Potential First Time Rental

So these could be my first rental units. What do you think of the numbers?

Option A - 4 Unit (All 1 bed / 1 bath)

Purchase $70,000
25% Down All units are currently rented on a monthly basis
$332 -PI $1,700 per month (tenants pay all utilities)
$257 - Taxes
$90 - Cost of HELOC - $90
$100 - Insurance
$45 - Trash

Option B - 3 Unit (2 -2 bed / 1.5 bath & 2 bed / 1 bath)

Stage 1 - Purchase $35,000
Rehab $40,000

Stage 2 - Refinance it for $75,000

      25% Down                                          Rental Income $1,800
      $365 - PI                                            Tenants pay all utilities
      $271 - Taxes
      $100 - Cost of HELOC 
      $100 - Insurance
      $45  - Trash

What are your thoughts?

Your rent vs purchase price looks good for both - even considering the sizable rehab for option B. I like that the tenants pay all utilities. Do you have any common area electric bill for hallway lights or external lighting?

It looks like you figured your payments for 20 yrs at 4.5%.

Your taxes are higher than my apartment building which has somewhat similar numbers. My taxes are a lot less than yours, but I pay about $120 for water each month and about $60 for common area electric. In the end, those differences pretty much offset the differences in your numbers.

I think your numbers are fine on each o f these. If you had to choose between them (could you do both if you wanted?), I would look at a few things to differentiate the two properties.

  1. What kind of area is each property in?

  2. What is the overall condition of each property? How do the roofs look compared to each other? What about siding or exterior paint? What do the insides of the units look like? Are they dated by 50 yrs? Things like that…

  3. If all else is equal between the two properties, realize your rental market for 2br will be bigger than 1br. 1br units will rent, but it’s usually a little harder than 2br units. Out of the almost five years we’ve been in our MS market, I only remember getting a single call from someone wanting a 1br unit. We get calls about 2br and 3br units several times a week with people looking for 4br here and there too.

Based on the numbers, I would do either or both deals. I think Option B will be a little more work for you because of the rehab and then re-fi.

It’s always nice to not have to rehab the units and just start collecting rent immediately. It saves time and money that can be used for the next deal.

Can you decrease the down payment, so you don’t have as much skin in the game? That way you have extra funds set aside for the unexpected events that always seem to pop up. And remember, there’s no guarantee that your units will stay occupied with 100% rental income coming in…Make sure you’re prepared in case you don’t have a tenant or rent income for a few months!

Better safe than sorry…

I noticed that you have a HELOC expense. I am assuming that you expect to be able to get a HELOC on each of these investment properties rather than using your personal property for the HELOC. Getting a HELOC on rentals is a little more complex than getting it on your personal residence.

In fact, most lenders will not even allow you to use a rental property. If they do then generally you need at least 25% equity (usually 30%) and the rate will be much higher (like prime +3). If this is absolutely critical to the success of your investment, I would recommend talking to your lender to see if this is an option.

Thank you for all the responses. I have been leaning towards the three unit and rehabbing it slowly. It would only take a few thousand to get the first unit available and with that rent, it would cover my monthly expenses for the property. Obviously, I want to get it completed ASAP, but I need to keep cash liquid for some potential flips (my bread and butter at this moment). The other reason, I like the three unit (as Justin said), it has more marketability/demand.

Regarding the HELOC, I was going to use it against my personal residence so I could have more cash available. However, since I am new to the rental side, I don’t want to be overly exposed and put my home at jeopardy.

I would love to decrease my down payment, but my financial institution will only allow up to $50,000 in house (and that is still 20% down).

After close evaluation, both properties would cost the same after the necessary repairs were made, however, the repairs would make the three unit energy efficient (new furnaces, water heaters, windows, etc.). This leads me to another question…how far does one go to make these dwellings energy efficient? Some windows are operable, and others have been caulked shut…should I just replace the inoperable ones? I noticed the four unit has older windows with storms. Does this matter?

Here’s my take on your questions:
I try to insulate the attic in all of our houses. I know a guy who does insulation really cheap and can get a small house done for about $300. My theory is that I can spend a little money one time which makes the house more energy efficient and hopefully the tenant will spend less on utilities and have more money to pay me rent.

On a couple houses that needed complete rehab and were going to get lots of work, we replaced the windows with new basic windows. I would never put fancy windows in a low income rental because I can’t tell you how many window panes I’ve replaced over the past few years. Some people are really rough on houses and I’ve had plenty of little panes broke out of the old wood windows.

I like making our houses really decent, but you can’t try to re-do everything every time. We own plenty of houses with old wood windows and they still rent just fine.

For your bank situation, you may want to check around and see if other banks will go >50k. We found some banks would only loan 50k or more on houses and we didn’t need that much so we didn’t use them. We work with four different banks. They all know about each other and help us out to varying degrees.

If a loan is being sold to the secondary mortgage market, Fannie Mae and Freddie Mac have a $50k minimum loan requirement. Considering these two properties, why not look into buying them both and wrapping it into one loan? Another remodeling option is to look into some loan packages that allow investors to wrap the purchase price and the rehab costs into one conventional loan (such as a FHA 401(k)). This might be a good option for you as well.

Thank you for the FHA loan idea. I would love to have less in the game than the 25%. I was trying to research the FHA 401(k) loan, however, the only thing I was able to pull up with using ones 401(k) as a down payment. What are the specs for this loan (estimated cost, how much above prime, loan value, etc.)?

What do you guys recommend for a finance option? I have great credit (800+), can put 25%, but down, but would like to have the rehab financed.

Also, with the figures I provided, what do you estimate the potential cash flow for either of these properties?

Lastly, would you recommend doing both deals…even though this is my first rental experience?

I value your input and just want to be thorough.

Regarding the FHA loan, here is a link that may offer some help: http://www.fha.com/fha_loan_requirements. Also, with FHA, if you put less than 20% down then you will be hit with their mortgage insurance which is higher than most other loan packages and will remain as a permanent part of the loan payment regardless of your equity position. IMO FHA loans are are last resort if you have enough for a traditional down payment. Oh by the way, I stated the loan title wrong. It is a FHA 203k loan - sorry about that.

There are other loan packages that can wrap renovation costs into the purchase price. Fannie Mae offers “HomeStyle Renovation” loans. Here is the link for more information on that: https://www.fanniemae.com/content/fact_sheet/homestyle-renovation-factsheet.pdf.

I have to admit, I’m as nervous as a whore in church. They want final and best by tomorrow morning, but there is new information.

After I did my third walk through, it looks like I will need to do about $48,000 in repairs. This would get mostly new plumbing (waste line is leaking & mostly galvanized water lines), repaired roof, replacement windows, new furnaces, carpets, etc.

I talked with the utility company and they said it has some quirky setups. All units have separate electric and gas, but two units share water. The only way to fix this is by redoing some of the plumbing, otherwise I will have pay for their utilities (side note…there are approximately $2,000 in delinquent bills) So it wont be cheap.

As we enter the “slow” season and I will have to pay all cash for purchase and repairs (which will make me somewhat strapped), what is worth the risk?

I still think doing a big rehab project for your first deal probably isn’t the best thing for you. Option A you gave looks like it would allow you to just kind of take over, collect rent, and do some repairs that may have been neglected over time (trust me pretty much any place you buy will need something). I think that’s a more prudent deal to do for deal #1. It’s already performing so you get in there and just start learning about being a LL.
If you were experienced, here would be my thoughts for deal two with your new info:
It’s hard to replace carpets and some plumbing with tenants in place. Having the tenants pay gas/electric is really good. Water isn’t as big of a deal in my opinion. You don’t want to pay for electric and gas for tenants who keep it at 60 in the summer and 90 in the winter. Water isn’t as likely to get abused. The exception is something like a running toilet, but even my low income tenants where we pay the water will still let me know if they have a leak or running toilet.
The delinquent bills should be addressed at closing and the seller should cover this. Maybe the amount is deducted from the seller’s proceeds on the HUD-1 and then you get that money to pay to bring the account current.

Keep in mind that with deal #2, you’re not only jumping into being a LL but you also have to manage a large amount of repairs. You’ll have to find people to do all that work and you may not find the best deals the first time out. Between the two, this deal is a lot more to bite off than the other one. Remember I said that deal #2 should rent easier, but there are these other issues which make deal #2 a lot more of a headache for you than deal #1.

Also remember one of the most common newbie errors is to over-improve properties. I had that same tendency for our first property.

Here’s the thing, rental properties are about cash flow. Tenants are notoriously lax in caring for a rental nor are they usually willing to pay for energy efficiency. Do not look at these properties as you would a fix and flip.

It sounds like there are some water leaks, okay fix the leaks but leave the galvanized pipes. Your tenants will not die from drinking water out of old pipes. IMO, unless the tenant asked to have the caulked shut window replaced or fixed - why bother?

I am not suggesting becoming a slumlord by any means, but it is rare that you are going to get a return on the money spent. Spend enough to get top rent in that construction class and leave it like that.