Case Study: The Little Flood House

Pretty nice, eh?

It’s been a long time since I did my last rental property case study so it’s about time that I do another! Today’s case study is about our second investment property which we purchased back in the winter of 2010. I’m going to gloss over a lot of the details of how we found, financed, fixed and leased the property since these topics have all be covered in the first case study post.

This one didn’t go quite as smoothly as the first one did, in case you couldn’t tell from the name of this post. Real estate transactions are complicated and don’t always go as planned. The lesson here is: “don’t panic!”

Panic? What Panic?

After the fantastic experience that was the first house, we knew that we wanted to acquire another (and another and another). So as soon as we completed the refinance on the first one, we went on the hunt. A few months later and we had a contract accepted on an a (soon-to-be) beautiful two-story, 3/2/2 in Mesquite, Texas.

The house was another foreclosure and this one had been on the market for I think 60 days before they accepted our offer. It was around the holidays and I’m sure the bank asset manager wanted to get it off of his books before they closed out the year.

Regular readers might be wondering if this is the very same house where we just evicted someone. If you were wondering that, then you wondered correctly. :)

So Far, So Good

We got the house under contract for $62,900 and it was in pretty decent shape. The AC unit outside had been stolen but other than that, all that was wrong with it was the usual problems associated with foreclosures: holes in the walls, missing fixtures, missing or disgusting flooring.  In total, it needed about $18,000 in repairs, about 4k of which was the condenser unit.

The day of closing, we stopped to get something to eat on our way to the title company. As we finished eating, we got a call from our contractor who had some bad news: an electrician he had sent out to get some bids called him and said that there was an inch of standing water at the property!

Breathe!

Nice play area or office upstairs

What the hell do we do?! Nothing like this had ever happened to us before! Do we go to the closing anyway and buy it so that we can have our guys immediately fix it? Or do we postpone the closing and wait for the bank to take care of it?

What would you do?

I’ll tell you what we did: after calming down and setting emotion aside, we decided that we had nothing at stake and that the leak is really the bank’s problem and not ours. We postponed the closing and waited to see what the bank would do.

After what seemed like forever, we got a call from our real estate agent who said that the bank wanted to see if we would still buy it if they gave us a $5,000 price reduction. Hot damn! I quickly called up our contractor who surveyed the damage and gave us a quote to fix it… for $600. We were going to throw out the nasty carpet anyway so really all they had to do was cut out the drywall up a couple of feet and replace the soggy insulation.

I called our agent back and said we’d take it! A few days later, we signed the papers and our contractors got to work.

As usual, leasing it was a cinch and the tenant moved in pretty much right after the work was completed. Clearly, we should have spent more time and accepted another applicant but that’s another story. Let’s do the numbers.

The Numbers

Here’s a little graphic I made outlining all of the costs:

You read that right: our cost to purchase, fix and rent out this property was a little over eight thousand dollars. Some back of the envelope math puts our cash-on-cash return at 64% before maintenance and vacancy. Some of those second closing costs were actually escrow balances so if we excluded that, we would come in around 7k out of pocket.

Are we actually getting this return? Sadly, no. We had 1.5 months of vacancy since the tenant skipped out on the end of her lease. She also ruined the carpet along with a few other things and so we used more than her deposit to get the place back into rentable condition. Let’s do a few more calculations, shall we?

The Nightmare Numbers

Our total income would have been $13,380 but the 1.5 months of vacancy reduced that by $1,672. If we add back in the $340 in late fees she paid and the $1,200 deposit we got to keep, that’s a only a $132 loss. Total income would then be $13,248.  Total expenses come out to $8,039.16 if we take the expenses from the figures and multiply by 12 to get the yearly amount.

That leaves us with a potential profit of $5,340.84. The total cost of the turn around was $2,600 including a deep carpet cleaning, a fresh coat of paint, and replacing or repairing some fixtures. Taking that out of our potential profit and we get an actual profit of $2,740 and some change.

What does this mean? It means that even if we had a new horrible tenant every year, we’d still be making 33% on our money ($2740/$8255).  I’d actually be pretty happy if we made only 33% instead of the potential 64%. At that rate, we’d have all of our money back in 3 years!

So what can we do to make sure we get 64% instead of 33%? Pick the right tenant!

Conclusion

Well, I hope you enjoyed reading this as much as I enjoyed writing it. This deal had a bit of a hiccup in the middle but everything worked out in the end because we didn’t panic. You can’t get emotional about investing and our detachment to the situation allowed us to wait it out until it worked in our favor. Business is business: don’t panic!

Additionally, I think this property serves as an example of how forgiving real estate investing can be if you buy the property right. This one was purchased so cheaply that even a deadbeat tenant couldn’t kill our return. She’d probably have to resort to straight-up vandalism before we would have lost money for this year. Thankfully she didn’t and I think we learned our lesson with her: your tenant can make as much of a difference in your return as the property itself!

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16 Comments

  1. Posted March 19, 2012 at 1:31 am | Permalink

    I enjoy reading these case studies, thanks for sharing. Well done for not freaking out over the water! That would have tried the nerve of any investor. Staying calm, figuring out what it would take to repair, and waiting for the seller to offer at a reduced price is exactly what you should have done. Unfortunately we don’t always do what we should do in these situations and lose out on profitable investments.
    The Stoic recently posted..AT&T- A Foundational StockMy Profile

    • Dollar D
      Posted March 19, 2012 at 8:59 am | Permalink

      I’m glad you enjoyed it! It’s hard to be impartial when you’ve invested your own time, as well as others, doing your due diligence. I think you’re right in that we played it exactly as we should have. It all worked out in the end!

  2. Posted March 19, 2012 at 1:58 am | Permalink

    That’s a nice little rental place you have there and a killer ROI. I think I should consider some rental property myself, although I think it would be much harder to do now that we are in Thailand. The Bangkok rental market is so flooded with properties that it is difficult to break even let alone turn a profit. I have heard good things about rentals in Jakarta though…hmmmm
    Money Infant recently posted..Frugal Meals: Chicken RotiniMy Profile

    • Dollar D
      Posted March 19, 2012 at 9:01 am | Permalink

      Haha, you’re waaaay out of my territory/league/comfort zone with rentals over seas. It would actually be easier (and probably more profitable) to own rentals in the states. Then you could get paid in american dollars. I bet it wouldn’t take too many properties to pay all your bills given the exchange rate. But then again, I don’t know too much about Bangkok :)

    • Posted March 20, 2012 at 7:14 am | Permalink

      Hi MI….

      I thought expats couldn’t own property in Thailand, or has that changed?

      JC
      jlcollinsnh recently posted..How I lost money in real estate before it was fashionable, Part II: The Limits of the Law.My Profile

  3. Posted March 19, 2012 at 7:34 am | Permalink

    That’s so interesting! I love reading about property and real estate. Is that the house in the photos? Beautiful!
    Daisy recently posted..Birth Order and Finances: My TakeMy Profile

    • Dollar D
      Posted March 19, 2012 at 9:02 am | Permalink

      I’m glad you enjoyed it! That’s the house in the pictures, and those weren’t even the best ones. My wife has some great ones she used for the advertisement but I couldn’t find them when I wrote this post.

  4. Posted March 19, 2012 at 8:54 am | Permalink

    Very nice article. I own a single duplex. We live in the lower unit and rent out the top. It has been nice so far. They pay our mortgage escrow and most of insurance. It is easier to get good tenants because I am actually onsite.
    Christopher recently posted..Help!… Jerry is burning the bridgeMy Profile

    • Dollar D
      Posted March 19, 2012 at 9:03 am | Permalink

      That’s a strategy that I’ve heard a lot about and many people seem to do really well with it! There’s a lot of benefits but I kind of like the fact that my tenants don’t know where I live: we use a PO box for our business address. But it’s awesome that you’re almost living there for free :)

  5. Posted March 19, 2012 at 1:16 pm | Permalink

    I love photos. Actually I really like the hardwood floors. I think I would do an office or a library (a small one) upstairs. But we don’t have kids. :)
    Aloysa recently posted..My Mother Was a Mail-Order BrideMy Profile

    • Dollar D
      Posted March 19, 2012 at 1:24 pm | Permalink

      Thanks! People love those floors and they are more durable than carpet so we use that same flooring in most of our rentals.

  6. Posted March 20, 2012 at 7:18 am | Permalink

    another great case study here DD….

    and like the others have said I very much enjoy reading these. +1 on the pictures. It would be very cool to see more. that looks like a stunning house for the money.

    were TX prices hit especially hard in the collapse?
    jlcollinsnh recently posted..How I lost money in real estate before it was fashionable, Part II: The Limits of the Law.My Profile

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