get at least $1,900/month. What part of Orlando is the duplex in? $190,000 is expensive for a 2/1 duplex even for an expensive area like downtown 

Don't write the offer "contingent upon roof inspection", just write it "contingent upon inspection".  

I think the higher interest rate reflects the 5% down as opposed to lender credits.

You can easily get insurance quotes online for your property to get a more exact figure.

Can you get a cost estimate for a new roof even if you don't need it?  Regs in my area changed in the last decade and flat roofs are ridiculously expensive to bring up to code. 

If you're owner-occupying half then you're in a great spot.  Even if you make a significant mistake it will be blunted by not needing to pay additionally to live.

Insurance should be easy to quote.  Call your car insurance agent or renter's insurance agent.

Is there any way that you can avoid PMI? Ask the seller to take a 2nd mortgage? Borrow from family? What is your plan to eventually eliminate the PMI?

$14k cash to close seems high.  Offering 8% under asking seems high also; at least this is regional.  I typically end up at 8% under asking.

If fair market rent is $1750/mo then it would be very nice to achieve a purchase price of $175k (1% rule).

hey dude,

the mortgage broker's rate as well as the other rate (BoA) both include a loan origination fee.  the only difference is that more of the "profit" or "commission" goes to the broker vs. the bank.  

careful about 5% down conventional - duplex needs 15% even if owner occupied...

@Christian Marin  Could you explain further what you mean by negative return? I understand based on the 1% rule, I should try to negotiate the purchase price down to 100x rent ($175,000) in this case, however even at the current price it appears that it would cash flow positive, not negative.

The property is near Downtown, giving it the higher price which is comparable to other properties in the area.

@Erin Wysocki Wouldnt a higher down payment justify a lower interest rate, instead of a higher one? This comparison I am making is the higher rate of 5% down for conventional, vs the 3.5% down for FHA.

I did request an insurance quote, and to my surprise, it came back at $55, when my broker and mentor suggested an estimate of about $150. I'll make a phone call today to verify this. Thank you!

Yes the plan is to have a bunch of contingencies written into the contract, but contingent upon inspection will certainly be in there. I suppose what you're saying is that I might not need any other contingencies, so long as it is "pending an inspection"...do I have that right?

@Raj Gandhi  I'm not sure about the regulations here, or what pricing is to get a roof redone.  I suppose that would be questions for the inspector when that comes around, right? 

The plan is to owner occupy half (for a year, hopefully will have the next one lined up before the year ends). It's pretty tiny (700sqft each side) and I will have a roommate on my side, so it's going to be interesting.

I haven't been able to come up with a way to eliminate PMI. I don't think anyone in my family would have sufficient cash available, and I certainly don't want to come to the table with that much of my own funds. I need to learn more about how to eliminate PMI on a conventional loan. I've heard that with FHA it is now for the life of the loan, I'm not sure if its the same for conventional. I suppose I would have to wait till I had 20% equity and then refinance. I could definitely use some strategizing help here.

Thanks for the input on my offer, this is all new to me. What would you suggest as an offer if my strike price is $175,000 (1% rule)?

I would also like to work in some concessions to reduce or eliminate my closing costs.

Planning to speak with my realtor today to set up an offer so I greatly appreciate any input you have.

@Patrick Britton  Hey Patrick, I spoke with my mortgage broker again last night, much more prepared this time than last (thanks to you). I let her know my concerns about what we discussed on the minimum down for conventional, and she said that 5% conventional is doable if my credit is good enough, which she believes it will be.

How do you think I should handle the discrepancy? Should I move forward with both conventional and FHA in mind so that if conventional doesn't work out (at 5% down), there is a plan B? Is this 15% minimum down a national thing, or is it state by state? Do you have a resource I could send her that shows minimum down is 15% for all conventional loans?

Thanks for clarifying the loan origination fee, I was definitely expecting a bit more of a lender credit with the higher interest rate, but I realize these are just estimates that my broker and I discuss on the phone, and I am keeping in mind lower rate = higher cash at close.

@John M.  John, you said that you will have a cash flow of $263 before property management. The usual Property management fee in Central Florida is 10% of the monthly rent. That's $175 a month, so out of the $263 you will actually have a monthly cash flow of around $88/month. That is an extremely low cash flow in my opinion and not worth the risk vs reward. If anything happens like longer vacancy, major damage expense, maybe you have to drop the rent due to a slow economy then you can very easily go negative every month.

@John M.  After all expenses and debt service, I prefer to look at properties with a minimum of +$150 per door (+$300 cash flow for a duplex).  Any properties below that threshold are thrown out.  The percentage down and interest rate vary for each lender, but in general if you want to put less than 20% down, the lender will be charging you a slightly higher interest rate.  There isn't a 'national minimum down'.  One option is to negotiate the best rate/down payment you can with the lender and run your analysis with those.  A second option would be to ask your family members to loan or gift you half of your down payment.  This way you are still giving the bank 20% but you are only paying 10% out-of-pocket. 

In your specific example of quoted rates (5% conventional, 3.5% FHA), you will be paying Private Mortgage Insurance (PMI) for the conventional loan until you achieve 20% equity. You will need to contact the lender to find out what the PMI cost is for that loan. An FHA with requires PMI for the life of the loan, or at the end of 11 years if you have greater than 10% equity ("LTV less than or equal to 90%.  Annual MIP will be collected until the end of the loan term, or 11 years, whichever occurs first.", source: HUD.gov)

Call your local Water Utility and ask what the average water usage/cost was for each unit.  Will you also be paying for lawn care, trash removal, or any common electricity?  Account for these if necessary. 

In your analysis, it would be in your best interest to account for Property Management (10%), even if you are moving out after a year and managing yourself.  If you decide to move out-of-state or purchase 2, 3 or 10 more properties and don't want to manage on your own, will you have enough cash flow to cover a PM at that point?  

Are your "Repairs" accounting for monthly maintenance?  Do you have cash to put up for bringing units up to rentable condition if needed?  There is an FHA 203k loan program where you could get repair costs rolled into your loan.  You will have more hoops to jump through, however.

Best of luck!

@Christian Marin  Understood. My situation is a little unique because I am currently renting, and have a limited time line to get in a living situation for next year. For that reason, I am willing to forgo the property management expenses and assume that I will be managing the property myself (for experience and additional cash flow). I know this is not the best long term decision, however with my situation it seems appropriate. Duplexes in Orlando haven't been easy to come by in neighborhoods that I would be willing to live in, especially at a price that meets or is close to meeting 1% rule.

@John M. I think the deal is a no-go if PMI is for the life of the loan. The drag on profit is just too terrible. Save for a year and then try again.

To increase your available funds, can your roommate pay 1 year up-front for a discount? Do you have a Roth IRA or 401k from which you can borrow medium-term funds? (Borrowing from your retirement isn't a very good suggestion.)

Regarding your offer, maybe initially I'd try $165k with buyer paying all closing costs, seller provides 24 months @ $10k warranty for the roof (funds held in escrow at title company), buyer puts 5% down, seller takes 15% 2nd mortgage (rate 5% @ 5 year term). This offer will not be accepted but hopefully will garner a response. Hopefully they bite on the 2nd mortgage which would allow you to avoid PMI.

For the 2nd offer, dump the roof warranty.  Increase offer to $172.5k with seller providing $5k towards closing costs.  Note the switch from buyer paid closing costs in the first offer to seller paid closing costs in the 2nd offer.  The specifics of the offers can probably use some tweaking but the point is to start with enough variables in the first offer(s) so that you have room to negotiate later.

One last tip.  Before you are serious with your offer, set a max amount for yourself.  If this is business then there must be a point where the deal doesn't make sense.  If you don't have that preset price then, invariably, their "final" offer will be $5k yours.  Then you'll capitulate because you're emotionally invested in the deal.

@John M.  Howdy John,

the 15% down minimum for conventional loan applies to owner-occupied duplex. Is she aware that your looking at buying a duplex? as well, what was the lender credit exactly? it will be affected by a couple of things: credit, debt ratio, down payment, purpose, etc.

the lender credit works the following way: if par or 100 is currently trading, yes, they "trade" at 4.25%, and 4.75% gives 103...then you take 100 off to get 3...you then take off any loan level price adjustments which typically dont vary from company to company. for instance, investors get hit 1 - 1.25%, credit scores under 680 another .5% etc. so take 1 off 3 to get 2...this is now 2% of the loan amount, which let's say is 200k...so your lender credit should be 4k. if this isnt enough try to see what sort of seller credit you can get. so instead of offering 200k with 0 seller credit, offer 205 with 5k in seller credit. the seller ends up with the same amount, but now you have an extra 5k to play with.

yes, always have a plan B. so get her to work on both scenarios.

i'll email you something on the LTVs shortly. they come from fannie mae who is the ultimate authority and doesn't vary from company to company a whole lot.  

@John M If you can do it conventional will give you more options down the road. 5%dp will lessen your cash to close (there isn't a 1.75% funding fee that is included in FHA loans). If there is rehab work that needs to be completed, you can wrap that into your loan (depending on the severity of the rehab). Most educated lenders will have options like a 203k loan or a homestyle loan (fannie mae). This can lead to increased cost due to draw fees but if it keeps more money in your pocket all the better. I do a lot of rehab loans throughout the midwest for my clients and would be happy to answer any questions you might have.

@Adam L.  Thanks Adam. This property is renovated nicely. There's still some things to be done (tree removal, fencing), but I don't know if these would justify going for a rehab loan. Good point on avoiding the 1.75% funding fee. If the conventional works out that will be a great perk. 

@Patrick Britton  She is aware that I am purchasing a duplex. She's been doing business in the area for a very long time as well. I do not know the specifics of what the lender credit was, as we did this all over the phone, I just know that the numbers we ran didn't account for a seller credit, which I plan to incorporate into my offer to reduce cash at close. Would you recommend that before proceeding with an offer on the property through my realtor, I get a cost break out with the specifics of the loan from my broker? 

@John M.  Would you recommend that before proceeding with an offer on the property through my realtor, I get a cost break out with the specifics of the loan from my broker? 

it wouldnt hurt but so long as you have a rough idea as to how much lender and seller credit you'll need you should be ok.  but inform your realtor of your desire to close with as little cash as possible, thus requiring a seller credit. 

@Patrick Britton  Sounds good. I will definitely let my realtor know.

For everyone else reading this, I spoke with my broker and she contacted her lenders and confirmed Patrick's statement that 85% LTV is the minimum for owner occupied duplex via conventional. From here, I am returning to FHA as my only viable option with as little money down as possible. Apparently lenders used to have "portfolio" programs where they would offer 5% down to owner occupants for MF's, but they have done away with that.

@Drew MacDermott Thank you for your well written response. This really helped me put the pieces together. I'm finding that in my market, it is incredibly difficult to find MLS multi family properties (in a decent or better neighborhood) that meet a buying criteria that is ideal based on some of these things you mentioned. I've been searching for 3 months now and this is the first I have come across thst is even remotely close. Unfortunately I haven't taken the time to send out mailers or do any of the other things that might lead to off market properties, so this is what I have to work with at the time (which unfortunately is right before I am about to move out of my current living situation). You caught me on a couple expenses I hadn't considered such as lawn maintenance and trash. For trash, I was under the impression that it was a part of my property taxes, is this not the case?

@John M.   You are correct, the town may include trash bins for every property and have the regional trash company stop by your house, paid by your property taxes.  When I was in college, a few landlords of 2-3 unit buildings did have one of those commercial trash bins, where a truck would empty it once or twice a week.  Again, its an added cost.  Might as well put your tax dollars to work!

Thanks for the reply.  

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