Updated: Apr 14, 2020
I was laying in a hospital bed in my beautiful cap and backless gown, I had a nerve block in my shoulder that made my left arm completely numb, and I was on a bunch of pre-surgery medication to sedate me before the anesthesia. As the nurse wheeled me away from the waiting room to the operating room for shoulder surgery, I looked at my girlfriend and said...
"If the seller says the property is combined, tell Alex (my realtor) to submit the offer! If they say it's not, tell him to ask about separate utilities!"
I didn't say bye, I didn't have some witty joke, and I certainly didn't say anything cute...I was giving my girlfriend a script to say when talking with my friend/realtor about a deal I was pursuing as if the world could end if I couldn't respond immediately (to her credit, she laughed and said I should probably make these decisions when I was coherent).
Two days later I was sitting on my couch, nearly forgetting that I submitted an offer earlier in the day, numb from the otherwise excruciating pain in my shoulder thanks to my prescribed medication, and I got a call from Alex to say that the seller countered right where I hoped. I was thrilled! (Also a little unsure of where I was at the moment)
Now I'm certainly not recommending that anyone make important financial decisions while enroute to or recovering from shoulder surgery. I also don't recommend tearing your labrum, it's not the least bit fun. But that was the start of what has so far been a solid investment and what looks to have incredible potential. Let's take a look at how it all unfolded!
FINDING AND NEGOTIATING THE PROPERTY
Like my first investment property, this was a deal I found on the MLS. My search criteria previously included Charlotte and the smaller town of Gastonia just west, but that was the extent of where I was looking. Alex recommended a property in Statesville, and while I didn't end up pursuing the one he recommended I found this one instead!
This was an interesting and unique property. The listing was for three duplexes that had all been combined on one parcel and were sold together, listed for right around $180,000. This presented its own challenges because a 6 unit property is considered commercial, but I'll cover more about that below. Each unit in each of the duplexes contained 1 bed/1 bath and was 500sqft.
As I ran the numbers and realized the potential of this property that had been sitting on the market for a few months, I determined that if I could get the seller down to $160,000 this would likely be a great deal depending on the financing. We submitted an offer for around $140,000 and they countered at $155,000. It was perfect!
THE WORLD OF COMMERCIAL FINANCING
I quickly learned that commercial financing often has shorter terms and higher rates than conventional loans, making them more expensive to hold onto when given the option between the two. The way the three duplexes were situated afforded me the opportunity to subdivide the property onto separate parcels, allowing me to qualify for a conventional 30 year fixed mortgage. This meant I just had to get a commercial loan for less than a year to give myself enough time, but that was more difficult than I anticipated.
I researched and called a number of local and regional lenders, with only a few that had loan products that would work. I ran into three primary challenges:
1. Loan amount - many larger banks and national lenders (think Bank of America, CBRE, etc.) won't originate a commercial loan for less than $200,000
2. Funding with a cash partner - I was purchasing this property with a partner who was going to provide a significant portion of the down payment and closing costs, but preferred not to be on the loan. In many cases this is difficult as they want any parties with financial interest to be underwritten on the loan
3. Prepayment penalty - a lot of lenders that I researched included a prepayment penalty as a part of their terms. Refinancing within a year could lead to a fee of 1-5% of the loan amount depending on the lender, which was an unexpected expense my partner and I had not planned for
After talking to 10-15 lenders I finally found one regional bank that met the criteria we needed (as a side note, 4 months later I've still not found a lender able to meet all 3 criteria anywhere else). We wound up with a loan at 5.5%, 5 year fixed and amortized over 20 years. That's another aspect to commercial lending that I quickly learned-you're not going to find a 30 year fixed mortgage. That shorter amortization period can have a serious impact on your cash flow if you're planning for a longer term, so make sure you plan accordingly!
DUE DILIGENCE PERIOD
I learned the hard way from my fourplex that a lot could go wrong leading up to close (quite the understatement...if you are unsure what I'm talking about, read the story of how I acquired my first property) and this time had a due diligence period of nearly 6 weeks. After the appraisal headaches I faced on that first property, I was naturally cautiously optimistic about how it would go the second time around.
Fortunately, a commercial appraisal works out a little differently. Because commercial mortgage appraisers take income into consideration much more than a residential appraisal, they can be much simpler to appraise and aren't reliant on comparable sales that may be difficult to find. The appraiser scheduled a time to go out and I had the opportunity to meet him at the property as he walked it, a marked change from the prior appraisal. While he was focused on condition, he was most interested in income and expenses and therefore asked a lot of questions about who was responsible for utilities and what the rent roll was.
The great income from the property boosted the value and ultimately the appraisal came out to $160,500! How about that for an instant $5,500 of equity! From there it was fairly straightforward. The rest of the loan closed without an issue, and at the closing table I got a check for $800 worth of pro-rated rent!
PLAN, PROJECTIONS, AND NEXT STEPS
Like I mentioned previously, the plan is to subdivide the property and refinance into conventional mortgages. Combined rent is currently $2,410 (3@$445, 1@$375, 2@$350), with the 3 units under $400 requiring some maintenance and minor updates to bring up to $450-500. Each unit is likely capped at around $500, but with 6 units that's no problem.
As of the time I'm writing this, the subdivision just wrapped up and I now have 3 separate parcels. The next step is to make some improvements to the 3 units needing updates to raise the quality and value of the property, likely costing no more than $3,000 per unit, and also increase rent to at least $450/unit (yielding $2,700/mo).
After the initial appraisal report came back I deconstructed it and attempted to reconstruct the After Repair Value (ARV) based on what I planned to do. Luckily I had the contact information for the appraiser and ran my estimate by him, and he confirmed that he believed the total ARV to be between $205-220k. A cash out refinance on this amount would end up putting more than 50% of cash back in my partner's and my pocket!
On top of the monthly cash flow, the separate parcels give my partner and I the opportunity to sell off units individually if we decide we need the cash for something else. We will have to pay closing costs for each, but ultimately this gives a lot of flexibility to us both while also producing fantastic returns!
In the coming months, likely starting around March, some of the updates will take place in the units. Some of this will be hired out, some of it will be done myself, but stay tuned for some of the before and after pictures! I'll update them here on the website, but you can follow them in real-time on my Instagram account @InvestDGP. You can also follow along as I work on my fourplex (once my tenant gets evicted), so stay tuned!
If you enjoy this content and/or find any of it helpful, please share it! If you have any questions, whether about this property, getting started in investing, or anything else, please reach out to me by either commenting on this post, emailing me, going through the Contact page, or writing me on Instagram!