Case Study: House #1

It's got some curb appeal

This post is one of many rental property case studies I hope to do, both on the properties we currently own as well as a few from some of our investing friends.

Today’s case study is from our first rental property, which we purchased the summer of 2010. I’m going to walk you through all the steps and show you how we found it, rehabbed it, and leased it for positive cashflow.

The Search is On

As it turns out, a coworker of my wife was a real estate agents and a house flipper. We gave him our criteria and he set up an automated search which emailed us properties daily.

Since we both had full time jobs, our strategy was to make a conservative guess on all the relevant figures (repair price, closing costs, appraised value) and make offers without even visiting the property. This allows us to put more offers out there without having to spend a lot of time on a property we might not even able to buy. The disadvantage, of course, is if our figures are too conservative, we might offer lower than we had to and end up losing the deal.

If we did get one under contract, our offer had a fairly short inspection period during which we could conduct additional feasibility and back out of the deal if our guesses ended up being way off.

Acceptance!

We made a lot of offers (probably 10+) before we finally got one accepted. The house was a foreclosure and had been on the market for over 100 days. They had just reduced the price by a few thousand and by the time we made our offer, there were already multiple offers on the property. We submitted our “best and highest” offer and were notified a few days later that we were accepted!

Here’s a few details about the house:

  • 3 bed, 2 bath, 2 car garage
  • 1410 Sqft
  • Pitched roof, slab foundation
  • Built in 1982
  • Good neighborhood
  • Typical design for the neighborhood (you don’t want the weirdo house)

All in all, this makes it a “bread and butter” deal for our area.

The house needed a little of everything but none of the expensive stuff: the roof, HVAC and foundation were all in good shape. It was actually a pretty typical foreclosure in many ways: the flooring was absent or damaged, the paint was hideous, appliances were missing, there were holes in the walls here and there, and some “remodeling” needed to be re-remodeled. The previous owner had turned the little dining room into a bedroom by kinda sorta walling up the doorway into the kitchen and putting up a plywood door at the entrance. All of this combined scares off the would-be home owners and so if anyone was going to buy this house, it was going to be an investor. I’m glad it was us!

Doing Due Diligence

Now comes the fun part: get some real numbers and see if it still works. With our accepted offer, we could do more in-depth analysis to see how close our guesstimates were. It turns out they were very close: repairs came in right around the $10/sqft that we budgeted for and our insurance quote ended up being lower than expected. The appraisal for the “After Repair Value”, the price it would fetch it if it were all fixed up, came in at $105,000 which was a little higher than we guessed. All in all, this was shaping up to be a pretty good first deal for us.

Buy, Fix and Rent

To purchase the property, we used an investor-specific loan product called a “hard money” loan.

We use this product because:

  • There’s no down payment requirements
  • Most lenders can close extremely fast (within a week)
  • The loan includes funds for repairs, up to 70% loan to value (in our area)

Since they are expensive and short-term, you will eventually have to get a bank loan and this does increase the total cost since you have to go through two closing: the purchase with the hard money loan and the refinance with the bank loan. But the extra costs associated with hard money are worth it in the end if you can get the deal with a lower amount out of pocket.

Anyway, we closed on a Friday and renovations began on the following Monday. The repairs were completed in about four weeks and we met with our contractors on a weekly basis to survey the progress and point out any issues. The rehab went off without a hitch and we’re really happy with the results.

Unfortunately, we don’t have as many pictures as we’d like to have but I’ll share a few of the ones we took.

Look at that nasty carpet!

You would be surprised how often we see these kinds of bright accent walls.

We started marketing the property about two weeks before it was done. At the time, we put ads out in a lot of places and even paid for an ad in a local circular. But after renting out a few houses we realized that for us, the two most effective advertising methods were craigslist and a sign in the yard.

We advertised it for $950 which was $20-$25 less than the competition. We had a lot of interest and after a total of one showing we had two families fill out applications. Both of them paid the application fee and met our requirements so the race was on: we called both families and told them that the first one to agree to meet us to sign a lease would get the property. Sure enough – we got a call back less than half an hour later and the lease was signed the next day!

Refinance

After it is rented, you can start the refinance process. Our mortgage broker arranged the financing through Bank of America and we got a great rate 5.125% on a 30-year loan. The final loan is at 75% loan-to-value and the second appraisal came in a little less at 103k.

The Numbers

Finally, the part you were probably all waiting for: the financial analysis. Well, let me fire up my bookkeeping software throw out a few figures then!

We do, however, reserve some funds for maintenance and vacancy, though this house has been rented since we bought it and maintenance has been very low. Also, this family had a pet and so the rent ended up at $970 after the $20/mo pet rent.

This works out to a yearly cashflow of $3698 and some change, and a cash-on-cash return of 25.8% ( 3698/14305).

We’re extremely pleased with our results on this one. The family who rented it is taking good care of the property and they have paid on-time every month since the beginning. They even pay electronically so we don’t have to run to the post office or the bank to collect the rent.

Parting Thoughts

Before that fateful day, where I came across this concept of “passive income”, I never would have imagined in a million years that I would own 3 rental properties. Rental properties weren’t even on my investment radar and I didn’t know the first thing about buying a house, let alone a house for investment purposes. This one house, which cost us less than a lot of cars cost, has made a tremendous difference for family. Just think, what would you do with a $3,000 raise?

I hope you enjoyed reading this as much as I enjoyed writing it. When I started writing, I had filled up a whole page before I even got to the part where we bought the dang thing! I had to trim it down but I’ve got a lot of stuff to share with y’all in the coming months. Stay tuned!

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18 Comments

  1. Posted February 1, 2012 at 10:16 am | Permalink

    Great analysis. Your numbers are very similar to my first property sans the purchase price :-). Also, you have a 30 year mortgage (I’m envious) while I have a 12 year HELOC. I need to look into Bank of America for 30 year mortgage products. That would bring my monthly cashflow up big time.
    YFS recently posted..5 Finacial Tips I Learned From Watching MTV’s The Jersey ShoreMy Profile

    • Dollar D
      Posted February 1, 2012 at 11:06 am | Permalink

      Do you have a post about your first property? I’d love to read it.
      We always do 30 year to keep our costs low in case of vacancy. What kind of rate do you get on that HELOC? Did you pay cash and then get the HELOC? I’m always interested in new strategies.

  2. Posted February 1, 2012 at 10:16 am | Permalink

    Quick question. How did you title the property and why?
    YFS recently posted..5 Finacial Tips I Learned From Watching MTV’s The Jersey ShoreMy Profile

    • Dollar D
      Posted February 1, 2012 at 10:49 am | Permalink

      We hold all of our properties in our personal name. There’s a few reasons for this but chief among them is that banks don’t lend to LLCs for rental properties. You have to get a commercial loan, usually for several properties at once. Additionally, in Texas, the courts have shown that it’s really easy to pierce the “corporate veil” and come after you personally, even if you have an LLC. For liability-risk, we have big liability policies on our properties and umbrella insurance for $1M. This insurance is actually really cheap: $384/year for the first million.

  3. Posted February 1, 2012 at 5:13 pm | Permalink

    just bloody fantastic, DD!

    Even though they are far beyond my personal skill and inclination levels, I l-o-v-e reading about these kind of projects.
    win-win-win…
    The delict house gets rescued
    The neighborhood gets improved
    Jobs are created
    New tenants get a beautiful home
    The you get wealthier

    what’s not to like.

    My question: am I reading correctly that you hired pros to do all the work? no DIY?
    jlcollinsnh recently posted..Muk Finds Success in TahitiMy Profile

    • Dollar D
      Posted February 1, 2012 at 5:17 pm | Permalink

      Thanks, JC! I’m working on a post now about the effects that real estate investors have on the community but you got it right: it’s a win for everyone!

      You read it right: my wife and I didn’t know the first thing about home remodeling so we hire a general contractor to do the work for us. These guys only work with investors and so they offer a pretty good price and they know exactly what to do. They picked the paint colors, the flooring, countertops, all of it since they’ve done 100s of “rental grade” rehabs like these!

      Going forward, we’re going to transition into managing and scheduling our own rehabs, after the Mrs leaves the corporate sector. That will be another exciting adventure in itself!

      • Posted February 1, 2012 at 5:42 pm | Permalink

        I didn’t know there were such folks. how did you find them?
        jlcollinsnh recently posted..Muk Finds Success in TahitiMy Profile

        • Dollar D
          Posted February 1, 2012 at 5:44 pm | Permalink

          We’re part of a local real estate investing club, which is where we learned almost everything about this business. The club maintains a vendor list with comments and reviews from other members so it’s easy to see who’s good and who’s not. These guys were a little on the pricey side but they provide excellent service and we don’t have to monitor them all the time.

  4. Posted February 1, 2012 at 9:08 pm | Permalink

    Very interesting! I always wondered how it all works out when it comes down to numbers. Now I know!
    I loved how the hard wood floor changes the whole look of the room! I love hard floor. So much better looking!
    Aloysa @ My Broken C recently posted..Nine Wardrobe Staples To ConsiderMy Profile

    • Dollar D
      Posted February 1, 2012 at 9:10 pm | Permalink

      Glad I could shed some light on it for you!

      We love the laminate flooring because it’s more durable and it looks really nice. We do carpet in the bedrooms and laminate in the common areas.

  5. Posted February 7, 2012 at 9:49 am | Permalink

    This is great, really great. Thanks for posting the numbers and walking us through them.
    Economically Humble recently posted..Blog Report: January 2012My Profile

    • Dollar D
      Posted February 7, 2012 at 10:00 am | Permalink

      You’re welcome, thanks for reading!

  6. Posted February 7, 2012 at 5:48 pm | Permalink

    I have been looking for active landlord posters for the longest time!!! I am so happy to have found your blog.

    I constantly write about landlord’ing and do case studies but I always come out with the investment not being worth the effort.

    That $3698 sounds great, but there are so many factors — where to begin. Please do not take this negatively!!! These are MY thoughts.

    1. What about costs to prepare for the next tenant (repaint / clean / repair / etc) – Maybe it’s only a couple of hundred dollars between tenant, but paint has gotten expensive.

    2. What about your bottom line if your tenant doesn’t pay and holds your property for 2-3 months and decides to trash the place before he leaves (very common).

    3. What about costs if your AC or furnace goes out — Major repairs destroy your bottomline

    4. What about legal costs to defend against lawsuits or threat of lawsuits? I have friends who own rentals (lots of them) and they say its only a matter of time.. its a numbers game before you get sued.

    5. You said in a previous post you did not LLC this property — but LLC’s are essential to protecting yourself. That being said — a lot of banks as you said won’t work with LLC’s and some insurance companies won’t even insure them!

    6. How much do you value your time? I would argue you should subtract (Number of hours) * ( what you time is worth) out of your profits. That includes repairing, showing, leasing, everything,.

    7. What about costs for screening tenants / gas and wear and tear / misc home depot runs for repairs?

    Do you really think that you will get that 25.8% return? I really hope you do. I want to be able to justify locking myself into rental properties, but 11 out of the last 13 years I have finished in the stock market with double digit return (I believe 5 of those years being over 20%) – I will be following your blog!! Bookmarked.

    • Dollar D
      Posted February 7, 2012 at 7:50 pm | Permalink

      Thanks for stopping by!
      You’ve highlighted a lot of great points here and I’ll try to address all of them. I don’t take any of this negatively at all! This is an open discussion and these are some very important concerns.

      The first big point I want to highlight is that the returns quoted above did not include vacancy and/or maintenance reserves. We save $50/mo for repairs and 1/12 of the rent for vacancies. If we were actually living off of this income, we’d take this into account when we take distributions from our business.

      1) Turnover is something that we haven’t experienced yet, though we are about to. One of our tenants is moving out this month so I’m sure I’ll have a post detailing our experience with this. I think the highest cost during turnover is replacing worn out carpet. For that reason, we’ve opted to do laminate in the common areas and carpet in the bedrooms only. We’ve got a decent deposit on all of them so that should cover a lot which isn’t wear and tear.

      2) Texas is a very landlord-friendly state. Here’s a sample schedule for what you could realistically expect regarding evictions:

      Rent is due on the first, late on the fourth. Send a 3-day “Notice to Vacate” on the 2nd and they will get it on the 4th.
      If they haven’t paid or moved out by the 7th, go to the JP court and get a court date in 2 weeks.
      On the 21st, go to court and win (they didn’t pay, you have the lease – you’re going to win). They have 7 days to move out
      On the 28th, if they haven’t left the sheriff shows up with a moving truck.
      If you were really good, you would have another tenant lined up the move in within another week. :)

      You have to know the local laws regarding eviction. I know in some parts of the country it’s a lot harder to evict but in Texas we don’t take kindly to that kind of behavior.

      3) Our strategy from the beginning has always been to sell the house within 5 years, ideally to the tenant, and roll the money into another property. At some point in the future, we’re going to get into apartment complexes and that’s probably what I will end up retiring on. I’ll go into that in another post. So when we bought the house, we looked at it and asked ourselves: what could possibly break in the next 5 years? Then we fixed or replace that. If something goes wrong, we do have some cash reserves to cover it but so far maintenance has been very low.

      4) This has been on my mind more and more lately but really I think legal risk can be significantly reduced through management. You have to consider why you might get sued and most of the time it comes down to mismanagement. Accidents do happen and that’s why we carry a $1M liability policy above the $250k liability policy on the property.

      5) LLCs might be better in other states but in Texas they are weak. If someone is going to sue you for negligence, they will sue your LLC and also you personally, so there isn’t a lot of point. This is in addition to the points you mentioned: you have to use (expensive) commercial financing and commercial insurance.

      6) The amount of time it takes to manage a property is more or less a function of your management style. I spend some time on the phone less than once a month. 2 out of 3 prefer email communication and pay their rent electronically. The other one has taken more time because we’ve had to chase after her for the rent, but she paid for this time with late fees. Management itself can be outsourced if you’re willing to pay for it.

      Finding suitable properties and getting them into shape also takes some time but some of this can be outsourced as well. You can spend as little or as much of your time as you want.

      I look at our real estate investing as a business: we’re basically self employed property managers, who happen to own the properties we are managing. Framing it this way sets us up to treat it like a business and not just a source of “passive income”.

      7) Prospective tenants pay an application fee which pays for their background checks. We do group showings and thus far have only had to do one showing per property to get a tenant.

      Overall, I think we will probably come pretty close to that return if we sell before anything serious can break. As you mentioned, this return does managing it ourselves but it doesn’t take that much time if you do it right.

      Thanks so much for your comment!

  7. Posted February 10, 2012 at 1:24 pm | Permalink

    Awesome, DD. I’m itching to do the same. I just have to figure out what city I’m going to be putting down roots in.

    Your commentary about the different legal landscape in Texas is especially important to highlight for people who are new to real estate. I think it warrants several posts on its own. I would love to invest in rental properties in Texas, for example, but only a madman or masochist would do it in California or Massachusetts.
    Sean recently posted..Most Retirement Advice is Worse than Useless — Part IV: The Devil’s DueMy Profile

    • Dollar D
      Posted February 10, 2012 at 1:47 pm | Permalink

      Thanks, Sean. For a low cost of living, I recommend North Texas if you can stand the outrageous heat in the summer!
      You’re absolutely right: not all areas of the country even make sense for real estate investing. I’m not sure how anyone could break even in California or the North East. I don’t know that much about the laws in other parts of the country but I think in California evictions can drag out for months.

      Some day I might post my lease up here for everyone to see. It’s pretty awesome how landlord-friendly it’s allowed to be – there are a lot of protections for us built right into the lease.

      • Posted February 24, 2012 at 2:58 pm | Permalink

        What is the difference between CA/MA and the rest of the country that makes renting difficult? I’m planning to move to CA in a couple years and always assumed I would have rental property…
        Emily @ evolvingPF recently posted..Living a Step BehindMy Profile

        • Dollar D
          Posted February 24, 2012 at 3:02 pm | Permalink

          Basically, the price/rent ratio is a LOT higher on the coasts than it is in the midwest. One of my rental properties would probably cost 3-4 times as much in California and only rent for 2-3 times as much. With prices so high compared to rents, a lot of people are content to break even and hope for appreciation to make them money in the end. Either that, or they invest in Texas :)

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