My first deal...anything I'm forgetting?

Question

1st time poster.  Long time lurker.

4 unit property - 3 are tenant occupied, I will live in the 4th
$370k purchase price
$3200 monthly income
$19k in seller assisted closing costs
$11k - 3% buyers agent fee toward closing costs (I wrote my own offer without a buyers agent)

I only have 20k in liquid funds, so I'm applying for an owner occupied FHA loan @
3.5% down.  Good credit & income.  Applying the $30k in closing cost help to buy points on the loan, and get the rate down to 3.75%.

monthly costs:
$1654 P&I
$400 tax
$350 MIP
$100 insurance
$200 trash & water
$160 assumed vacancy is 5% of the gross income per month

$2854 assumed expenses
$3200 income
$346 monthly cash flow

New-ish roof, siding, and appliances.  Lower middle class neighborhood.  Not a warzone.

Would you do this deal?

Lance H. · Answer

Hey Everyone,

One thing to note about the 5/1 ARM is that unless there are some major changes to FHA, refinancing won't be an issue.  With an FHA loan you can do a streamline refi that allows you to refi with no appriasal and no credit check.

I'm still not a fan of the 5/1 as rates are at all time lows right now, I'd prefer to lock that in for 30 yrs.  Who knows, 5 years from now 30 fixed could be in double digets. In my opinion that is the real gamble with the ARM.

Just my 2 cents!

James Hamling · Answer

Matt,

Not knowing much on the CA area, I will speak in generalities.

Know the value, on something like this with a 5/1 ARM you are gambling plain and simple, your rolling the dice on your bet that in 5 years time you will be sitting in XYZ position, the financial industry will be XYZ, housing industry, local market, YOUR income, so on and so fourth. For most investors it's the worst of both worlds, too far out to really make an accurate gauge, and to soon to ride out the unknowns and make adjustments, gain equity and leverage. It's that center seat on a fence, not a fun place to ride.

If you are sold on it, as a retirement builder, I'd suggest press all extra equity into the loan over the 5yr term, that is unless you are going to get active in investing, where if that were the case you should not be living in an investment in the first place unless it is the absolute cheapest possible if you need the cash.

A 5/1 ARM is a gamble I would NEVER make unless I was equity drenched in the property. We have seen >20% equity losses all too often, still. No, I think we are at bottom in most markets, and as in mine, below the bottom, BUT, BUT BUT BUT, you are leveraged in this thing way too tight the wrong way, with an ant fart in the wrong direction your gonna be in a real pickle.

Matt Jesse · Answer

I see what you're saying Ralph.  So a 5/1 ARM would be an appreciation play?  After 5 years, if there's no appreciation, I'd be at 87% LTV.  Probably not enough to do a re-fi.  I could probably sell though and break even at least.

I suppose the biggest risk is if prices keep falling.  That would really suck to be into a 5/1 ARM then, but I wonder how likely that is to happen...

Ralph S. · Answer

Matt

Pay me now, or pay me later.  Isn't later always the higher cost?

ARMs are currently driving the foreclosure rate as those 5 & 7 year ARMS are resetting and people are finding themselves underwater, unable to refi or sell.

Why am I against them, ask your neighbors in this situation.

Even worse, you are contemplating a 97% LTV.  You will have little skin in the game, as they say.  Since selling costs are 6-10%, you can't sell from day one.  You think prices are going up enough in 5 years to cover your selling costs?  The option to refi also relies on appreciation. Pretty sure no bank will refi at such an LTV, and am not sure what HUD programs are available for refi's at such a high LTV.  So, I don't think either option is doable.

With a 5/1 ARM and a high LTV, you are screwed.  It just doesn't happen for 5 years.

Uwe S. · Answer

Matt,

here we have the variation, you`re not the normal investor, you will live in this house to save some money + you have the opportunity to buy a 4-unit for your later retirement.

So in this case it make sense to invest in this house.

My calculation:
$3,200 a month = $38,400 GI - 55% ($21,120) expenses (safe side) = $17,280 NOI - your debt service of $19,848 = - $2,568 per year. So your "rent" for the fourth unit is $214 monthly, not bad I think.

-Uwe

Matt Jesse · Answer

Thanks for the responses.  Living on this property is more a necessity than scheme to be watchdog...I need a place to live, and am currently renting.

Ralph, by living in the 4th unit, I save the money I've been throwing away on rent.  So for my situation, it seems to make sense.

The interest rate of 3.75% is a 30 year fixed, after buying 2 points.

I'm curious, why don't you like a 5/1 ARM?  I'm thinking about one, to get the rate even lower.  I could definitely see myself selling after 5 years, or at least re-finance...

Patrick Snyder · Answer

I have to agree with Michael.  You'd have to pay to live somewhere, and this will allow you to know about everything going on.

Michael Seeker · Answer

What would the 4th unit (the one you'd live in) rent for if you weren't living in it?

One of the factors that you can't really put a price tag on is the fact that you'll be able to live there (essentially for free).  Since you'll be living in the building, you should be able to keep expenses lower and quality of tenants high.  I found that by telling prospective tenants I live in the building and will be around if anything goes wrong, I tend to attract a much better quality tenant.  The crappy tenants that are out to screw you over won't want to live a wall's thickness from their landlord.

Ralph S. · Answer

On first blush I’d say no, don’t do it.
$370K for effectively a 3 unit, or $123K/unit.  That’s a lot.  For $38,400 in annual gross scheduled rents, the 2% rule would value this at $160K (but, it doesn’t  sound like war zone or low income, so the 2% rule is not a very good guide here).

On second blush, applying the 50% rule, this 3 unit is essentially break even.
Scheduled Gross Income (SGI or Rents)	$38,400 
Operating Expenses (@50% of Rents)	($19,200)
Debt Service (PI)	($19,843)
Annual Cash Flow	($643)

But there is still that pesky fourth unit, and the operating expenses it will consume.  So, it is far from free rent.

From a different perspective, the analysis of renting all four units, assuming for example purposes, that fourth unit would rent for $1,200 per month:
Scheduled Gross Income (SGI or Rents)	$52,800 
Operating Expenses (@50% of Rents)	($26,400)
Debt Service (PI)	($19,843)
Cash Flow	$6,557  ($137/month/unit)

So, there is your rent charge (opportunity  cost).   $6K/year NOT in your pocket.

If you can really get a 3.75% loan with a LTV of 96.5%, good deal.  I’d work on that sales price, though, and get it down as much as possible.
My opinion is you’re accepting a high price, and it only appears to work (with all units rented) because it is offset by a low interest rate. 
If the interest rate you mention is an ARM, forget it.

Matt Jesse · Answer

The $3200 is for 3.  $1350, $1000 and $850.  I would live in the 4th, rent free of course.

A 10% vacancy estimate would be $320 per month...sure I should estimate that high?