Recently, I was having lunch with my friends Rob Novak (fellow Loan Officer) and Andrew Norman from ING. It was one of those lunches where topics moved left to right without filters or agenda. While sharing ideas and opinions of the current marketplace, the topic of first time home buyers was mentioned. At that moment, I told Andrew, “By the way, if any of your clients have children who are looking to buy their first home and would like to get more for their money, tell them to buy a multi-family.”
From that statement, we started to discuss all the benefits of why a first time home buyer should buy a multi-family. Within a 2 minutes of talking about this, I wondered “Why didn’t I think of this earlier?!” FHA has always allowed buyers to use FHA financing to buy a multi-family as their primary residence.
The basic concept is simple. The buyer buys a duplex, triplex or four-plex with the same 3.5% down payment requirement as a house. They rent out the other units and cover the difference from the mortgage payment as their share. If the homeowner decides many years later that living in a multi-family doesn’t fit their lifestyle, they either sell the property or move out and rent the unit they were living in.
I always ask my buyers, “How long do you see yourself in this home? What do you plan on doing when you move out?” Almost all of my first time home buyers do not see themselves in their first home forever. With home prices and mortgage rates so low, many of them plan on renting the home when they’re ready to buy their next place.
Statistically multi-family properties have a much better CAP Rate (capitalization rate), which is a fancy term for how profitable a rental property is compared to the price you pay for it. If these buyers don’t plan on keeping the property anyways, why not buy a property that will make more money?
Here are some bullet points:
- The down payment required is the same as a Single Family Residence (house), which is 3.5%. On 3-unit and 4-unit purchases, you must calcualte the maximum loan amount by making sure the property rent rates can sustain the mortgage payments if the owner moves out (see more details below)
- FHA loan limits for multi-family are higher than for standard 1-unit homes
- Rates are the same as a FHA loan for a Single Family Residence
Let me paint a perfect picture. Let’s suppose a young college student, Johnny, is considering buying his first home. Johnny’s parents want to co-sign for the purchase. Johnny knows he can’t afford a house by himself, so he looks at condos and townhomes for sale.
However, Johnny can’t commit to buying anything because he doesn’t want to live there forever. His very smart real estate agent (hint, hint) tells him to make sure he buys a FHA warrantable condo and that his association will likely have restrictions if he chooses to rent the condo out in the future (see related blog).
Johnny’s parents suggest looking at a multi-family. Johnny finds a great four-plex by his school. The price is much more, but after doing some research Johnny calculates he’ll be paying less than any of the condos he’s looked at due to the rental income he’ll get from the other 3 units. If and when Johnny graduates from school, he knows he can either put the four-plex up for sale or rent out the last unit he previously occupied, making even more money than he did when he lived there.
When purchasing a three-unit (triplex) or four-unit (fourplex), the maximum loan amount is calculated by both the maximum amount set by HUD AND the max loan amount where the payment doesn’t exceed the estimated rental income for all units combined. The appraiser is required to do a rent-schedule on the appraisal to determine the average market rent rates for each unit and the average vacancy. The vacancy rate is 15% for most areas. You can see this rate HERE.
Here is an example:
Let’s suppose you have a four-plex where the rent schedule shows each unit should demand $1,000 a month. The average vacancy rate is 10%, which means we should expect the $1,000 a month per unit 90% of the time.
four units * $1,000 a month = $4,000
$4,000 * 90% occupancy rate =$3,600 estimated rental income for all units
In this scenario, the mortgage payment including all housing expenses (Mortgage payment with taxes, insurance, mortgage insurance and HOA dues) must be at $3,600 a month or less. .
Sounds great, right? Of course, you’ll want to prepare properly before diving in. Being a landlord is a job. Here are a few pointers for the novice landlord:
- Find out the market rent for your area and charge that amount. Renters who are willing to pay way above the market price should be a red flag. That’s often a sign of bad rental history. However, you also want to make sure you don’t leave money on the table.
- Do credit and background checks on your tenants. You can easily setup an account with a company like Kroll Factual Data that will collect a renter’s background and credit for a small cost. You can even setup the account so these reports can be charged to a credit card, which the renters can pay.
- Keep a slush fund for rainy days. You’re probably going to save a lot of money for your living costs by buying a multi-family. Try to save most of it to cover the cost of unexpected repairs.
- Learn the laws and steps to evict clients. Hopefully you’ll never need this, but if you do have a renter that has to go, you should know how to do it.
- Be properly insured. Remember, every renter can sue. Having the proper amount of coverage is vital to protecting your assets.
Sounds like too much work? You can always hire a property management company to do most of the chores listed above. They take a share of your profit and handle your service and maintenance duties including collecting rent payments and maintenance calls in case one of your renters toilet breaks or they have a leaky faucet.
I just read about some obscure facts about the current home buyer tax credit that is set to expire on April 30th, 2010 which includes multi-family purchases.
A home buyer is to use 10% of the purchase price at a maximum of $8,000 for first-time-home buyers and $6,500 for move-up buyers to determine the buyer’s tax credit. For buyers of 2-4 unit multi-family, they are to use 10% of the unit they own.
For example, if a first-time-home-buyer buys a 4-plex, they would need to spend at least $320,000 to get the $8,000 credit. Here is the formula:
$320,000/ 4= $80,000
$80,000 x 10%= $8,000
You can learn more about this and other tax credit facts at the link posted HERE.
When buying a 3-4 unit, you must have enough to cover your down payment and 3 months of payment reserves. The reserve requirement includes your principal/interest payment along with property taxes, homeowners insurance and FHA mortgage insurance.