Buying Multi-Fam and Living in it

[REI101]

My wife and I are thinking of buying a multi-family and living in one of the units. We would be first time buyers and applying for a conventional loan. Do banks factor in potential rental income at all when deciding how much of a mortgage we would qualify for? One of the ones we're looking at is fully rented with all renters on month-to-month leases.

[davewindsor]

My wife and I are thinking of buying a multi-family and living in one of the units. We would be first time buyers and applying for a conventional loan. Do banks factor in potential rental income at all when deciding how much of a mortgage we would qualify for? One of the ones we're looking at is fully rented with all renters on month-to-month leases.

Most, if not all, banks don't use stated or "potential" income anymore.  They use real or actual income based on its history and they'll want to see proof of what it made from your or the vendor's income taxes for the past three years.  If you've had high turnover with month-to-month renters and a lot of empty months between tenants, then that will reduce the actual income.

If it's a smaller building like a triplex you're moving into, they only let you use half the actual rental income plus a third of your personal income minus expenses in determining whether you can make the mortgage payments or not.

Conventional mortgages for rental properties are a lot harder to get than you think, at least in my area anyway.

[Estrogen Hostage]

We got started doing this. We used FHA financing and qualified on our own income. The banks probably won't look at potential rental income anyqay, so I would forget about it. We put 3.5% down on our first duplex and lived there about a year and two weeks (one year is the minimum). I now own this duplex and rent it out, with a $700/month positive cash flow.

[REI101]

We got started doing this. We used FHA financing and qualified on our own income. The banks probably won't look at potential rental income anyqay, so I would forget about it. We put 3.5% down on our first duplex and lived there about a year and two weeks (one year is the minimum). I now own this duplex and rent it out, with a $700/month positive cash flow.

This is precisely what we're looking to do - duplex, FHA loan, etc. We've found one with both sides rented on month2month leases. They're currently renting about $200 month under market. Our plan is to kick one side out and move in and very slightly raise the rent on the other side until we're settled. Then, after some time, raise the rent on the other side to market value knowing full well the tenant might opt to leave. The duplex is in Northern Virginia about .2 miles from the VRE in a nice neighborhood. We shouldn't have a problem renting it as long as our rent is accurate.

First, I need help with an exit strategy. We'll have PMI with only 3.5% down and we'll need to get rid of that in order to acquire more cash flow. We only want to live there about two years (have a one-year old baby). I think we'll use the rent payments from the other side and throw it at our mortgage to try to build up 20% equity asap. Once we got that, get rid of PMI. Refinance and then move out and use the money for.... This is where I need help!

[Estrogen Hostage]

PMI doesn't go away at 20%. They have a seasoning on them, in my case it was 5 years. Most mortgage brokers don't even know about this, mine told me I can pay it down at any time. The only way to get out of it is to refi and you can't count on rates to be this cheap in two years.

$200 is a big rate increase. You might talk to both sides about it and see if one or the other would rather move. That way it doesn't go vacant since you can move into either side. You need to get them to sign a lease, your lease.

For me the exit strategy was to move out and put a for rent sign in the yard. End of story. In my case the cash flow was fine even paying PMI. If you are going to refi, you will probably want to do it at one year and try to get to 80% LTV then. Most owner occupied loans require that you live there for one year after signing.

How much $$ are we talking? Mine was $165k with rents at $950/side. It was in good shape when I bought it, rents are near the top of the market.

[REI101]

That was helpful. Thanks! I've already moved on as I think it was just too pricey for me. I found myself trying to make it work instead of it just being obvious that it would work if that makes sense.

Still, I am looking for another multi-family and looking at a working-class town about an hour from DC. They have been hit by hard times and they have many multi-families on the market right now. What is the general rule of thumb for renting? Is it that gross rents must equal at least 1% of the purchase price? I know there are many other factors to consider but I thought this might be a starting point.

[justin0419]

1% will run you out of money.  I strive to be at or above 2% although that will be much more difficult to achieve in nicer areas.

[Estrogen Hostage]

I don't necessarily agree. I think it depends on the area and type of property. My duplex was bought at 1% and it's one of my best rentals. Taxes and insurance are cheap, vacancy is nonexistent, and it's almost new and maintenance has been dirt cheap. I bought it at $165k in an area in which it will easily sell for $100k/side.

Right now I am cash flowing $350/side on the place and that will go up to about $400/side after I refinance soon. I put new paint, carpet, and tile in them when I bought them, but other than that I had a microwave fail and that's it for maintenance.

Keep in mind that's on a $5000 initial investment. That's a 100% cash on cash return.

I would analyze your situation like you are paying rent to yourself at market rate.

[REI101]

There is one four unit building I'm looking at that is listed for 119,900 (down from 149000) and has been on the market for six months. The claim is that its rents total 1900 per month but I haven't investigated for myself yet other than that is what one would expect for that area.  The bathrooms, floors, and back decks are all new.

Problem is I don't know if I can convince my wife to live there for a year. It is very working class neighborhood and we have a one-year old. Maybe I could let her keep our apartment in near the city but that would certainly eat up our profits the first year.

When you moved out of your first rental, how did you buy your next place? Did you pull equity out and use it for a downpayment?

[Estrogen Hostage]

You're talking about a lot different place than mine. You'll have twice the tenants at half the rent (tenant difficulty and rent are in inverse relationship). So that equates to at least about 4 times the trouble I have. It's a place your wife doesn't want to live (mine made me move after we had our fourth kiddo). Wear and tear will be higher, along with insurance and just about every other expense. With a property like that you'd have to be closer to 2% than I do on mine. Multifamily is harder to keep rented too. 

That said, you're close to 2% already. 2% is 95k.

I think it's worth looking into. I would plan on using the rent from two units to make the payment, the third to make repairs, and the fourth for profit. Another advantage is that you will be able to combine trips there and not be driving all over the place for visits.

No, I didn't pull cash out. We spent a year saving up enough money for a 25% down payment on the house we are in now. I don't like being leveraged.

[justin0419]

I don't necessarily agree. I think it depends on the area and type of property. My duplex was bought at 1% and it's one of my best rentals. Taxes and insurance are cheap, vacancy is nonexistent, and it's almost new and maintenance has been dirt cheap. I bought it at $165k in an area in which it will easily sell for $100k/side.
Right now I am cash flowing $350/side on the place and that will go up to about $400/side after I refinance soon. I put new paint, carpet, and tile in them when I bought them, but other than that I had a microwave fail and that's it for maintenance.
Keep in mind that's on a $5000 initial investment. That's a 100% cash on cash return.
I would analyze your situation like you are paying rent to yourself at market rate.

I agree the quality of the property and area factors into it.  In some places, people would never be able to buy investment properties near 2%.  My opinion is that 1% is still what I call "Realtor math" because they advertise things as cash flowing rentals at that point.  I guess it will cash flow if you stretch it out long enough.  I just don't like carrying long term loans on investments like that. 
RE101, make sure you're checking out which utilities you'll be paying as the owner so you can make an apples to apples comparison.  For the new place you found, do you pay for everyone's water, electric, gas, etc?

[REI101]

Thanks, Justin. Yes, I am comparing utilities and factoring that in as well. You're right, 2% will be tough here but it seems that 1.5% and even 1.7% could be possible. Most listings, as you suggest, are priced about 1% or 1.2%.

Also, it's important to bear in mind that we would essentially be living rent free for at least a year. I will not buy a place that cannot fully pay for the mortgage installments, taxes, and PMI. We'd either use that moneywe'd normally spend on rent (we currently pay $1600) to throw at the mortgage or save it for a down payment on the next place.

There are two different towns in play. One is more desirable and closer to DC by about 15 miles. The other is more blue collar (euphemism for poorer) and has really fallen on hard times since the crash. While it may have more opportunities to score, I worry about being able to keep tenants and maintain the properties.

With so many multi-families (almost 70 between the two towns) on the market, I'm going to look at a bunch soon so I can really get a feel for the area and the market. Now, I just need to pick a realtor and I've asked around but no one I know knows any realtors in that area. Do I just pick one based on their web site? I suppose in a way the realtor doesn't matter too much as long as I know what I'm doing and stick to good investor math.

[justin0419]

My wife found our Realtors after searching several local websites and seeing that ours advertised that they would work with investors.  We learned our Realtor had previously owned several rental properties so we chose him and his son to work with us. You should be able to find some in those towns who invest too.  Some Realtors don't have rentals. They just help people buy and sell houses.  I would at least narrow down my search by looking for people who understand rentals like that. Sounds like you have plenty of properties you can evaluate. You're right about the math. Know your numbers and don't let anyone talk you into paying too much just to make a deal.

[Ashon]

Our three properties are running about 1.75. But what we looked a wasn't the percentage so much as we looked at the cost involved and if we could get neutral cash flow at 50% occupancy.  75% gives us about 300 a month in cash flow after debt service and 100% will give us 800-$1000 a month in cash flow after debt service.

The problem that we discovered was that there are 4x the costs involved with a plex.  4 refrigerators, 4 washer/dryers, 8 showers, 8 toilets etc... and like all things it all happens in the same month.  But for the Money I've always suggested that a great place to start being a buy and hold investor is to buy a 4plex live in one, pay rent and rent out the other three.  First off it keeps that budget inline and turns it into investing cash, but it also is a great way to build equity and learn how to deal with tenants.

[REI101]

Thanks, guys. I've been thinking about this for over a year and trying to figure out a way to get started. We have virtually no savings but excellent credit (780-820 scores). My wife, as an attorney, earns easily a six figure salary but we threw away most of our paychecks on stuff we didn't need. Only in the past two years have we really focused on tightening our budget. But our extra income has all gone into retirement accounts so we don't have funds on hand. Also, another thing going for us is time. I stay at home with my son and have part-time job in the evenings. This sort of flexibility should come in handy.

I figured the best way to get started would be to buy, hold, and rent. My main criticism of this strategy is that with a salary like my wife's we would be better off saving as much of a down payment as possible over the next couple years and then go for it so we're not leveraged as much. On the other hand, there is something to be said for not waiting and actually doing. Living in one unit while renting the other(s) seems to be a sensible hedge against having too much risk.

One intriguing place, for example, would be 1.76%. The claim is that it rents for $2200 and all three units are currently filled. The listing is 124,900. If we moved into one that would eat up $850 of the gross rent leaving us with $1350 left. Mortgage plus insurance plus taxes plus PMI would be $1050 per month (this is paying asking price and putting $9000 down). We would go from paying $1600 per month on rent to essentially $850. The building has new windows, new roof, and new carpets.  I haven't seen yet, however. I don't know if the units are separately metered. I would love to get realtor that has done this before and really has an eye for repair issues as well.

Does anyone know the type of expense involved in getting separate meters for utilities and if they have an opinion on whether it's worth it?