Here are the details of the second 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.
My real estate plans are coming along quite nicely (though not without a hitch here and there -- thus is the nature of the beast) and it's time for an update.
I previously shared the details and financials on my first rental property. Thankfully that property is purchased, renovated, and humming along with 100% occupancy.
Today I will be giving specifics on my second purchase. It's still a work in progress (as you'll see, it's much bigger than property #1), but it's well down the road to being what I want it to be.
Two Buildings, Eight Units
This purchase was much different than property #1 (which was basically two homes on one piece of land.) This one gave me eight units in one purchase.
In December 2012 my real estate agent, Eric, and I arrived at a piece of property. It was night time (and thus very dark - December in Michigan at 6 pm is almost pitch black) but even looking with flashlights at the one unit that was open, we could see the potential. Here are the highlights:
- Two brick buildings. Each has four, two-bedroom units (8 apartments all together).
- The property is in an area not far from other rental units, but on each side for about a block or so we are surrounded by single-family homes (in other words, it's a nice location for the renters).
- Six units were currently rented and generate $550 each monthly on average.
As I stated in My Real Estate Objectives and Strategy, here's what I'm looking for in properties:
- Identify value properties that have decent cash flow. For example, many of the properties I consider already earn 5% to 6% as they are.
- Look for properties where, for a reasonable investment, rents can be significantly increased.
- Buy the places, make the improvements, increase the rents, and fill them up.
This place fit the bill perfectly.
We wanted to move quickly since we thought there would be lots of activity on this place. We made an offer right away and after a bit of back and forth agreed on a price of $260,000 (generated from the sale of some index funds and cash on hand). The fact that we had cash and could close quickly (the owner wanted to be done with it before the end of the year) helped quite a bit.
After the inspection turned up no major issues, we moved quickly and closed at the end of December. Merry Christmas to me!!!! :)
Then the real work started.
We spent two months upgrading the two vacant units. We will be faster in turning these in the future since we now have a "system" in place, but we were still working out some kinks during this time. Oh, and I took a 12-day cruise to the Caribbean in the middle of it. :)
Anyway, here are the major changes we made to each unit:
- Knocked out a wall between the kitchen and living room to give an open floor plan.
- Built a small bar area where the wall was knocked out with nice hanging lights overhead.
- Put in new kitchen cabinets.
- New stainless steel appliances (which I got at a great price http://wealthlion.com/stack-multiple-discounts-for-big-savings/) in the kitchen. Included refrigerator, range, dishwasher, and over-the-range microwave.
- New vanity and tiling in bathroom.
- Took out carpet and put hardwood flooring throughout the unit.
- Painted the place (of course) in "contemporary neutral" colors (an acceptable tan/brown combination and a light green in one bedroom).
We also made some changes to the property as follows:
- Upgraded the common entry areas (stairwells) of one building (the one with the two upgraded units)
- Added insulation to that building (I am paying the heating bill, after all).
- Updated some electrical in the other building at the request of my insurance company (we knew this would likely need to be done when we bought the place).
The work per apartment (including all new stainless steel appliances) worked out to be roughly $10k per place (it was actually slightly less, around $9,600, but let's go with $10k for now.)
Here are a few shots of what the place looked like when we were done:
New cabinets, new floors, and wall between kitchen and living room taken out.
Our plan is to update/upgrade each unit as the leases run out and tenants decide to move. (If they want to stay and have their rents increase, that's fine, but we'll be raising the rent one way or the other, so most will probably move.) My property management company oversees 1,100 units city-wide, so they are helping me move out tenants as soon as we can by offering them alternative living arrangements.
The cost per unit upgrade will be roughly $10k including everything. We just finished the third apartment (and are showing it to potential renters) and the fourth is set to open up any time now.
I still have a few general changes to make to the place - common areas in the other building, insulation in the other building, landscaping, and a small parking lot repair. When all is said and done, I'll have $10k in "general" repairs.
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 will look like for this scenario when all is said and done:
- Purchase price: $260,000
- Capital Improvements (will be depreciated over decades -- $10k per unit plus $10k general): $90,000
- New cost basis for property: $350,000
- Other, one-time, short-term costs to get property rentable: $0 (there were a few, but they are in the general numbers)
- Total investment into property: $350,000
My initial financials were based on increasing rents from $550 to $700. But after seeing how good the places looked, the management company wanted to try and rent them for $750 each. A month after they went on the market, they were rented.
In addition to rent, I make a small amount from the coin operated washers and dryers in each building (I have a service that handles it for me in exchange for half the gross).
As such, here's what my revenue looks like:
- Monthly income for eight units at $750 per unit: $6,000
- Monthly income for washers/dryers: $35
- Annual income: $72,420
- Real Estate Taxes: $6,937
- Vacancy reserve (1 mo): $6,000
- Manager (8%): $5,794
- Utilities (heat): $4,800
- Utilities (water): $2,500
- Insurance: $2,351
- Maintenance (snow, lawn): $1,650
- Long-term Repairs: $1,500
- Cleaning: $1,200
- Trash: $800
- Annual Repairs: $500
- Utilities (electric - common areas): $300
- Miscellaneous: $250
- Mortgage: $0
Total expenses: $34,582
- Net income (before depreciation): $37,838
- Net Income % (Capitalization Rate): 10.81%
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.
- The revenue numbers seem pretty solid and have a bit of room for upside.
- The cost numbers will get more solid over time. As I'm seeing them come in, some look high and some look low, but my guess is that the total is pretty close.
- Yes, I pay heat and water, which is common in buildings where everyone shares a boiler and hot main. That's why I invested in insulation for the one building (we're comparing costs there versus the costs in the other building to see if the insulation pays off.) As we remodel each unit, we are also installing low-flow showerheads and limiting thermostats (the highest tenants can turn the heat up to is 70 degrees) to keep costs down.
- If we keep the places completely rented, I earn an extra $6,000 a year. :)
- We're thinking of adding free wi-fi to each building (there are services that manage this for you). I'm willing to do it if we can make up the extra (and maybe some more) in rents.
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 $500k range in value based on the rents.
- Borrow 50% of this value ($250,000) at 4.5% for 30 years. This gives me an annual mortgage of $15,201 (FYI, I will also have some one-time loan costs in Year 1).
- I will now have only $100k of my own money invested in this place ($350,000 - $250,000), so my return shoots through the roof and is at 22.64%.
- I will then have $250,000 that I can use to acquire another property or two.
This property is my real estate joy. Yes, the first one does just as well from a return standpoint, but I really like the multi-unit format. The fact that there are two multi-unit buildings on one property just makes it completely a home run in my mind.
As I said when I reviewed property #1, one thing I don't especially need now is income (my income is at a point where 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 buying a new boiler (my management company is looking into tax incentives and cost savings of doing so), replacing windows (better insulation), 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 $450,000 in today's market). I'm debating whether or not to sell, but won't make a firm decision until spring. I need to get settled at the new place, see how real estate is doing here, look at my overall plans, and so forth before I make any changes.
We have completed four of the unit remodels as of now and two more are underway at this time. So the place is very close to being completely done. I did have to shell out $3k for a driveway repair (ouch!) but everything else has been according to plan.
One upside with this property is the potential for more rent. The management company suggested trying to list at $795 at one point, but they (for some reason) didn't follow through. That's on my discussion list with my property manager.
In a future post I will 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.