Property 4: We Bought a Duplex
We closed on a duplex in Madison, NJ. There were many bumps along the way, but it should all be worth it.
We have three exit strategies for this acquisition and I can’t wait to see how this all pans out.
A few months ago, I cold-called the listing agent for this property.
However, the listing I called wasn’t a property for sale on Zillow or the MLS. It was a Craigslist rental listing for a 3 bed 2 bath apartment in a side by side duplex.
My intention behind calling rental listings is to find a tired landlord sitting on a vacant unit. In my head, that makes for a highly motivated seller.
My logic panned out.
- 2,200 Square Feet
- Unit 1: 3 beds, 2 baths
- Unit 2: Studio, 1 bath
- Separate utilities
- Separate basements
- Roof and Mechanicals in Healthy Condition
- No Oil Tank
- Decent Condition - No immediate work required
- 10-minute walk to a train station that goes to NY Penn
- Quiet street on the edge of downtown
- Off-Street Parking for ~4 cars
- Purchase Price: $485,000
- Property Taxes: $8,300 / year
- Insurance: $1,700 / year
- Unit 1 Rent: Currently Vacant
- Unit 2 Rent: $1,000 / month with lease expiring on 8/31/2021
According to the Small Area Fair Market Rent Tool, stabilized rents are:
- Unit 1: $2,790 - We’re using $2,750
- Unit 2: $1,510 - We’re using $1,500
The tenants are separately metered and pay their own utilities. The common area utility expenses will be minimal. We factored in $50 per month for each utility.
Once the rental income is stabilized, this property should generate $2,500 per month in Net Operating Income.
Exit Strategy 1
This is less of an exit strategy and more of a monetization strategy.
We improve the vacant unit with a new kitchen and new baths and rent it out at $2,750 per month.
Once the studio lease is up at the end of August, we can improve that unit as well with a new kitchen and bath and rent it out at $1,500 per month.
These improvements will cost ~$30,000:
- $15,000 for both kitchens
- $15,000 for three bathrooms.
We would then refinance the property and put a new loan of $420,000, which leaves ~$95,000 of cash in the deal.
Although we’d cashflow $500/mo, I don’t love leaving money in deals, so let’s move on to option number 2.
Exit Strategy 2
We exit the property in its as-is condition.
We immediately turn around and list this property for sale. This was an “off-market” acquisition and we believe we got a healthy discount.
If we list it as is, we believe it can sell for a minimum of $550K. We are testing the market with this approach right now.
$550K - $485K = $65K in gross profit. That will probably dwindle to $50K after all fees associated with the sale.
At this price, the right buyer stands to make a killing. Allow me to paint a picture.
Let’s say a young couple with or without one child decides to buy this duplex to live on one side and rent out the other.
They buy this property using a 203K Loan. They put 3.5% down on $550,000 and add on a $30,000 loan for repairs. Their total cost-basis would be $580,000.
So that’s $20,000 down and a loan amount of $560,000 at 3% fixed over 30 years.
Their mortgage payment would be $2,361 per month for principal and interest only. If you add in property taxes and insurance, their monthly payment would be closer to $3,200.
As they live there, the studio tenant would reduce their cost of living by $1,500 per month. So they’d be living in a 3 bed 2 bath unit in Madison, NJ for $1,700 per month. So far so good, but it gets better.
Once they move on to bigger and better things, they’ll have a cash-flowing asset because the unit they’re living in will rent out for $2,750 per month. So they’ll go from paying $1,700 to live there to getting paid $1,050 per month to not live there.
The best part is there’s no need to worry about PMI. Once the $30,000 of improvements are made to this property, it could be worth up to $700,000, but let’s say $650,000 to be conservative.
A $650,000 value means they’ll have the 20% equity required to do a Streamline refinance out of their PMI loan into a loan without PMI.
Solid deal, right? If you know someone who wants to bring my painting to life, please let me know!
Exit Strategy 3
We improve the property ourselves and then exit. If we can’t sell for $550K before 8/31/2021, we’ll likely go down this third and final route.
We’ll go ahead and make the $30K of improvements to the kitchens and baths ourselves. Then market the property for $650K.
I’d rather not go down this route because our carrying costs are high.
I used 100% financing at a blended interest rate of 9%.
- $485,000 * .09 / 12 = $3,600 per month in interest.
- Plus another ~1,000 per month in taxes, insurance, utilities, etc.
My carrying costs here are $4,600 per month!
The earliest we’ll have access to the studio unit is 9/1/21. That’s if and only if the tenant agrees to leave amicably.
Let’s say it takes a month to do the work in both units. Then another 2 months to market and complete the sale. That puts us at an exit date of 11/30/2021. Let’s round up to the end of the year: 12/31/2021.
June 25 to December 31 is 6.25 months of carrying costs, or $30,000.
- +$650,000 sales price
- -$40,000 sales cost (6%)
- -$30,000 carrying cost
- -$30,000 improvement cost
- -$485,000 purchase price
- = $65,000 in potential net profit.
This math looks way too simple so let’s chop off another 15% and call it $50,000 in net profit.
My preferred route if we decide to sell is to do nothing and sell the property in as-is condition.
It’s not worth spending all that time and money to net the same profit.
Where Will We Land?
I’m excited to see how this all shakes out. This is the first property I’m buying where I’m more interested in flipping than I am holding. The main reason is there’s not a lot of equity here.
Definition: Equity = Value - Loan Balance.
I believe our equity today is $550K - $485K = $65K.
I could be wrong, but I think most people prefer to sell properties with a lot of equity so they can cash out. I am the opposite. I only want to sell if there’s not a lot of equity.
When there’s a lot of equity, I’d rather refinance the property, keep it, and ride it into the sunset.
Hear me out. If we sell this house for $550K today, the partnership will net ~$50K.
My share of that will be something like $35K pre-tax. Don’t get me wrong, $35K is a lot of money, but it’s not going to change much for how we live our lives today.
Now let’s say we spend $30K improving the property and we’re into it for $515K. Somehow we get an appraisal for $650K and we’re able to refinance 75% of that out. That’s enough to pay off almost all of my purchase money loan. (650 * 75% = 487.5).
Then I’d have ~$40K of cash left in the deal, but ~$160K of equity (650 value - 487.5 loan). I may or may not make a few hundred bucks per month over the life of the deal.
However, in 30 years, it will be paid off and it’ll be worth close to $900K if we assume just 1% appreciation per year.
Now THAT is life-changing money.
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