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!
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.
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!
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!