Feedback on our four-plex strategy

[Stephaniekb]

We recently sold a single family home property that we owned and are looking to invest some of the proceeds in a four-plex. Our goal is to generate enough money to cover the mortgage on our current (not-very-mustachian) house (approx. $1900/month).

We just had an offer accepted on a 4 plex in a town just north of Denver, a fast-growing area that is now and should continue to be a very attractive rental market. The property is in an OK neighborhood -- mix of SFH and rental units. It was in poor condition but was just flipped by a real estate developer that put in all new plumbing, wiring, windows, kitchens, and bathrooms. The outside needs a little TLC that my husband plans to do mostly himself.
Here are the numbers:

purchase price: 436,500
downpayment: $200000 (to generate maximum cash flow)
taxes:              $   2100
insurance:        $   2400 (high due to fire loss on the property we just sold)
expected rent:  $   3800 (I know this doesn't quite meet 1% rule)

PITA comes out to $1837/month, cash flow at $1772/month, cap rate of 8.42% and annual ROI comes out to 18.91.

Numbers seem pretty good and we like the fact that all the mechanicals on the property are new. We current own one rental property that is pretty low-hassle from a tenant perspective, but I'm a bit nervous that 4 units = many times more potential for tenant problems.
Would welcome feedback on either the financials or the complexities of renting a multi-unit property.

[Another Reader]

Four-plexes in marginal areas should approach 2 percent per month, as expenses are higher than SFR's.  You don't even hit 1 percent.  Is it vacant?  If so, did you adjust for lease-up costs, including rent loss?  What allowance for vacancy and collection loss are you making?  What about renovation costs and utilities at turnover?  What do your comps show for market rent?  Do you pay the utilities or do the tenants?

Even newer four-plexes will run 40 percent expenses at a minimum.  $3,800 x 0.60 = $2,280.  Your PITI is $1,837.  If things go perfectly, you can expect a monthly cash flow of  $2,280-$1,837 = $443.  Annually that's $5316, or around 2.6 percent on your $200k down payment.  The GRM is 9.57.  Thanks, but I will pass on this one.

[fa]

Four-plexes in marginal areas should approach 2 percent per month, as expenses are higher than SFR's.  You don't even hit 1 percent.  Is it vacant?  If so, did you adjust for lease-up costs, including rent loss?  What allowance for vacancy and collection loss are you making?  What about renovation costs and utilities at turnover?  What do your comps show for market rent?  Do you pay the utilities or do the tenants?

Even newer four-plexes will run 40 percent expenses at a minimum.  $3,800 x 0.60 = $2,280.  Your PITI is $1,837.  If things go perfectly, you can expect a monthly cash flow of  $2,280-$1,837 = $443.  Annually that's $5316, or around 2.6 percent on your $200k down payment.  The GRM is 9.57.  Thanks, but I will pass on this one.

As almost entirely ignorant in rental properties:  why is the expense on a 4-plex so high?  I would guess that SFH has a higher cost than a 4-plex.  As I said, I know nothing about it, so I am trying to get educated.  I do understand that the very high down payment distorts the financial picture by "artificially" improving the cash flow, but reducing ROI because of decreased leverage.

[waltworks]

I am not a multi-unit expert but as I understand it:
-Tenant quality *tends* to be lower than equivalent SFR and this means more vacancies, unpaid rent/evictions, damage, etc.
-It is often difficult/impossible to bill tenants for utilities as they are often not metered separately for the separate units.
-Yard work/snow shoveling/etc must generally be taken care of by the owner, not tenants.
-In some areas taxes for multi-family buildings are considerably higher.

I will admit, however, that those don't seem like enough to double the usual SFR 1% rule, to me. Then again, I have never dealt with a multifamily property.

In the OP's case, not making the 1% rule (even not accounting for exterior repairs?) is a pretty bad sign. I'd get out of that deal if possible.

-W

[Overseas Stache]

Four-plexes in marginal areas should approach 2 percent per month, as expenses are higher than SFR's.  You don't even hit 1 percent.  Is it vacant?  If so, did you adjust for lease-up costs, including rent loss?  What allowance for vacancy and collection loss are you making?  What about renovation costs and utilities at turnover?  What do your comps show for market rent?  Do you pay the utilities or do the tenants?

Even newer four-plexes will run 40 percent expenses at a minimum.  $3,800 x 0.60 = $2,280.  Your PITI is $1,837.  If things go perfectly, you can expect a monthly cash flow of  $2,280-$1,837 = $443.  Annually that's $5316, or around 2.6 percent on your $200k down payment.  The GRM is 9.57.  Thanks, but I will pass on this one.

I would listen to Another Reader! You didn't include any amount for closing costs, upfront and continual repairs, vacancies, or management fees. Even though you self manage you should always include a 10% management fee so you can objectively project your ROI.

[Setters-r-Better]

One other thing is that I'm really wary of properties that have been flipped by someone else. I don't trust them to make the repairs completely and correctly,  and then they want you to pay a premium for doing the work for you. 
Is 436 the asking price?  You can run your own numbers,  see what you think it's worth,  and make a lower offer.  Maybe that's 350k, or 380k. Don't sweat it if they reject your offer,  just go look for a different property.

[Another Reader]

Higher vacancy and collection loss, higher turnover costs, higher common area maintenance costs, the list goes on.  Expense on 4-plexes are higher overall, and a marginal neighborhood increases everything.  Read this landlord's blog for a guide on how to operate these properties efficiently.  Good luck getting the tenants with the 620 credit scores he requires in a sketchy area.

http://www.nononsenselandlord.com/ 

[NoNonsenseLandlord]

Always calculate 10% for maintenance, 7-10% for management and 5% for vacancy.  Add those number in and see what happens.  If you are not factoring in a management fee, I have some buildings you can manage for me for free.

If you are in a D area, look for 12% cap rates, C would be 10%.  I think you are a bit low on the cap rate.

[NoNonsenseLandlord]

In further looking at this, who pays for water?  There must be some utilities, as there must be a common area for laundry?  Or stairway lights?  Any HOA dues?  Yard maintenance?  Snow removal?  Garbage?

How about  any holding expenses while you are waiting for your first tenants?

You might be better off putting your money in a shoe-box.

[Overseas Stache]

Always calculate 10% for maintenance, 7-10% for management and 5% for vacancy.  Add those number in and see what happens.  If you are not factoring in a management fee, I have some buildings you can manage for me for free.

If you are in a D area, look for 12% cap rates, C would be 10%.  I think you are a bit low on the cap rate.

When Another Reader posted the link to your blog I knew it must be good. And I must say I was not disappointed, your blog was full of great articles that were very useful. So thank you and keep it up.

From reading your blog I know that you self manage all your properties with very minimal effort. So when you are evaluating a new purchase what % do use for management? Being that you have streamlined the process do you use a lower percentage or do you still use 7-10% as if you were going to pay someone to do it?

[Icecreamarsenal]

Looks like you're forcing cash flow with the large downpayment. If using biggerpockets 1%, not cutting it. 2nd another reader.

[GrayGhost]

I would definitely not do this. I don't even look at single families that don't hit the 1% rule, and as has been mentioned, quads have far higher expenses than SFHs. Tenant quality also tends to be worse.

Given that it only looks like an okay deal if you don't account for vacancies or repairs, I'd pass for sure. What I recommend doing is running your numbers with worst case scenario inputs, high repair costs, high vacancies, and stuff like that, and if it still seems to flow cash, then you look at it more seriously. With such conservative expections, you're far more likely to get that high ROI.

But yeah, I'd pass on this one for sure.

[Blindsquirrel]

   I would pass for a couple of reasons. Most are above.
1. Apartments are way more of a pain in the butt than SFRs. We have one house that has a carriage house apartment and that apt has been more of a pain than any 5 sfrs. Lower rent in apt, you generally get worse tenats and higher turn over frequency and cost.
2. What did the developer pay for it prior to flipping? I would never buy another persons flip as most of the meat is off the bone in the first one unless they are are professional wholesalers.
3. You can find REITs that pay that with 0% hassle and can sell with a click of a mouse.
4. I would hope that better deals are available esp if you are going to do the work yourself.
5. I know results may vary with area but check out the following link. Some folks are F'ing printing money off houses.

http://forum.mrmoneymustache.com/real-estate-and-landlording/examples-of-rentals-you-own-that-perform-well-financially/msg275898/#msg275898