Small Properties Can Pay Off for Owner Occupants

Small income properties continue to be popular with people who buy them as inexpensive homes to live in. Some are very large, with garages, but most of the stock in Anchorage consists of 20 year old buildings with no covered parking. That doesn’t stop these home owners, who say the tax advantage and opportunity to live inexpensively outweigh luxury.

Fourplexes work best for this type of home owner. Duplexes can provide more luxury—several new ones are under construction this year, the first such new construction in many years. There are not many triplexes in all of Anchorage. Fourplexes are very common, however. No beauty queens, they are usually just a box with little or no architectural detail. R-3 zoning only requires a 6000 square foot lot with 50 feet of frontage and 400 square feet of usable yard, so maximum density can make a fourplex neighborhood look like a military camp.

The owner-occupant buyer hopes for lesser density and a more residential setting. A well-kept yard, a current exterior paint scheme, and no deferred maintenance are essential to creating appeal to this buying public.

Financing for properties having no more than four units is very similar to financing for single family homes. FHA and VA down payment schemes are the same, with zero-down possibilities for the veteran, albeit with some deposit requirements and, for VA, the need to show management experience. Conventional lenders and AHFC want 20 percent down for three- and four-unit properties; duplexes take ten percent down. All lenders scrutinize fourplex transactions closely, to weed out the investor who tries to secure owner-occupant financing without intending to live in the property.

Depreciation rules apply to the rental portion of the structure. A $200,000 fourplex on a $50,000 lot has $112,500 of depreciable basis, for example, about $4100 per year to subtract from net operating income. On a cash flow basis, a fourplex with $700 per month average rents generates $2100 from the three rental units to apply to a payment that with taxes, insurance and mortgage insurance on an FHA loan might be about $1750. The remaining $350, plus about an equal amount of tax savings, covers utilities and perhaps most of the repair and maintenance expenses. The trade-off, of course, is all those renters for neighbors, and the management responsibility.

That doesn’t slow up these owners from bidding up fourplexes now that rents are stable and interest rates are low. Anchorage MLS reports show 54 closed and pending sales of fourplexes for the past six months. Two or three months is the average time on the market. Closed sale price averages were just over $190,000; more recently it’s been the lower-priced smaller properties selling, with an average price of $179,000. The average asking price of 28 properties now on the market is just over $200,000. They keep coming on the market, as the average market time of active listings is only 79 days.

This market has come a long way from its height 20 years ago when an average fourplex sold for about $250,000, then cratered to about half that value at the bottom of the market in 1989. The factors contributing to that disaster don’t loom now, which explains why lenders are more friendly toward these buyers. Much of this property had considerably more favorable tax advantages in the early 1980’s. Congress destroyed that with the 1986 Tax Reform Act. At the same time world oil prices crumbled and 40,000 people left Anchorage. When rents for a basic two-bedroom apartment dropped from $900 to about $450, income property values declined proportionately.

Those of us caught owning one or more of these properties had to consider giving them back in foreclosure. Those who had the financial strength to hold on rode out the storm—they don’t issue a margin call asking for more money, like stocks—and fed the negative cash flow until rents came back up. Loan workouts and renegotiation of the terms of private notes were common.

Some of us saw the market crash as a buying opportunity. Armed with cheap property, the rising tide floated all boats, including our properties that were under water. Now many of these investors are able to exit. They are the source of much of today’s inventory that these live-in buyers are purchasing.

Today’s sellers, many of them, have taken excellent care of these properties. Bringing them back from the bottom of the market, they and the lenders who foreclosed rehabilitated them. With improved cash flow, the new owners had the money to maintain them to a degree that’s still appealing to the live-in owner.

The downside to these purchases is the age of many of these buildings. Most are now 15-25 years old or more. Anchorage weather is hard on two-by-four frame structures. Insulation in ceilings settles, loosing R-value. Roof systems are not to today’s standards. Mechanical systems wear out, as do appliances. Floor coverings installed in the late 1980’s were often a grade that doesn’t last very long. The wise owner of one of these older properties needs to inspect closely, and plan on some major expenses in the next ten years.