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.
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
Total cost: $68,000
Cash-out loan: $70,000
Cash profit: $2,000
Equity profit: $25,000
Monthly rent income: $950
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%
Lastly, this wouldn’t be as fun without before and after pics!