You can create your own duplex investment by converting a home into a duplex. This can make a negative cash flow house into a positive cash flow duplex. Of course, zoning and permit problems are definite possibilities.
Houses may be a losing proposition as rentals in your area. They are in many areas now. However, if you find the right kind of home, you may be able to convert it into a duplex and turn that cash flow situation around. Let’s look at an example.
Make A Duplex Investment
First you go to the county or city to find out what residential areas are zoned for both single family homes and duplexes. Take a map and mark it well, so you won’t waste your time looking at houses that you’ll never be able to convert. You don’t want to try to get properties rezoned for small projects like this – it just isn’t worth the trouble and probably won’t succeed.
Suppose you find a 3-bedroom, 2-bath house in one of these areas. The seller is asking $102,000. This is less than the surrounding homes, but it is because the home is in rough shape. You don’t want to tie up more than $20,000 in any one project, so you quickly realize that positive cash flow would be difficult to obtain, since the usual rent for houses like this is around $775 per month. You look at the home anyhow, with the idea of making a duplex out of it.
The repairs necessary are mostly cosmetic. The bathrooms are on opposite sides of the house. There is an office that can be made into a bedroom. There is a natural place to divide the house that will leave a dining room on one side – which will become a living room – and a living room on the other side. One end of this living room will be used to make a small kitchen.
You will end up with two 2-bedroom units, which rent for about $630 in this area. The vacancy rate for the area is 5%, so you project an annual gross income of about $14,360. Taxes, insurance and repairs will be about $4,660, leaving a net income before debt service of $9,700.
You have already checked, and know that you can borrow 90% of the value of a duplex, at about 8% interest on a 30-year loan. You figure (roughly – all of these numbers will need to be firmed up before closing) that you want cash flow of at least $1,800 per year. Subtracting this from the $9,700 leaves $7,900 for debt service. Dividing this by 12, you see that you can have a payment of up to $658 per month.
Now you pull out your amortization book, and turn to the page that says 8% interest. Working your way down the monthly payments column under “30 years” you see that you can borrow up to $90,000 and still make your plan work. Since you don’t want to put more than $20,000 of your own money into the deal, this means the whole project has to be done for $110,000 or less.
Roughly estimating the construction costs, clean-up costs, holding costs, closing costs, loan costs, refinance costs (once the project is done) and other expenses, you figure your total costs will be around $23,000. When you make your offer, you will have an inspection contingency that allows you to cancel the contract if there are problems that put the likely cost beyond this.
Subtracting $23,000 from $110,000, you arrive at a figure of $87,000. You know this won’t thrill the seller, but this is the price you need to make the deal work for you. You offer $83,000, and he counter-offers at $93,000. You offer $85,000 and drop the clause that had him paying $2,000 of the closing costs – you had only put it in there as a negotiating tactic anyhow.
Eventually, when he realizes that you really will walk away from the deal, he agrees to $88,000. You decide that this is close enough. Your inspections and quotes come in and you are satisfied, so you close. You borrow only 80% of the value to avoid mortgage insurance and points. You intend to refinance when you have the place ready anyhow.
You find some cheaper ways to get the job done, and the total costs up to the day you rent the units is just $20,500. This means you have total of $108,500 into the duplex. You shop around and find a new loan at 7.5% interest. You also decide to finance 90% and have less cash flow. You like the idea of having only $11,000 or so of your cash invested.
You borrow $97,650, making your payment $682 per month, or about $8150 per year. This leaves $1,550 per year cash flow – close to what you wanted. Your cash-on-cash return is around 14%, and if rents are rising in the area, it will soon be higher. This is why you might want to create your own duplex investment.