Here are the details of the first rental real estate property I purchased late last year. I originally posted a shorter version of this here on FMF and then on Wealth Lion. Hopefully this will be the last time I post the original details. :)
FYI, I have added some updated information at the end, so even if you've read this before, you'll find something new.
An Old Place Needing TLC
After a few months of looking at properties, my realtor and mentor, Eric, and I happened along the following:
- There were two buildings on a single piece of land (0.7 acres) in the northern part of our city (about 25 minutes from my house).
- The first (main) house was built in 1920, had four bedrooms (2,028 square feet), one bathroom, central air, and reminded me of something my grandma would have grown up in. The inside showed lots of promise -- great wood floors and nice architectural touches -- but the outside looked like the Adams family would be afraid to live there (siding was terrible, windows were terrible, vines had grown up all over the front and side, etc.)
Here's what it looked like:
The second building was in the back part of the lot. It was built in 1953, had two bedrooms (768 square feet upstairs), and one bathroom. It didn't have the character of building 1, but it did have a garage (very nice benefit). It also had a second garage stall below the apartment which had been converted into a room (kind of -- they didn't seal the opening very well so it was a storage room at best.)
Here's what it looked like:
The property (including both buildings) was owned by the government (Fannie Mae) and had been sold to someone who was going to live in one of the homes (these government-owned places let people who are actually going to live in the home make offers for the first 15 days and if no one does, then it's open for anyone to buy.) But the buyer had needed financing to purchase it and the financing fell through, so it was up for grabs. The government was asking $60k for the property, and we offered asking price. Eric found out that another bid had been made. He knew the agent who listed the place and got a sense the offer was in the upper $60k's, but needed financing. We moved up to $65k cash and the place was ours. We closed at the end of September 2012.
Repairs and Upgrades Needed
We had an inspection and it confirmed what we expected -- there were massive updates/upgrades needed. These were part of our financials from the get-go, so there were no surprises. Here's a rough list of the work needed:
- New windows with wrapping
- Siding and soffits on big house
- Kitchen counters, sinks, etc.
- Electric update
- Flooring (sanding big house and new flooring in small place)
- Wall fixed in basement of house 2 to form third bedroom
- Chimney fix
- Patch front steps
- Expand parking area (blade and fill with gravel)
- Take down several dead trees
- Miscellaneous -- TONS of small details here and there
Eric and I decided to split the work to get this project up and running (I agreed to pay him 10% to be the "general contractor" for the work if he kept the total expenses -- including his fee -- under $40,000.) As you might imagine, there were a gazillion tasks to be done, but we hit it hard and fast, concentrating on the outside issues first. After all, it was the beginning of October and it could be snowing almost any day here in Michigan from this point on. :)
Here's what home #1 looked like when we were done with it:
Here's what home #2 looked like when we were done with it:
Before I purchase a property, I run financials including purchase price, fix-up costs, and profits after expenses. Of course these figures are really a guess since there are so many unknown variables. But it's an educated guess and I build in safety by estimating expenses a bit high and estimating rents a bit low. What I'll be sharing below are the post-purchase financials (what we actually spent and made), but rest-assured that I ran these numbers before we bought the place and they looked good.
When evaluating a property, I look at three revenue/cost scenarios (BTW, I will be sharing the spreadsheet I use at some point in the future). They are:
1. Year 1 "Get up and running" financials
2. Year 2 "On-going" financials, with a property manager (which I will be using for now)
3. "Retirement" financials, the property return with me as the property manager
I look at #2 and #3 the most since they are "on-going" financials based on whether or not I want to manage the property. For now I won't be managing the property myself, so I look primarily at option #2. Here's what the financials looked like for this scenario when all was said and done:
- Purchase price: $65,673
- Capital Improvements (will be depreciated over long period of time): $36,470
- New cost basis for property: $102,143
- Other, one-time, short-term costs to get property rentable: $6,822
- Total investment into property: $108,965
By the way, based on the rents I'm now getting (see below) and what the going rent multipliers were when construction was done, I could have sold this property for roughly $144k almost immediately. It's now worth even more (see below).
Initially Eric tried to get the places rented, but he was too distracted managing his own properties. I finally turned the places over to a property manager (FYI, I'll discuss the pros and cons of using a property manager in a future post -- I've learned a lot over the past few months) and they got tenants in fairly quickly and at good rates. Here's where we ended up:
- Monthly income apt 1: $1,100
- Monthly income apt 2: $900
- Annual income: $24,000
- Mortgage: $0
- Insurance: $1,069
- Real Estate Taxes: $3,716
- Maintenance (snow, lawn): $1,000
- Annual Repairs: $500
- Long-term Repairs: $1,500
- Utilities (water): $0
- Manager (8%): $1,920
- Vacancy reserve (1 mo): $2,000
Total expenses: $11,705
- Net income (before depreciation): $12,295
- Net Income % (Capitalization Rate): 11.35%
A few comments on the revenue and expenses:
- I am not using a mortgage on this place. But I may. Read below for details on my options.
- Since I have two separate houses, I have two separate insurance policies. The costs are higher than they would be for a duplex.
- I would normally only have snow removal as an expense and have my son cut the yard, but this place is not close to our house, so I have money for yard work as well.
- These places are old, so I assume repairs will be generally higher than average. I have money set aside for annual costs and am saving for longer-term repairs like a roof and so forth.
- Generally, the landlord pays for water because there's usually only one water meter going into a duplex and it's impossible to assign a cost to each tenant. Since we have two different homes, we also have two different meters, so the costs can be passed on to tenants.
- If we keep the places completely rented, I earn an extra $2,000 a year. :)
If I get a mortgage on the place, the numbers become much better than above. My possibilities:
- I can get the property appraised and am guessing it will be in the $140k range in value based on the rents.
- Borrow 50% of this value ($70,000) at 4% for 30 years. This gives me an annual mortgage of $4,010 (FYI, I will also have some one-time loan costs in Year 1). Note: 4% was a reasonable estimate when I initially posted this, but I'm guessing it's not a reality at this point. That said, the analysis is still valid -- getting a mortgage will yield a better return.
- I will now have only $39k of my own money invested in this place ($108,965 - $70,000), so my return shoots through the roof and is at 21.64%.
- I will then have $70,000 that I could use to acquire another property.
For my first property, I'm pretty happy with it. It's earning the return I want (actually higher than my hurdle) and looks like appreciation will be good too (which I am not counting in my financials). Best of all, it will throw off $12k in income every year.
That said, if there's one thing I don't especially need now it's income (taxes are killing me). So my plans for the first couple of years is to take the cash generated by these places and put them back into the property -- replacing the roof (eventually), maybe adding a second bathroom to the older house, and so on. In 2-3 years, this property should be completely fixed up and set to kick out all sorts of income.
Of course, things will go wrong somehow. There will be bumps in the road that we cannot forecast now. That's one reason I want more properties -- to spread out the risk.
Whatever happens, we'll take the circumstances in stride. And, of course, I'll keep you updated as things progress.
Since I posted the above, I have accepted a new job in a new state (moving from Michigan to Oklahoma). At the same time, rental real estate prices in Michigan have gone through the roof (based on the rents I'm getting, this property is worth about $170,000 in today's market). Now that I'm past a year of ownership on this property, I'm thinking of selling it (capital gains taxes are lower after a year) if I can get a decent price from it. If not, my plan is to hold it at least until spring before I decide whether or not I'll actually sell.
I'm not listing it at the moment -- just have some feelers out among my real estate network to see if anyone is interested.
In a future post I may talk about the pros and cons of managing a property when you're not near it. Even with a good team like I have, there are challenges.