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House #6 Smooth as butter

Another project is getting wrapped up and I’m excited to share some details about it!

My deal processes are getting easier each time, and that’s great but the business lessons I’m learning are becoming far more nuanced. The last 2 deals I’ve done have gone very fast: this one was about 11 and the previous was just under 9. Even though the process has gotten easy, it’s not to say there isn’t still a lot to learn each time. 

This deal went very smooth, I did it long distance as usual, and by the time of this posting I’m already bidding on the next property! 

Your goal is to keep smarter people around as much as possible

When I bought this house I really thought I paid too much. Not grossly overpaid, but 5-8k grand which is kind of a lot on a $55k house. I had recently closed on a refi loan so I had capital and I wanted to buy a house immediately. The deals in my area are getting tighter, competition is getting fierce, and rates are going up, so it’s time to move.

I’ve been working with a new realtor for this project and that’s it’s always scary to rely on new people. After not finding a deal for a few weeks, she convinced me to look back at this house after we passed on it. She made a great case for this property: good location (especially for the long term), the ARV will be higher than I had originally thought, and it was a simple rehab. Not the way I usually buy, but it sure didn’t’ sound bad! 

I thought the ARV would be 80k at most and her estimated 90k was naively optimistic. 90k wasn’t out of the realm of possibility, but you should never buy a house assuming best case scenario. Luckily I knew if the value did come in a bit low we would be fine.

I also really wanted to show this person that I trusted them, and I wanted to actually put skin in the game on it. I think this is incredibly important in building a team. They must know you trust their advice

The house was a light rehab, that may sound good, but I was apprehensive that an appraiser would come look at a house that I JUST paid a total of 65k for, and give me 85k for it 2 months later. I have no idea how appraisals really get decided, but it seemed a little iffy to me. OK whatever, we moved forward and closed. 

Appraisal eventually came in at 100k, more than either of us expected. The rent came in $100/month higher than we anticipated as well.  How easy is real estate?! 

This was an eye opening experience for me in terms of how to build great teams and work with people to accomplish common goals. I literally had a partner find me this deal, sell me on it against my intuition, and it turned out to be very profitable. All the credit for this deal belongs to my team, and I look forward to relying on them more in the future. 

The money:

Purchase – $54,463

Rehab – $11,329

Total all-in – $67,487

ARV – $100,000

Equity created – 32,512

Rent – $950/mo

Difficulty  – SUPER EASY

This is the HUD, I like to put them up because it makes the process much more transparent, and not enough people share them. Line 103 is the additional settlement charges to get the rehab and insurance money back.  (I can’t find the page 2, so it doesn’t show the charges itemized).

The total cost of the project is on line 120,  this is what the lender is going to look at. 

My process for BRRRR:

Bid

Offer Accept

Contractor estimate

Insurance quote

Add these to the HUD 

Close. I paid for the house, rehab, insurance all at once, upfront. 

Rehab

Tenant placement

Start refi loan process

Close 

How could it be MORE easy?

 

In all seriousness, this was a fun deal and hopefully, this and my other deal writeups encourage people to go out and use this information to make themselves some money. I don’t make it seem easy, once you have great people it is easy.

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Beginners look at deal creation BACKWARDS

When I was new and trying to lock in my first deals, my approach was to try and find a deal FIRST, then put a team together to get everything done. This was a big mistake! The problem here is that when you’re new you don’t really know what great deals look like, having smart and experienced people around you can help tremendously. Another big problem is this method is, by design, destined to create bottlenecks. Hurry up and find a house, then wait to find a contractor. Hurry up and get the rehab done, then wait and find a property manager to get a tenant. We finally got the house rented, now I can’t find a lender to get a loan. This is madness! and going through that kind of annoying setbacks forced me to approach my acquisition differently by getting a team together FIRST!

Click here head to Bigger Pockets and see the full article

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Rental #5 Full rehab and refi in less than 9 weeks

I promised I would update this post when the deal was complete. Since the original post is mostly just text, I’ve decided to put the pics up top here along with some context of the deal. The second part will be a detailed description of the overall strategy and acquisition process:

This deal was by far my fastest. From the day I closed on the property to the day I closed on the loan was just under 9 weeks. Why is this a big deal? Well, I used 100% of my cash and was refunded 100% of my cash while having to leave it in the market for a very short amount of time. Also after 9 weeks, I have all my original capital plus the $19,000 I made in equity and a few hundred dollars a month in cash flow. Since I pulled 100% of my capital out, that’s all free profit. Imagine if I could do this 5x per year and make $100K in equity plus $1200 per month in cash flow, without having to put any money in my deals. The dream! In fact at the time of me writing this, less than a month since this current deal has been completed I already have another house offer accepted and look to close on it soon, and hopefully repeat this process.

The house rented nearly immediately once it was complete. When using delayed financing one of the requirements is having a signed lease with tenants in place before you can close. I didn’t want to start underwriting and then have something go wrong with our brand new tenant which prevents them from moving in. The week of overlap would have been nice to have but really seemed like an unnecessary risk.

One big mistake I made on this deal was my ARV estimate came in low. I had anticipated the house would be worth 85K but in the end, the appraisal only gave me 78K. Not the end of the world, but I wasn’t pleased. This allowed me to only borrow 58.5 instead of the 59.9K I had in the deal. Luckily my rehab came in about $1300 cheaper so really I broke even like intended! I learned my lesson though, need to take my time to ensure the house will really appraise at what I need it to. Overall this was a great deal, profitable and as FAST AS POSSIBLE. EASY!

ORIGINAL POST:

I had just finished my last house refinance and received the funds on February 12th, wasting zero time I started to bid on units the next day. While going through the process there were a few unique situations which I thought would be valuable to share with those who want to buy rental properties. I decided to document the process as detailed as I could, a change from my usual ranting about high concept abstract topics.

 

The hard part of home purchasing for beginners is that it’s easy to learn the concept, but the details and the day-to-day operations aren’t often talked about. Houses aren’t lined up on a shelf like at a store; you have to HUNT for what you’re looking for, beat out competition and, and most times fit what’s available to what you’re trying to do.

 

February 14th
Bid like a madman

I bid on 7 houses today, a few that I really think will be great and a few that I’m just feeling out the activity on the property. I fully expect the good units to come back and ask “highest and best price” which is common, and most I’ll just never hear about or find myself passing on as new information come in.
My realtor is GREAT and an invaluable member of my team, she sends me properties as often as she can, but I still spend a good chunk of time looking on my own. I’ll email wholesalers or other investors and see if they have any leads, I’ll check websites like bigger pockets, Zillow, Trulia, realtor sites, craigslist, and anything else I can think of. When in buying mode I like to be aggressive.

February 15th
Highest and Best….and Pass

One of the houses I bid on came back with a “highest and best” response. The property looked great on photos and I really liked it, the numbers looked good and the location was good, but when I called my PM he told me it was a 3/2 and could not be converted to a 4/2. This is a BIG DEAL for my strategy because we use a lot of section 8 tenants, and section 8 pays by the number of rooms. So we convert 3/1.5 to 4/2 when we can to get more rent in case we use section 8. 4 bedrooms just commands a higher price point as well for a very low conversion cost. This house would rent for $900/month as a 4/2, but as a 3/2 we would only expect $750, that’s a HUGE difference and enough for me to pass on the unit. It’s important to develop a plan and then work the plan, not deviate out of excitement or fear. If I had gotten emotional (since I really like the house) I may have overpaid or made a poor decision. Hold steady and trust your strategy and your team.
On to the next deal….

February 16th
Hold on the current bid, don’t get stupid

Living in Las Vegas has a really small but impactful benefit that I often consider myself lucky for: time zone difference. When my people get to work and start doing business at 9am east coast time, I’m starting my work day at 6am thanks to the time zone change. While going to work at 6am doesn’t SOUND great, I see it as an advantage that I can start working 3 hours earlier than my Vegas peers. Plus I find nothing more motivating than waking up to text and email with information that can help me make money.
So 6am I get an email about a house I had bid on that said: “highest and best on Walnut”. Houses move quick, no time to delay. I bring up Walnut on Zillow and start looking at details to see where I want to be, I also text my PM for his thoughts on the unit. I loved the area of the house, the price was decent $34,000 list and rehab would have been about $15,000. I figure the house would be worth $80,000 when we are done and it could rent for $700-750. These are close to my numbers, this is a deal I would be willing to do, but I could tell my PM wasn’t very fond of the area, and I know that $80,000 ARV on this house could be a stretch, any lower than that and it can start messing with how much money I can pull out of the deal afterwards. Bank will only lend 75% of value, and no less than $50,000, so an $80,000 house gives me a $60,000 loan, not much room for error. Based on these factors I figured I could bid up to $36,000 but I didn’t feel much reason to stretch so I held at $34,500, and I expect not to win the bid

 

February 20th
Having no results is boring

President’s day made for an expected slow weekend, so, it also seems that most houses drop onto the MLS on Sunday night or Monday morning. Since this week started on a Tuesday after a vacation weekend, I didn’t get a lot of opportunities to bid on new units this morning that said I did find one small house I was interested in. It’s on Rim Road and I know this is a popular location, and very popular for rentals. It’s a straight shot to the military base, but far enough away to satisfy those who may not want to live close (this is common) or those who have no affiliation to the base as well. The unit was a bit smaller than I would like, I can’t convert it to a 4/2 and the ARV will be a lower than I usually like, regardless of all that I know this is a GREAT location for my strategy. I bid on this house at asking price, which may have been a little high honestly, but I would love to own a unit in this area and I want to be bidding on everything that’s even CLOSE to my goal. The name of the game for me isn’t “get the best deal of all time” it’s “get all the profitable deals I possibly can FAST”. Competition has been higher and increasing over the last 2 years here as well, so it’s not as wise for me to hang on and wait out for the best deal, it may never come. This one will make money so I bid on it.

 

February 21st
Slow week, keep prodding

Had a long weekend and a bit of slow period here, not much action or conversation for a few days. Things got back in the groove this morning with an email for another house on street I had bid on a similar house earlier this week. I came across a house on Bemwick that I got excited about but quickly remembered that Bemwick had a house we bid on last week and ultimately passed on because the floor plan wasn’t what we wanted. Considering this house is only 2 doors down from the last one, I can safely assume they are similar designs, so I passed on this one. I was also told that I’m still in the running for the Walnut dr house and I still think that one will be a decent deal if I can snag it.

 

February 22nd
Patience is not my strong suit

My realtor texted me this morning and let me know we are still waiting for the Walnut property. I liked this unit but wasn’t too excited about it, but that’s to be expected when looking at ~40K beat up forec

 

losures: hard to fall in love with them.

 

February 23rd
Moment of truth

Got one! The email came through that my offer on Rim rd was accepted. As I started diving in to see what commitment I’ve actually just made I start to realize I probably should have bid a bit lower. I call my PM to see what he thinks, he saw the property last week like I did and looked through it already. He does this a lot because myself and other friends of ours are always buying houses so stay on top of what comes on the market in case he ends up doing the rehab or PM for one of. This allows him to help us make good and fast decisions, and it’s invaluable to me since I’m across the country. Regarding the deal, he says the same thing I thought: I probably paid a little too much, but it’s still a good deal as I expected.

Before I could even print out and sign my offer letter, I find an email from the selling agent saying “thank you!” Open it up and I find the offer agreement already has my initials and has been sent to the seller agent, the realtor must have done it for me. This is the value of GREAT people, my realtor did all my paperwork for me and my property manager already has been through the unit and has an expectation of rehab costs. The value of finding and relying on great partners cannot be understated.
Next thing I did was call my lender. I want to use a program through Fannie Mae called “delayed financing” and to do it the way I want requires some critical steps to be taken BEFORE I purchase the house. Getting your team in order early and ahead of your moves is an important albeit undermentioned strategy. I don’t want to buy the house and then go to the lender 3 months later only to find out he says I can’t do the loan for some reason. Get them involved early and often to strategize both short and long-term.

 

February 26th
The devil is in the details

We are set for a 20-day close, starting on the 23rd. Lots to do in that time.
One key to real estate (maybe all of life) is to get AHEAD of your problems as early as possible. This means planning and lining up WORKING on everything you have to do as far ahead as you can.

• Pay EM (earnest money) immediately
• Prepare my settlement sheet with rehab included and get it to my lender to approve
• Talk to my rehab partner to make we have a solid estimate, and he can start as soon as the house closes. Idle time is expensive. If you don’t have a contractor lined up, waiting until you have a house to get one is a mistake!
• Speak with my photographer friend about taking GREAT after photos. This is not something that everyone needs to do at this level of rental, but I happen to find value in it. It helps make units look nicer on advertising and it’s great for before/after photos for the blog
• Get insurance estimates and prepare to have service started on the day of closing. Also, I will add this cost to the settlement sheet
• Start advertising for a new tenant IMMEDIATELY. It takes time to find tenants; I like to start telling them the unit will be available as soon as we start work on it. Sure not everyone will be willing or able to wait for it to be finished, but many will be! This is an easy and small benefit that costs nothing and can only help.

Once all this stuff is done we will close on the house. The rehab will start immediately and I expect it to take about ~6 weeks. In the meantime, I’ll be working with my lender to ensure a smooth underwriting process. Hopefully, this informal but thorough blog is useful to anyone who may be curious about the day-to-day of the closing process. It’s probably a boring one for most, but in my opinion, that’s a good thing. Closing on a house SHOULD be boring because nothing boring is scary and fear is what prevents people from moving forward on investments. So if this process seems mundane or easy then I consider that to be a success.

March 5th
Is it easy? Yes. Does it go smoothly? Never.

I was waiting patiently for our closing date. I had spoken to my partner about getting invoices for total rehab which we needed prior to closing to use delayed financing. I had my HVAC contractor get me an estimate on a replacement system since the house had been gutted of the nearly the entire system. Things were going smoothly and I was feeling confident that this deal would go smooth

Then life came around and smacked some sense into me

This happened in the form of an email from the law firm who is closing the deal telling me they found out that the local water utility company will be doing some sewer infrastructure work to the unit in the future and it would cost approximately $5,000. OUCH! Time to damage control!
I emailed my realtor and asked if we could either

A. Bail from the deal completely
B. Re-negotiate our purchase price

This house had been on and off the market a few times in the past, this certainly gives me leverage. If I bail on the property I’ll lose $1,000 which is painful but not the end of the world. Far better to lose $1,000 now than get a property that doesn’t make money each month for the foreseeable future. If I can get the seller to eat the $5,000 then life is great, a really good middle ground would be if the seller will meet me halfway and eat $2,500 and I’ll eat the rest. This keeps all parties in fair circumstances and we get to keep moving.

After I did some research this expense doesn’t seem to be so painful. First, it’s scheduled for the future but at an unknown time, and the longer the I can stretch the deferment the better for me, in fact, I wouldn’t pay for anything until long after I’m dead if I could!! Defer Defer Defer! I also found out it’s not a lump sum charge but instead can be made in installments, and I don’t really have to get this paid until I sell the property, not that I would take this long, but it does mitigate the risk quite a bit. As I learned more about the situation I became less worried. I told the realtor my thoughts and we are hoping to come to an agreement once we find the sellers’ position.

March 7th
Renegotiate to win

The seller was easy to work with and offered to split the $5,000 future expense with me by reducing the price of the home. So my new purchase price on the house is $38,500.
If I had bailed on this deal it wouldn’t the end of the world, this deal isn’t even that great. That said I didn’t want to bail on it I want to get it done, get it making money, then go find the next deal. Having worked this out with the seller allowed me to make a fair compromise and keep moving, happy to do it again.

Also on this day, my rehab guy sent me an invoice for the work to be done. This is a crucial step in delayed financing because I want the rehab costs on the HUD statement so I can pull the cash out of purchase price AND rehab costs later. I sent this invoice to the closing attorney so she could have it put on the HUD.
The last email of the day was a group message from the realtor and the lender advising me that we are set to close Wednesday, March 14th. Hopefully no more hiccups

March 13th
Last step

I made this post probably longer than it could have been, but I wanted to express how laborious the process can be. Every deal is always one unexpected phone call away from falling apart, and keeping it together requires TENACITY and perseverance. Everyone will move along just fine and forget about you if you give up on deals or can’t see through to close. You must be diligent in solving problems as they arise, and you must be willing to always be the sole advocate for your success.
Today was simple, I got an email with the HUD early morning and I sent it to the lender
THIS IS A CRITICAL AND UNDEREMPHASISED PART OF THE DELAYED FINANCING STRATEGY
My lender and I have an aligned goal: get Alex as much of his cash back from purchase as possible so he can buy more. As soon as I sent the HUD over he told me to include a cost of insurance, good call too!
For full transparency I have placed the ACTUAL HUD here, also called a Settlement Statement, this will come with all your real estate purchases.

I have to come up with $58,553.36 and remember, I want to get as much as the possible back of this cash as soon as a tenant is placed. So if I think the house will be worth $85,000 when I’m done, and I know I can only borrow 75% of that. With delayed financing, the rule is you can pull 75% LTV or 100% of HUD whichever is LOWER. So I want the LTV number to be higher than my cash input, but not much higher because that means I’m leaving money in the deal.

ARV: $85,000
75%: $63,750
HUD: $59,802.55

Difference: $3,947.45

What this difference means is that if I waited for 6 months of financing I could pull out 75% of line 120 on HUD for an additional $3,947. Point is, I sacrifice a little capital (~$4,000) to get my money back in 2 months rather than 6: WORTH IT!
So with the HUD updated, lender happy, insurance quote in place, and lawyer set to close in 2 days, I expect my next update to be as boring as possible.

March 14 & 15th
ALWAYS BE CLOSING

The closing attorney sent me the docs to sign for the house. I filled them out, ALL 4 OF THEM, sent them back and wired the money. It’s 10x as much paperwork to buy a cell phone than a house!
On March 15th I got an email saying they had recorded the deed, I’m an owner. EASY

 

 

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House #2 First house hack

In 2012 I started learning about real estate, and when I say I started learning I really mean that I became obsessed.

I crammed education for almost 2 years when my girlfriend and I decided to move in together. I considered this a great opportunity to turn my knowledge into profitability. So around 2014 when we moved I was better equipped to make a good financial decision rather than just find a house I liked.

We house hacked

House hacking basically just means some variation of living in your investment. Sometimes people do this with a duplex, they live in one side and rent the other. Sometimes it’s done as a live-in-flips, I did it by living in a foreclosure that I turned into a rental later. My plan was to buy a foreclosed house that was move-in ready, had a lot of value-adds, and I could use the FHA 3.5% down program.

Why this is valuable:

  • Buying a foreclosure means the purchase price is depressed, I can get in cheaper
  • Value-add is a term that describes a house that will respond well to a capital investment. Upgrades have a large swing in increased value
  • The Fair Housing Authority (FHA) is a loan program that will allow owner-occupied homes to get loans with low down payment

The combination of these things allowed me to move into a house with a lot of equity potential, without putting up a lot of my own cash. It takes time to search for great deals that fit in this category, and not everyone will be willing to move into a distressed home with lots of work to do, but I highly recommend it for anyone who can put it together.

We went hunting for homes and after a few weeks of looking, Nikki found this listing online:

This was no mansion, but not a bad little house and it fit everything we needed economically. Nikki and I wanted to move in together and even though it wasn’t new or fancy it was plenty fine to live in! We chose to make a small sacrifice and not buy a big expensive house that stretches our budget. Instead, we lived in this fixer-upper that cost us FAR LESS than our peers and friends were buying. It was rewarding and profitable, it also allowed us more freedom and sense of accomplishment afterward because of it.

We paid $54,500 for the house, but I knew it was way underpriced and with a little work it would be worth much more. We put a little money into improvements, a fence in the backyard, hardwood floors (self-installed), fixtures, etc. 18 months later we went to refinance and the appraisal came in at $115,000. Because of the equity, I was able to refinance to a conventional loan and drop the PMI, this new loan was also .5% cheaper. So with the discounts from lower interest and no PMI

I was able to cash-out $20,000 and keep my house payments the same.

This was a big deal for me, and was part of the reason just 2 years later I paid for a rental house in cash. Also, I want to note that what I SHOULD have done was finance this house to the maximum the lender would allow me to which would have cost me a little bit more per month, but I could have cashed-out a lot more capital. I didn’t do this because I was scared of a perceived increase of risk. Instead, I have more equity in the house that I can’t use, the opportunity cost is far more than the monthly payment would have been.

Purchase price $54,500

Downpayment $3,000

Rehab $5,000

Total Invested $62,500

I currently have it rented for $950 per month, the total projected expenses with a mortgage is around $750 per month. Thankfully because I have a great property management and rehab parter my expenses have historically been far lower than projected. While this has allowed me to expand my business faster, it’s still important to project expenses properly and not be biased because of a good year or two.

I had to spend a few hundred dollars on repairs before we closed in order to satisfy the lender. This should not be taken lightly. Repairs were done to a house you don’t own can be risky, if you spend the money and still don’t close you won’t get that money back. I was confident this would satisfy our last closing requirements and it was a small amount so I moved forward.

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House #1: Accidental landlord

When I was 27 I only knew one thing about real estate: owning was better than renting,

Now it turns out that isn’t always true, but it did set me on a course to buy my first house.

I had a good job at the time and went out to put a house purchase together. I got prequalified for to spend $270,000 which was more house than I had any business owning by a large margin (newsflash, retail banks won’t help you make good decisions). I looked at condos because I was a single guy who didn’t want a lot of maintenance and I figured I could spend a little less than buying a full house.

I assumed at the time I could turn it into a rental down the road when it was time to move.

I ended up only spending $65,000 on the condo, far less than my peers were spending on their first houses. Looking back I am so happy I didn’t spend a ton of my house because houses are a big responsibility and any money tied up in them is difficult to get out. This means buying a house can be valuable, but it can also be an anchor and this purchase was mostly an anchor for me.

Low overhead = more freedom

Luckily since I had spent so little my mortgage was low which as time went on helped more than I had considered. Ever hate paying your bills each month? Ever think they are too much and wish they were smaller? Who made the choices to get those bills? The smaller your monthly spending requirement is the more flexible you are to invest. My total mortgage each month is only $398 Mortgage+165 HOA = $563 total payment, this worked out perfect too because less than 2 months after closing on this house I lost my job!! A job I never thought I would lose, remember this when you sign a loan commitment and assume nothing in your life will change. If your life was vastly different 5 years ago, I guarantee it’ll be vastly different in the next 5, give yourself room to grow, don’t cripple yourself with high overhead. Real estate can make your life fun, productive, and flexible, but a mortgage that’s so big you struggle to make is only going to cause you problems.

I used a VA loan to buy this house so it required very little cash of mine to buy it. The VA has zero down products which I used on this loan so the only thing I had to pay for was the $1000 earnest money which I received back at closing. Certainly, not everyone has access to a VA loan, but most people have access to the FHA loan program and that only requires 3.5% down payment which is still really low. On $65,000 using FHA a person would only need to pay $2275 in down payment. Anyone can work hard and save this amount of money, which means anyone can work towards profitable home ownership (even though this particular house isn’t very profitable)

About 3 years later I moved and decided to rent it just like I had planned. This is when I realized that myself along with most new investors calculate profitability really incorrectly. Like many people, I was under the assumption that rental income minus my mortgage payment would be my profit. What I wasn’t accounting for was all the other stuff that happens in a rental: maintenance, vacancy, capital expenditure, property management. So the house rented for $650/month and my cost was $563, this seemed good when I purchased but now that I know better this is terrible. Let’s look at the detail

Rental Income $650

Mortgage (Principle/Interest/Taxes/Insurance) $398

HOA Fee $165

Vacancy (8%) $52

Maintenance (10%) $65

CapEx (5%) $32.5

Property management (10%) $65

Total Expense and debt service $777.5

This results in a cash flow of -$127.5

You sure you still want to take advice from me??? Losing money is rarely a long-term viable strategy and to be thorough I’ll say that losing money in the short term isn’t ideal either. Now the good news is that historically my capex, maintenance, and vacancy expenses have been lower than I anticipated which helps. The margins are still razor thin on this property and that’s not great. Last year I also raised the rent on the newest tenant to $750/month which is a big help but not life-changing.

What can learn from my mistakes and what to do better:

I still recommend buying real estate (obviously) but it’s important to buy smart from the very beginning, and most importantly: BUY WITH STRATEGY. If you’re buying because you think it might make money, or you really like it, that’s a mistake. Buying the right asset to later convert into a profitable rental is a financial move that can create massive wealth for almost anyone. Buying the wrong asset can also be a massive hindrance or even possibly catastrophic to your future financial situation. I recommend a few ways to maximize your first home purchase to buy better than I did:

  • Learn about real estate! If the entirety of your real estate knowledge happens a few weeks before you buy a house and then you never look into it again that’s fine, that’s what most people do, but that’s why most people don’t make much on their house.
  • Buy a house that can be turned into a rental later or sold for a significant profit.
  • Buy an inexpensive house. Stretching on first home purchases can be a financial kiss of death. Don’t buy something so expensive that you’re tied to it like an anchor. A house is an asset that works for you if you buy it right, and it’ll fight against you if you buy it wrong.
  • Learn to calculate the details of a rental income transaction and apply it.
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Why it’s good to use debt for real estate

There are plenty of horror stories about people with debt and the troubles they go through over it. Dave Ramsey has made a career telling people NEVER to use debt and he’s become so famous that people think this is a hard and fast rule. Being debt free is not a completely unwarranted position to have, but that doesn’t make it ideal for growth nor does it necessarily reduce risk. Using debt to grow a company instead of relying on cash is done by all of the greatest companies we know about, it does sound a bit counter intuitive but may also be more common than people may notice.

The concept I use may be somewhat complex in the details, but overall it’s very simple.

1. I borrow money to pay for an asset
2. That asset produces income
3. The income covers the cost of the debt, plus the interest, plus profit

Once a person understands that debt created to make money is good, and it’s not as risky as it sounds, then it’s much less intimidating. It’s common not to understand debt and how it can be used to advantageously when someone has only been exposed to consumer debt (credit cards) which IS bad debt and aren’t usually very helpful usually.

The stock market works on debt as well, shares of a company are a debt which a firm sells to the market. The sold shares are debt then they take the income from the share sales to reinvest in their company at a higher yield. They raised capital from sold shares to shareholders, and then made a profit from consumers and repay shareholders in equity price increases or dividends. Now, I’m certainly no large-scale public operation but the economic principle is identical.

Using cash is slow. Now slow and steady might sound nice, but slow is really bad because it requires trading the most valuable resource: TIME, in exchange for money. Money is supposed to CREATE time buy working passively, debt allows cash to be leveraged and be used to control much larger assets and the income that comes with them. If you had an infinite amount of time, then I would advise using cash.

PLAN A

If I have a house worth $100,000 and it rents for $900 per month

900 * 12 = 10,800 / 100,000 = 10.8% cash-on-cash ROI

10.8% is good but now we have zero cash and the equity is sitting in the house not making any money. It also has a payback period of 9.25 years which means we won’t be able to buy another one for almost a decade! Paying a rental property off for the cash is a common goal but this blog doesn’t advocate for common returns, We can do better!

PLAN B

This time let’s use a conventional loan with 20% down payment.

$100,000 – $20,000 = $80,000
The mortgage will be at 5% for 30 years.
The loan is $80K so the payment will be $420
(900-420) = 480 * 12 = 5760 / 20,000 = 28.8% cash-on-cash ROI

This formula is: rental income – debt service = cash flow * 12 months = 5760 gross yearly income / 20,000 cash invested = cash ROI

So do we prefer a 28% ROI or a 10% ROI? Sure there is less cash flow per month using plan B, but remember when using the 20% down, we still have the $80,000 remaining in the bank! We could repeat this 4 more times using the same capital as plan A, make far higher returns, and much higher cash flow. The payback period here is only 3.4 years as well so in less than have the time as Plan A we can recoup our initial investment and still make some cash flow each month. Debt is looking good!

PLAN C

Here is the plan I personally use, the numbers will be slightly different than real numbers for consistency and ease of explanation, but the overall math is the same. Let’s say I buy a distressed house at a major discount. After the house is purchased and repairs are complete I have 60K in the house

$65,000 my total cost
$100,000 value the bank says its worth
$75,000 is what the bank will lend on this house. (75% loan-to-value)
75K-65K = $10,000 (I get this cash back right now)
100K -75K= 24,000 is the amount of equity I still have in the house
$402 is the monthly payment for this loan (75K for 30years @ 5%)
$900 is the monthly income from this unit
(900-402) = 498 x 12 = 5976 / 0 …….. Wait it’s not possible to divide by zero.

This is what is sometimes called “infinite return on investment”. When you try to divide the cash return, by the amount left invested in the deal, but all the money invested in the deal has been cashed out with my loan. This results in a house that makes $5976 per year and not only is there nothing remaining invested in the property but it’s also already made that $10,000 in cash right at the start.
Also, let’s not forget about the original 100K we started with.

plan A: Use the entire 100K, make 10.8% yearly and then wait 9.25 years for it to come back to me
plan B: Use 20K cash, still keep 80K and good cash flow each month. I make 28.8% ROI and it only takes 3.4 years to be repaid
plan C: Keep the 100K, an additional 10K in cash, plus good cash flow each month. Infinite CoC return and instant payback period.

So which do you want?

$10,000 per year income with ZERO cash
Or
$6,000 per year plus $110,000 in cash?

It must be noted that none of these examples include ancillary and overhead costs, so the returns won’t be this extreme in real life. In fact, the real world numbers would be even less favorable towards paying cash since that 10.8% would likely drop to a return that is closer to low-risk stock market gains. Regardless of this information, the basis for how the money works out is identical. If I added a 40% expense ratio to each scenario, the total returns will fall, but relative to each other would be the same.

Paying cash is actually the riskiest part of my business

The method I use to buy houses requires me to pay for houses with (someone’s) cash, and then get a mortgage on them usually around 6 months later. It wasn’t until I paid cash for my first investment property that I not only learned the lesson this post tries to teach but it also really made me FEEL the risk of being cash poor. Being cash-strapped and running a business is not fun, and it creates a risk where there wasn’t any before. I’ve heard plenty of people say being debt free gives them peace of mind but a much safer peace of mind comes from keeping $100,000 cash in the bank. It will protect against a lot of unexpected costs and a lack of cash opens up to 2 kinds of risk, opportunity risk, and emergency risk.

Let’s say we use our $100K to pay the house off. On $100K the principle and interest payment will be about $540 each month, so once the house is paid off we save that $540 per month but what if something comes up that is unexpected and expensive? By letting go of all that cash we have gotten rid of the REAL safety net and the peace of mind people claim they so desperately want! Once the house is paid off and some unexpected $10,000 expense for (anything) comes up how are we going to pay for it? Will we borrow against the house, which is possible but not easy? Wouldn’t that be ironic, to “save money” by paying off a house only then to loan back to it going back to square one? Also, loans are nowhere near as easy to put together as writing a check is. Houses are very illiquid, meaning spending the equity is not easy, this is why the saying goes: cash is king.

Also we must consider opportunity risk, which might be the most expensive cost of all. means, the cost spending money is all the other opportunities that were available. If I spend $100K on a house, and the next day a GREAT deal comes across my desk and I don’t have the cash to close, that’s my opportunity cost. I can’t afford to do that deal because my money is tied up in dead equity. Paying cash literally costs me money! The cash I use isn’t usually tied up for long thankfully, but if I left the house paid for in full I would miss out on a lot of opportunities. This is why I mortgage everything and I do it as quickly as possible.

But Alex, you’re paying so much in interest!

Am I?

Seems like most people are one of two ways lately, lousy with money, or anti-debt.

How much is the interest really?

$100K loan @ 5% interest, again, $536.82 monthly

$536.82 * 360 = 193,255 Total payment

193,255 – 100,000 principle loan value = $93,255 total interest paid.

Admittedly $93,000 sure is a lot of money (well, for me it is, you may think it’s chump change!) but people act like this interest is a fee they aren’t willing to pay no matter what. It’s important not to look at the costs of doing business as an unfixable problem, it’s much more valuable to look at the upside. Why worry about a measly 93K when this house could make me $500,000 over the same amount of time or maybe better. Think about what will happen over the next 30 years: The tenant is going to pay that interest, plus profit, 92% of the time (I factor in an 8% vacancy and it’s calculated before profit). This means as the loan gets paid down I gain equity, which I could borrow against again down the road if I want. Another thing that is going to happen, and is very commonly overlooked is inflation. Inflation makes future dollars worth less than today’s dollars so that $93K is going to scale down in buying power relative to what money can purchase at the time. Also, I intend to keep growing for the long term, 93K is going to be a much smaller portion of deal size as time goes on as well, making the 93K cost less burdensome. Lastly, inflation helps me on the income side as well, what happens to rent prices over time? What happens to all goods over a long period time? The costs of goods go up and rent will be no different, the $900 rents now will be $2000 or better 20 years from now. All these small effects compound over time to really add up, and it was still profitable from the start! Worrying about the interest compared to how much wealth that can be created is a mistake, chase the HUGE upside and don’t let the fact that someone else is going to pay all these costs bum you out too much.

Ive tried to explain this topic clearly and thoroughly but it can be hard to grasp at first because sometimes it doesn’t FEEL right. It’s important to always trust the math, and to understand the process as deeply as possible. I was very opposed to using debt when I first started but it was simply out of fear, not logic. As i’ve learned the process more clearly and had experience to show me which is better ive learned that debt is a valuable tool, and hope to help other people understand it better as well.

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Rental #4 or, how I bought a house from across the country that I couldn’t afford, and still made a profit

In 2017 I was antsy to buy another rental, a bit too antsy.

I had bought my previous deal the Summer before in 2016 and I was waiting to cash out on that house before I bought the next, at least that had been the plan. Patience is far from a strength of mine and luckily this hasn’t gotten me in too much trouble, actually, when done right moving fast is quite valuable.

I looked at all my finances and decided that I spent every dollar I had in both my business and personal accounts AND leveraged my HELOC to the max I could scrape by and buy another house. This is also assuming the rehab stayed cheap and no other large expenses happened in the meantime, which is never the case.

So I contacted my realtor anyway and told her I was in buying mode. The leads started coming in and it only took a few short days before I came across a deal I thought I could put together. I saw a few pictures of the property through email, I looked at the numbers and the area and decided it could work. From the pictures the house was awful but the neighborhood was decent

Usually, this process takes 2-3 days at the most. I’ll put an offer in, and I’ll know whether it was accepted quite quickly, so when I didn’t hear anything back (which is common) I assume I didn’t win the bid and went about my business waiting for the next deal. This turned out to be for the best because a week later I had an HVAC failure in one of my units that needed a full repair and some upgrading (it was a very old unit), so $6400 later I was really happy my bid wasn’t accepted because I was so tight on that deal I would no longer be able to afford it. Then OF COURSE about a week goes by and I get a call from the realtor letting me know I won the big, we close in 30 days.

 

Mistakes have been made.

 

I was terrified, but I took some time to really look at the situation. but I knew I could still afford to write the check for the house if I had to so I kept moving forward. It’s important in real estate to always move forward on deals. If you run away at ever hiccup you don’t get ahead and you don’t learn how to overcome. I learned a TON by moving forward no matter what and learning how to solve problems rather than bailing. The house was a deal, and I knew I had refi money coming in a few weeks. I had exit strategies

Ok let’s see where I was at this point:

  • House bid was mine, I intended to close
  • House was 2600 miles away, contractor hadn’t seen it yet
  • I was ~$6500 short on this deal IF the rehab came in at my lowest expectation.

 

Here was the strategy I built to get me out of this mess:

IDEAL:

  1. Get my rehab contractor over there immediately to get final rehab costs
  2. Start talking to lenders about getting a mortgage for House #3 and use those funds to pay for the costs of this house
  3. Look for partners/friends/everyone/loan shark who would lend me the fund to bridge the costs
  4. Use refi funds from house #3 to repay
  5. Install tenant, make fat stacks

LESS THAN IDEAL:

  • Close on house, then sit on it until I build funds to rehab
  • Wholesale the house as-is. Basically, I would sell it to a fellow investor to do what I couldn’t
  • Bailout of the closing

 

These are the things that were swirling through my head. As I had spoken with my lender more it seemed that doing a refinance for the last house HOUSE #3 was going to get done smoothly. This gave me some confidence AND provided me some additional risk mitigation when asking for private money.

 

I had never borrowed private funds before

 

This was a big deal for me actually as I had never borrowed money from a private source before and it’s there isn’t a massive demand to take the first chance on a guy like, especially when the ask is “hey can you loan me money for this great deal I locked down but didn’t find out I couldn’t afford it until AFTER”. People would probably describe me as arrogant, obnoxious, and intense, these are not qualities that make new investors want to fork over cash. Maybe this is a bit of an exaggeration, I’m not totally polarizing, more of an ‘acquired taste’. In all honesty I did have a few things working in my favor:

  • I spent a few years in sales and I got pretty good at it
  • The deal I had was solid
  • The loan would only be for a short-term
  • The amount I needed wasn’t an unreasonable amount,
  • I had skin in the game, so I set off to ask around.

So with this in mind I prodded and poked a few people I thought might be interested with zero success until I got to Frank. Frank and I met online at www.biggerpockets.com about a year ago. We had become really good friends through the site and hanging out in person, I introduced him to local resources and we met regularly to talk real estate and personal finance.  I explained to him the numbers on this deal, the risks, and my exit strategies, just like I did in this post. He knew I could pull it off, and he trusted me since I had just helped him lock down a similar unit earlier this year and I didn’t ask him for any fee. Just from our conversations I knew he probably had a bit of cash he could part with at least temporarily so I pitched him the idea and he was quite receptive. We negotiated terms, he agreed, and he wired me $20,000 in a few days. This was both a big step for this deal, but also for what I started thinking I can accomplish next. The ability to raise private capital could open all new doors of opportunity.

 

The Rehab:

This house was such a dump. It was ugly, beat to hell, and it had very few positive characteristics. As the pictures started coming in I knew it was worse off than I had originally thought, but I was feeling better that progress was being made

 

 

 

 

YOU SEE THIS GROWTH INSIDE THE HOUSE!!

 

 

 

 

 

 

 

The house needed all of the standard stuff I knew about and that we do with most houses. Paint, floors, cabinet painting, landscape, etc. What it also needed was a whole new HVAC, new roof, new driveway, and we converted it to 4/2 rather than keeping it the 3/1.5 that it started. This is going to set our rehab WAY over budget. This is bad news in the short run but not terrible news in the long run as long as I can still come out profitable. I don’t mind paying for capital expenditures up front if I have to, but if I can defer costs that’s always ideal. Why pay today for an expense today when I can pay the same for that expense down the road where I’ll be in better financial condition to absorb the cost.

 

Wrapping up:

The house was purchased for $36,000 and ended up needing about $26,000 for repairs. This is WAY over what I had expected to pay out, and it’ll all be ok. First off the bulk of the unknown cost came from CapEx that I knew weren’t far out to replace anyway. Basically, when I bought the house I knew it would need a roof and HVAC and I was HOPING I could defer these costs for ~24 months or so, this would allow me time to receive rent income ahead of the expense. Sadly I had to replace both during rehab, this means for cash outlay I had to put out more now, but this also means no roof/hvac/capex costs for a LONG time down the road.

I paid Frank back in 60 days exactly, I was able to do this because I had done a cash-out on the previous house HOUSE #3

during this rehab.  Worked out perfect, he was happy and I paid him a big bonus for the help and now I’m poised to ask him for more the next time (and coming soon hopefully!)

This wasn’t a great deal, to be honest; it was a good one but not a great one. I certainly paid a premium for being so far away and moving forward so arrogantly. I plan to fix this with the next deal by including my contractor much closer in the process. I’m thankful that my contractor’s goals and mine are closely aligned (not by accident, by design) so it’s in his best interest to make sure I’m as profitable as possible. If I had been a little more diligent and strict on this deal I could have saved money or found a better one. That said, I would do this deal over and over again if I had the chance.

Buying a house for many people is terrifying, buying one across the country must be worse, and buying one across the country and then finding out you can’t afford it should be debilitating right? Hopefully, this story makes it seem less scary. Fear is usually fear of the unknown, but this can be largely mitigated by KNOWING what can/will happen. Education is a valuable way to mitigate risk because thoroughly understanding a situation makes you less scared of it and also allows you to more accurately account for and deal with potential hazards. This is why I wasn’t too scared to get this deal done, I knew the risks and how to account for them. Next time you’re scared of taking a risk, just learn as much as possible about the situation and you’ll be surprised how much more confident it can make you feel.

What’s next?

So I bought a house I couldn’t afford and I’ve never seen from 2600 miles away. The deal not only worked out, it’s profitable. I’ve written my 2018 Goals in depth but the basic premise is to repeat this deal 3 more times this year. The cash from this deal plus hopefully being able to raise more private capital than last year should allow me to buy at least 3 units, maybe more!

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House #3 My first dedicated rental purchase

In early 2016 I had 2 houses, a primary I lived in and a second that I used to live in but decided to rent out instead of sell when I moved. I had been wanting to buy a pure investment property for a while at this point.

Turning a previous house into a rental is nice, but it doesn’t always produce the best deals. I wanted one that I bought purposefully as a rental from the start. So my intended plan was to find a foreclosure that I could buy cheap, rehab, rent, and then get a mortgage on later. This is commonly called the BRRRR method: Buy, rehab, rent, refinance, repeat. I needed to buy it cheap enough that when the rehab was done the mortgage would allow me to pull at least (and hopefully more than) my entire investment back out. So the house would be pure profit with no cash left invested and the rent had to be high enough to cover the mortgage, taxes, insurance, maintenance, future capital expenditure, property management, and potential vacancy.

So I had the funds to pay for the house and rehab in cash, though it took me 5 years of savings (I’ll write another blog about the specifics of how I accumulated this in the near future). This was essential because foreclosures go quickly and I wanted the ability to see a house, bid, and close FAST!

BUY: Finding an investor friendly realtor is key, my realtor is one of my most valuable business relationships, and she is one of my favorite people. She had been helping me look for units for a while now, but buying houses in a competitive market is, well, competitive. She would send me a house at 8pm and I would go see it the next day at noon and it would already be spoken for, it was brutal! 3 months of this, bidding on maybe 20 houses and this one popped up so I wasted no time and bid on it immediately (more like instantly) and won.

REHAB: Ok so house paid for, it’s in terrible condition, now I needed someone to fix it for me. Now I know some contractors, but I hate them, I had some friends who I had reached out to, but when you’re a new investor nobody believes in you. They all SAY they believe in you but they don’t, and really they shouldn’t because I hadn’t proved myself. I certainly don’t blame anyone for not taking a first chance on a person, friend or not. So I had to find a new contractor that I could trust with a fairly large job, and this is tricky. Many contractors won’t show up, their bids are all over the place, and the majority of them would come look at the house and then not even send me a bid at all. I did find someone to do this complete house and for the most part it was fine, although I overpaid by quite a bit. I had to chase him down a bunch of times, and it took way longer than it should have. That said it got done and it looked great, and I learned a lot on how to do better next time. All things considered, I was happy with the unit, it was complete, and it was ready to get rented.

RENT: For the other house I had I was self-managing at the time, but I didn’t want that job. You don’t’ really save money by managing your own units, that’s a common false understanding of the math. Pay a professional who has systems in place, and can make this passive investment truly passive, this allows you to focus your energy on things you can get the highest return on investment for your skill set. My friend Rodrick and I had just been developing a relationship talking about real estate, I hired him to manage this unit, and he has become another one of my business lifelines. Life would not be so easy for me without his help, insight, and our always growing relationship. He found a tenant in a lighting quick 2 weeks, and for the amount I was hoping for. This is important as you must properly analyze what a unit will rent for before purchase.

REFINANCE: So I had now bought this house in cash, had someone else rehab it, and now it was rented. I could sit back and just collect this rent risk and worry free for the next 30 years if I wanted to. Isn’t that what most people would do? Yeah it is, and they are dead ass wrong. It took me much longer than I had anticipated but I eventually got a mortgage on the house for a bit more than I paid for it, purchase plus rehab. If you’ve ever bought a house then you know underwriting can be tricky, and tedious. Getting a mortgage on an income producing property isn’t too hard, but the devil is in the details. Once it was finally complete though the house pays for itself each month, current and future expenses, and a bit of profit to me. Also since I have all my original money taken back out of it, it’s essentially free income. Some calculate it as ‘infinite return on investment’, since the income would be divided by my investment of zero.

REPEAT: This is the easiest part in theory. I simply have to do the same process again and hopefully get a little better at it next time. If I can do this 10 times I could retire in a few short years…or try something harder.

 

FINANCIALS:

This blog wouldn’t be helpful if it wasn’t transparent. These are the real world figures for this deal, albeit simplified:

Purchase price:    $45,000

Rehab:                    $23,000

Total cost:              $68,000

Appraisal:              $95,000

Cash-out loan:       $70,000

Cash profit:          $2,000

Equity profit:       $25,000

 

Monthly rent income:            $950

Monthly expense:

Maintenance (5%):             $47.5

Management (10%):           $95

Vacancy (8%):                      $76

Insurance ($500yr/12):      $41.6

Taxes ($900yr/12):              $75

CapEx (5%):                         $47.5

Total Expense:                           $382.6

Debt Service:                              $367.77

Total Monthly Profit:      $199.63

Total Money invested:       $0

 

Now 200 dollars doesn’t seem like a lot, and it isn’t, but it hardly paints the full pictures of profitability. First off, remember this is nothing invested, so it’s 199.63×12=$2395.56 per year essentially for free. Secondly this doesn’t take into account the full rehab has basically eliminated my maintenance and CapEx costs for a few years going forward. Also, this doesn’t take into account tax benefits and while my vacancy is set to 8% my real world vacancy rate across my portfolio has been under 5%. Add these conditions all up and the worst case scenario is unlikely to actually occur. In the meantime that difference in funds piles up and quickly allows me to buy another one.

Without debt service, the total monthly profit would be: $567.4

and the Cash on Cash return would be: 10% 

 

 

PICTURES:

Lastly, this wouldn’t be as fun without before and after pics!