Duplex Chick

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A recent scan of the pending and closed duplex transactions in the Twin Cities since the start of the year stunned me. Now, nothing scientific here, just some observations.

I haven’t done the math, but the majority of the pending small multi-family sales right now have an average number of days on market (DOM) in the double digits. Less than 100 days. Less than three months! Granted, there’s no way to know which of these were cancelled and re-listed at a lower price, but nonetheless, it’s encouraging.

In the last month, several unique duplexes have come on the market in the “waterhoods”; those by the lakes or along the river. They’ve been listed at pretty big prices, and their status has changed to pending in just a month.

I intended to get over to see a unique foreclosure duplex on the bluff in the Cherokee neighborhood of St Paul. It had a beautiful banister, a widow’s walk, and was built years before most of the properties I get to see. At $409,000, I was sure I had plenty of time to get there. Wrong! Market time of a month. Another, a gorgeous home in the Kenwood area which had been converted to a fourplex lasted just 44 days. At a price of $674,000 no less.

As I dug through the records of the properties that have sold and closed already this year, I noticed something interesting about the foreclosures. To illustrate, let me give you an example. There was a unique Queen Anne duplex in the Wedge neighborhood that lingered on the market all winter. When the bank first listed it in September, they did so at a price of $339,000. When that listing expired, they relisted it at $259,000.

Now, a lot of people watch these foreclosures, waiting for the bank to reduce the price to ridiculous. I noted several properties where this had happened, and learned that almost without exception, they ended up selling for well above their asking price. I guess the bank’s agent had the forethought to put the property on the MLS at a price so low it could do nothing but start a bidding war. In those cases, the properties sold at prices $50,000 – $70,000 above list.

In the case of the Queen Anne, however, a buyer wrote and had an offer accepted at $183,000, which is nearly half what the property originally came on the market for. That buyer got a deal because he or she had the courage to write an offer while others lingered, stalking the property until it couldn’t help but sell in a bidding war.

Lessons? If it’s a unique property in good shape and a great location, write the offer today. Even in this market, it might not be there tomorrow. And, as I’ve said before, the only person who “gets a deal” is the one who wrote the offer.

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At the start of the decade, vacancy rates for rental units in the Twin Cities hovered near an almost incomprehensible two percent. Demand for places to rent came probably about as close at it could statistically to 100 percent.

As a result, landlords didn’t have to offer very much in the way of perks, upgrades or property improvements. Rent went up every year. And owners could almost do as little as stick a sign in the front yard and have the new tenant move in the front door while the old loaded things out the back.

Times changed. Low interest rates and the boom in housing wreaked havoc on vacancy rates. Qualifying for home loans was comparatively easy. It made more sense for a tenant with a good credit score to buy a property rather than rent. After all, that way he or she could realize the tax benefits and appreciation that come with property ownership.

Needless to say, vacancy rates skyrocketed. While low compared to U.S. markets, the cities of Minneapolis and St Paul spiked to seven and eight percent, while the outer ring suburbs saw double digit numbers in several types of units.

To attract tenants, landlords started offering incentives. If a renter signed a one-year lease, he might get the first month free. Some landlords gave away televisions, free cable, and when all else failed, decreased the amount of rent until someone decided to move in. Rent increases became almost unheard of.

Here’s the good news about today’s down real estate market. Fewer people are buying houses. Some are even losing their houses to foreclosure. Those folks still need places to live. So they rent. Demand goes up, and inevitably, so does rent.

In the tight credit market, it’s also more difficult for people to get loans. Which means there are fewer buyers for rental properties, which means purchase prices are going down.

Translation? In the short term, I’m seeing small multi-family properties on the market with very good cash flows. In the longer term, those properties will appreciate rapidly when the market rebounds. (And c’mon — in all the negative press, name one single pundit who’s said it’s never coming back!)

Seems like the best of all worlds if you’re an investor.

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Once upon a time, well, not that long ago, most of the landlords I knew used a couple of tried and true ways of filling a vacant unit: print ads and yard signs.

In college, I worked part time in the classified ads department of a major metropolitan newspaper. There was no such thing as taking Friday night off, because that was the last opportunity for people to get their Sunday ads in before the deadline. We were there until 9 and the phones never stopped. After all, didn’t everybody consult the Sunday classifieds when the were looking for apartments? Cars? A used drum set?

We’ve all heard how the daily newspapers are struggling to stay afloat. The Internet has become the “go to” place for many of us for news, weather and a calendar of happenings.

I learned this the hard way. That’s where renters are looking too.

For weeks I advertised a unique property in the local paper: to the tune of $100/Sunday (and they wonder why nobody’s advertising). On a good week, I’d get two calls. I spent hundreds of dollars trying to chase down a tenant. Nothing. Not only was I out the ad money, I was out rent too.

Out of desperation, I tried Craig’s List. I had over 30 inquiries in a matter of hours. Close to 100 overall. And it was free. The downside? Fielding all of those e-mails (the property wasn’t right for everyone).

Since then, I’ve spoken with a number of friends and clients who own income property. They’ve all had remarkably similar experiences.

The lesson? Why pay for terrible when free works better?

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Over the last several years, it seems as if almost everyone I meet is, on some level, addicted to HG-TV. We’ve all watched those shows and now dream of finding a fixer upper at a steal of a price. We think, “with just some paint, carpet and of course, stainless appliances…I could turn a $20,000 profit for just a weekend of sweat equity.”

OK, here are the facts. In the peak of the housing market I saw that happen…once in a while. Most of the successful rehabbers, however, were professional contractors; with crews. It was the only thing they did for a living.

So many of the foreclosures on the market are half-finished rehabs. And it doesn’t take a novelist to imagine the story behind each one. Someone bought it to flip it, and it took more money and time than they ever imagined.

In spite of this, everyone still has the “Flip This House” mentality. Even with duplexes.

The other day I showed four duplexes. All were either short sales or foreclosures, with some level of deferred maintenance. They ranged in price from $114,000 to slightly less than $260,000. All were in different, but equally terrific locations.

The least expensive was a converted single family home with some decent turn-of-the-century woodwork. As with most of these properties, the upstairs unit lacked a true living room. That unit also featured a makeshift kitchen and the most unconventional, skinny bathroom I’ve ever seen. The basement had one enormous octopus gravity furnace. And the soffits on the exterior of the home had clearly been converted to squirrel condos.

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OK, so I mean duplex. But house sounded better in the headline.

At this point, we’ve all been absolutely inundated with media reports about declining property values and the present buyer’s market. And, on many levels, those reports are right. There are countless properties on the market right now at prices well under what someone paid for them two, three, or even five years ago.

But many buyers think if a property is a great deal now, they can offer half of what the seller is asking — and steal the house. Let’s be realistic. If it was THAT much of a buyer’s market, wouldn’t EVERYBODY be buying?

I can think of one property in a south Minneapolis neighborhood that’s a perfect example. It sold in 2006 for $320,000, and was on the market at one point last summer for $359,000. It’s a beautifully maintained Craftsman, with built-ins, fireplaces, hardwood floors, newer boilers, a new roof…on an on. It’s a terrific value, and likely, very close to the right price.

It’s on the market now at $239,000. Twenty-eight percent less than what it sold for two years ago.

Buyers seem to love the place. But they’re all waiting for the price to be reduced to the ridiculous… like $150,000!

It will be long gone before then. After all, it’s not a great deal until you buy it.

And then will come the “shoulda, coulda, woulda’s“…

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During the recent real estate boom, selling small small multi-family housing (duplexes, triplexes and fourplexes) was almost as easy as simply sticking a “For Sale” sign in the ground and getting the property on the MLS.

But the rules have changed for everybody.

When investing in larger apartment buildings, one of the first questions a buyer asks is, “What are the rents?” In other words, how much revenue does the building generate every year? If the property doesn’t generate enough money to cover its expenses and mortgage, it obviously isn’t a good investment.

That principle is increasingly true in the small multi-family market. In addition to location and condition, more buyers are comparing the rent of one building to another.

A client recently looked at three gorgeous duplexes, all next door to one another, all in a fabulous location. All were three bedroom units, with separate utilities, fireplaces, built-ins and good tenants. They were slightly different in size, but almost imperceptibly so. The only obvious difference was one had two bathrooms per unit. All three properties were in a short sale situation.

O.K., slight detour here. What’s a short sale? Think of it like this. If I borrow $100 from you, and when it comes time to pay you back I only have $90 on me. In that case, I may ask if even though I’m $10 short, if we can still call it good.

In this case, the sellers of these properties may or may not be behind in their payments. And their motivations for selling may or may not have anything to do with financial duress. However, they recognize under current market conditions they can’t sell the property for what they owe on it. So they’re talking to and working with the bank to find a way to pay back as much as they can.

Back to the buyer. Three comparable properties, virtually next door to each other. One was listed at $369,000, one at $395,000 and the third at $409,000. All had taxable values at or above $500,000.

Which one did he write an offer on?

The cheapest one, right?

Nope.

Would it help if I told you the first grossed $30,000/year in rent, the second $31,200/year and the third $38,400. Now which one did he want to buy?

The one with the highest rents; which was also the most expensive.

While it may seem like $7000-8000 a year in rent isn’t that important (after all that’s “only” $650 or so a month), it made the difference as to whether the property could support itself financially. The less expensive properties didn’t generate enough revenue to even break even. As a result, the buyer would have to reach into his pocket every month to make up the difference.

Due to higher vacancy rates the last five years (everybody who could bought a house), landlords have been forced to keep rents low. The poor housing market has turned rentals around, however. Now, more people have been forced to rent. So rents can be raised.

It’s important to keep your rents as close to market value as possible. It will make all the difference when it comes time to sell.

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Over the years I’ve met countless first time home buyers. More often than not, they in a popular area (near a lake, river, shopping or great architecture) and understandably have decided they would like to put down roots there.

The trouble is, these popular neighborhoods aren’t exactly a real estate secret. Almost everybody wants to live there — which is where that stuff from that high school economics class kicks in — the law of supply and demand. There are only so many single family homes in these areas (supply), the demand for which is high, thereby forcing the price upwards.

In the Twin Cities market, most first time home buyers are uncomfortable spending more than $250,000. More often than not, the homes in the neighborhoods and with the features they like start at that price.

OK, yeah. What about a fixer? Well, fixer’s require cash. Lots of it. And most first time home buyers don’t have the thousands of dollars required for immediate repair.

It’s usually at this point that I ask whether the buyer has thought about a duplex. And I usually get a dumbfounded look as a reply.

Instead of looking at the whole price for a duplex, why not take the number and cut it in half? So if a duplex is listed at $400,000, the buyer would only pay for half, or $200,000. The tenants would pay for the other half (providing, of course, the rent was substantial enough). And, typically, properties can be found at or near those prices in these neighborhoods — in part because not as many people have thought of it!

“Yeah, but…,” buyers say. “I can’t afford that much”. Well, if the property has been a rental for more than two years, 75 percent of the rent can be counted toward the buyers income to qualify.

There’s more. The buyer can depreciate and write off the half he or she doesn’t live in on his taxes. Not to mention the ability to get a higher deduction for the amount of interest paid on the home loan (because the property cost more than a $300,000 single family home).

Finally, in coming years, if the buyer chooses to sell the property, the income he earned from tenants can be counted as income to help qualify for the loan for a new property.

Then again, it’s always nice to own a piece of property in a neighborhood everybody loves. Better still when it pays for itself!

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Whenever I first sit down with someone thinking about buying an income property (either to live in or as an investment), I ask them a question:

What, besides mortgage and taxes, do you think is the most expensive thing for a landlord to pay for?

I get all kinds of interesting answers…things like water, mowing the lawn, painting. All of which are wrong.

Come on, confess. There was a point at some time in your life (probably college) when you lived on the top floor of an old building, it got hot in your apartment and you opened the windows. In January.

You weren’t doing it to punish your landlord. Well…maybe. More likely, you were young and simply didn’t understand the relationship between the open windows and the amount of your rent.

Of course, as soon as you bought your first home, you set the thermostat at “arctic” and decided that old, warm Norwegian sweater in the cedar closet was actually timeless and never out of style.

When evaluating a property to buy, it’s important to keep those little life lessons in mind. Given two equal properties, it’s always preferable to buy the one where there are separate furnaces.

That doesn’t mean a shared heating system is necessarily a bad investment. It just means that since the property is going to cost you more to own, it’s wise to purchase it at a lower price.

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We’ve all heard the reasons for the rash of foreclosures on the real estate market; bad loans, fraud, unethical loan officers– on and on. But I never hear anyone in the media mention the fact that some people just made really bad real estate investments.

Nowhere is this more true than in the small multi-family market (duplexes, triplexes and fourplexes). In the halcyon days of 2005-2006, I ran into countless buyers who wanted to leverage some of the equity in their homes to buy an investment property. After all, we all had been told real estate was a great investment, right?

I don’t know the statistics, but I’m sure hundreds of thousands of people across the country simply went out and bought an investment property. They used the same Realtor who sold them their house, and waited for the cash to simply pour into their pockets.

The people who ran into me didn’t do that. See, it’s absolutely imperative when you buy a property for an investment that it pay its own way (unless, of course, you’re looking for a tax write off or have some other goal). And it’s critical that you make that determination before you buy the property.

We’ve all read ads touting that a property “cash flows”. What most of those advertisers don’t say is that yes, it does cash flow — if you a) put enough down; b) own it free and clear or c) are 100% occupied all the time.

In the heyday of the Twin Cities real estate market, very few small multi-family properties sold at a price where they could cash flow. And those who bought then are losing those properties now.

I just showed a duplex in the Nokomis neighborhood that sold two years ago for just over $400,000. It came on the market yesterday for just under $200,000. It’s dated, with a lot of deferred maintenance, and even though it has two bedroom units and all the utilities are separate, it will still barely cash flow. No wonder it was foreclosed on!

The good news is I am now seeing properties on the market in highly desirable locations that do cash flow, or at least break even.

If you can, now’s the time to buy that investment duplex.