January 21, 2010

My First Rental - An awesome bargain

This is the first of four articles I'm going to be writing about the rental properties that my wife and I own and the experiences that we've had with each.

About eight years ago I made my first rental property purchase.  My father had already been invested in rentals and he owned three units at that time.   He had been a landlord for about twenty years.   So he knew the rental business pretty well and I'd seen his experiences with it.


I had been periodically searching Realtor.com looking for good investments.    I came across a four plex for sale in my parents city going for an extremely low price.   It was selling well below market at the time.  I'd say it was selling for half of what market value would be on a 4 plex.   It looked like a true 'steal' but there had to be a 'catch'.   I told my dad about the property and he decided to check into it.  I live in a neighboring state a few hundred miles away so I couldn't see it myself.  My dad contacted the Realtor and viewed the property.    There were in fact some problems.  The property had some bad renters, it was 25% vacant, it had some notable structural damage and a $10,000 sewer hook up bill.  With all the problems it would be unlikely someone would even be able to get financing on it.

We decided to go ahead and buy the property.  Even with all the problems the property had we felt the discount price made it worth buying.   I bought 50% and my parents bought 50%.   We made an offer and ended up getting it for $5,000 less than they asked.   We paid cash so we didn't get a loan or need any financing.   At the time I didn't have the full amount in cash for my half on hand immediately so my parents loaned me some of my portion for a short term.   We also later paid off the $10,000 sewer bill in full.  

My father did the structural repairs and improvements himself.  He remodeled one of the apartments quite a bit and fixed up two others somewhat also.   The costs of the repairs and improvements were paid for out of the rental incomes.  My Dad is very frugal and there weren't significant building materials required to do the repairs.   So we could pay for the work out of rent as he did it.   It took him a year or two of working in his spare time to get the place completely fixed up.

It also took a little while to rotate in some better tenants.  The tenants we had originally weren't that bad that they needed to be evicted by two of the three left on their own before too long.  One tenant was getting a big discount on his rent for acting as the property manager and we didn't need a manager.  As far as we could tell he never did much management work other than mowing the lawn anyway.  We increased his rent and he didn't stay too long.   One of the other tenants left on his own accord at some point. 

Since my Dad does all the work, I'm acting as the 'silent partner' in the deal.  I feel I'm getting an unfairly great deal since I'm not doing any of the work.   However my father refuses to take any compensation for his labor.   I've also suggested he just hire the work done but he wants to do it all himself.  I don't like taking advantage of the situation so I do what I can to pay him back in other ways.


We have no mortgage so there is good cash flow.   Currently we're netting a few thousand a year off the rents after expenses and we get a good tax dodge from the depreciation.   The actual profits go up and down a bit year to year. Sometimes an extended vacancy or rash of vacancies will bring the rent total for the year down.   Or some years a rental will be 100% occupied the entire year and you'll get maximum rent.   You also get random expenses due to needed repairs or tenants damaging a unit past what their security deposit will pay.

The property has appreciated fairly well from what we paid.  Based on the value in Zillow our property is worth 2-3 times what we paid for it.  So assuming we went doubled our money in eight years then that is an annual appreciation of 7.7%.   A lot of that appreciation is because the property was in poor shape and we bought it for well below market value of a 4-plex at the time.   Plus we've earned rental income that whole time as well.   The rent profits have gone up over the years but currently we're making about an 5.5% to 8% annual return on capital from rent.



Why was it successful?   The key reason this property has been a financial success is that we found a bargain being sold under stress.   If we'd paid 2 times what we did for the property we'd have lost money on the deal.   My fathers experience and knowledge in running rental properties and repair and remodeling work are also key reasons we were financially successful.  If we were both inexperienced in running rentals or had to pay someone to do all the work we may have made some big mistakes and overpaid for the repairs.

The other side of the story.   Not all rental investments go well and you only have to look at the previous owner for a good example of a bad experience.  The woman we bought the property from lost over 2/3 of the money she paid for it just 18 months previous.   And it seems like she overpaid by about 50% when she bought it.  I'm not sure why she overpaid so much, but she apparently did.   The woman lost 70% of her investment in less than 2 years!    She also ended up with poor tenants and damage to the property.   She was paying a tenant an excessive amount to manage the property and he was doing very little actual work.   She had bad tenants, a property in disrepair and lost most of her money.   We were told that the woman would rather "poke needles in her eye" than be a landlord.  Talk about a motivated seller!



How we got lucky.   Other than having the luck of finding a bargain property in the first place and me having my dad as competent partner there are other ways we were lucky in the investment (or at least ways we avoided bad luck).   When we bought the property I sunk almost all of my cash of my savings into it.  I should have held back some cash for an emergency fund or financed the purchase with a loan.  Buying the property made me cash poor and exposed and unable to handle to any emergency financial problems.   The property had some structural damage but nothing significant that we didn't know about.  If the property had had worse problems we could have ended up with a money pit. 

Can you emulate this success?   The biggest factor in this property success was finding such a bargain in the first place.   Properties like this don't come along that frequently or if they do they are usually snatched up before they hit the real market by savvy Realtors or their friends.   So finding such a bargain is the biggest hurdle.  You also probably don't have someone like my father and his knowledge and construction skills to rely on.   If you were to buy such a property you'd have to pay out of pocket costs to perform the structural repairs.  I expect that would amount to an extra $10,000 to $20,000 in costs.   Most of us also don't have the luxury of ready access to enough cash to buy a property without financing.  And again I relied on my parents there to give me short term loan for part of the money.  

If you found this property, bought it with a loan or seller financing, paid someone to do all the improvements then paid a property manager to run it then you would have had different financial results.   Even if you hired all the work you'd probably still have had 4% appreciation based on higher out of pocket costs and 4-6% return on capital after paying a manager.   So if you found this property or a similar bargain then yes you could emulate this success.

Finding a good property:   First you have to have your finances setup in advance.   You will either need a large pile of cash  which most don't have or some form of financing established.   That would generally mean getting preapproved for a loan.   Then you'll need to watch for good properties.   You can do what I did and search Realtor.com frequently or better yet I'd recommend finding a buyers agent to do that work for you.  If you have a good Realtor  they can keep their eye out for good investment opportunities. And of course you'll need some luck.  

Construction knowledge or good help.    For this property to be a success we had to do some major structural repairs.   That kind of work can be very expensive.  Doing the work yourself like my father did can be a major difference between a good investment and a loss.   If you can do construction work yourself then buying fixer uppers can be a good investment.  But if you're not very skilled or knowledgeable at construction repairs then you may still be able to find good, dependable and inexpensive contractors to do work for you.   Finding a good, cheap and dependable contractor is no easy feat.  If you're not savvy with construction or have good help then I wouldn't recommend fixer uppers.

Bottom line:   Finding a good buy is key to financial success with a rental.   We found a bargain and benefited from fixing it up ourselves.   The previous owner was distressed and eager to sell.  We were lucky to find the bargain and be in a position to buy it and further lucky that being cash poor didn't bite me.  This property ended up a great investment.  

1 comment:

  1. I would argue that the reason you made money and the previous owner didn't can be addressed in one word: "work". You looked hard (you didn't say how long) to find a bargain. Then you sunk a lot of money into it and you (or your father) worked at it continuously. You didn't try to flip it and make a quick profit. The previous owner sunk money into it, and expected it to work on it's own.

    Congrats to you and keep on working!

    ReplyDelete

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