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Fiery Millennials

Financial Independence from a millennial's point of view.

Rental Property #2

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As some of you may know (if you fol­low me on Twit­ter or Insta­gram), I made an offer on a sec­ond rental prop­er­ty and it was accept­ed! Those waf­fles were laced with the sweet, sweet taste of victory.

As for the tim­ing, I real­ized if I want­ed to buy anoth­er rental prop­er­ty eas­i­ly, I’d bet­ter do so while I have still W‑2 income com­ing in.Screen Shot 2018 02 07 at 7.21.42 PM

  • Stats: Duplex 
    • Unit #1: 2 bed­room, 1 bath
    • Unit #2: 2 bed­room, 1 bath
  • Size: 2,062 square feet
  • Style: Conversion
  • Con­di­tion: Bet­ter than average?
  • Built: 1910
  • Pur­chase Price: $69,000
  • Repairs: est. $12,500
  • “Total” Acqui­si­tion Cost: $81,500

What does that gross?

  • Rental Income:
    Unit #1: $675
    Unit #2: $500
  • Does it Meet the One Per­cent Rule? In spades!
  • Total bor­rowed— $51,750
    • Mort­gage: $51,750
  • Down pay­ment: $17,250 (25%)
  • Mort­gage: $392 per month
  • Tax­es: $122 per month ($1460/year)
  • Insur­ance: $83 per month ($1000/year)
  • Vacan­cy: $90 per month ($1081/year) at 92 per­cent occu­pan­cy, $1175/mo rent
  • Man­age­ment: $117 per month ($1,320/year) at 10 per­cent fee, $1175/mo rent
  • Repairs/Maintenance: $100 per month ($1200/year) because it’s an old house that needs some TLC
  • Total Expens­es: $904 per month

Cash Flow: $271 per month, or $3,252 per year

Cap Rate: $3,252 / $81,500 = 4 per­cent (edit: did I do this wrong? Should it be 9.7% as Stop Iron­ing Shirts says?)

Acquisition

My require­ments for a prop­er­ty were:

  • met the 1% rule
  • good shape
  • no pool or oth­er time/resource inten­sive landscaping
  • low main­te­nance exterior

I checked the crime stats in the area. Giv­en that it’s the far end of my neigh­bor­hood, I already had a rough idea of what’d they would look like. This prop­er­ty is on the bet­ter end, so the stats look bet­ter for this location!

Condition

The house is in almost immac­u­late con­di­tion upon first glance. The walls are still plas­ter with nary a crack in sight. The floors are beau­ti­ful orig­i­nal quar­ter sawn oak. Who­ev­er split the house into a duplex did a real­ly great job at not ruin­ing the orig­i­nal lay­out of the house, so if a mir­a­cle hap­pens and prop­er­ty prices shoot up, I could con­vert it back to a sin­gle fam­i­ly house. Until then, it’s more use­ful as a rental.

The out­side of the house is in good shape. The sid­ing is being billed as “main­te­nance free” alu­minum sid­ing, so I’m real­ly look­ing for­ward to not hav­ing to wor­ry about paint­ing a wood­en exte­ri­or. The roof is old. It’s in good shape, but best we can tell it was last replaced in 1994. No big deal when the roof is almost as old as me, right?

Challenges

This expe­ri­ence of buy­ing a prop­er­ty has been fair­ly rou­tine, with a few minor dif­fer­ences. I’m not buy­ing this prop­er­ty to live in, so I don’t have to care about find­ing a prop­er­ty with an open unit. Since I’m not liv­ing there, I can’t use a VA loan which means I have to go the con­ven­tion­al route. Since I’m not liv­ing there, that means any loan I get will be pret­ty ridicu­lous. Add in the fact I’m being respon­si­ble and not tak­ing out much mon­ey (see also: under $100k) means this whole find­ing some­one to give me a mort­gage thing has been more dif­fi­cult than I thought it would be.

I got offered the fol­low­ing loans:

  • 30 year, 25% down, 5.271% APR
  • 5 or 3 year bal­loon mort­gage, 20 year amor­ti­za­tion, 3.99%
  • 15 year mort­gage, 25% down, 4.375% rate

I want­ed a 15 year loan to knock out the mort­gage as quick­ly as pos­si­ble, but I had to call 8 dif­fer­ent lend­ing insti­tu­tions before I found some­one who could give me one. A few said I could­n’t get one because we’d be run­ning afoul of preda­to­ry lend­ing laws. A 4% ROI isn’t the best, but it’s a 15 yr mort­gage so I would be pay­ing dou­ble ish what I would be with a 30 year loan.

Inspection

The list price was $79,900. I offered $79,000 with them cov­er­ing clos­ing costs and an inspec­tion. This meant I end­ed up with a $2,500 cred­it and a chance to inspect the house for flaws. Let me tell you what, that $350 I spent on the inspec­tor is the best mon­ey I’ve spent in years.

Because of inspec­tion I had done, I’m walk­ing away from the property.

record screech

WHAT??

Well, as immac­u­late as the prop­er­ty looked dur­ing an open house, a clos­er inspec­tion revealed a LOT of things going wrong. The cur­rent own­er, as far as I can tell, is an old­er gen­tle­man who no longer has the time or ener­gy to keep up with an invest­ment prop­er­ty. There is a lot of deferred main­te­nance that’s piled up.

In no par­tic­u­lar order the house need­ed the fol­low­ing work done:

  • New roof with­in 2 years: It was last done in 1994. It passed inspec­tion, but barely.
  • New fur­nace: That bad boy has been around 30–40 years at least. It’s in good con­di­tion, but effi­cien­cy was­n’t a con­cern when it rolled off the line. A new fur­nace would cut down on util­i­ties (that I would have to pay).
  • Main water line drip­ping into the basement.
  • Some elec­tri­cal repairs (bad sock­ets and things not turn­ing on)
  • Prob­a­bly some foun­da­tion work: the inspec­tor could­n’t tell if the dirt slide was new or not, but the fact it hap­pened had him con­cerned and would need a look from a foun­da­tion guy.
  • New gut­ters
  • Bath­room repair/reno: the upstairs bath­room is leak­ing.… direct­ly into the bath­room down­stairs. Both bath­rooms are ugly and who knows what you’d find once you get into every­thing. I could see that turn­ing into a total gut job.
  • Stair ban­is­ter loose and spin­dles need­ing replaced
  • Some light regrad­ing out­side the house to fur­ther direct water away from the foundation
  • New door­bell

Now, some of those things aren’t a big deal. Some of them are a very big deal. Added all togeth­er, though, and I could eas­i­ly spend the entire cost of the house on ren­o­va­tions. This is not what I need right now with quit­ting my job and strik­ing out on my own.

The financ­ing was also more than I expect­ed. Just the down pay­ment was going to be about $23k! That is a mas­sive chunk of change. I have it, or will have it by the end of March, but that is almost ALL my cash on hand. I would feel incred­i­bly stressed and uncom­fort­able start­ing my solo­pre­neur life with lit­tle cash in the bank. Then add in all those repairs? And all the things that need to be done with my first property?

No, thank you.

Watch out for sunk cost fallacy

“Well, I’ve already put down $500 in earnest mon­ey and $350 in inspec­tion fee. It’s too late to back out now.”

NO. STOP. DANGER WILL ROBINSON.

That $500 earnest mon­ey can be got­ten back. I’m wait­ing to hear back from the sell­er with regards to my revised offer. If he does­n’t want to fix one thing, I can and will be walk­ing away- with that $500 in my pocket.

Even if the sell­er did accept my revised offer and fix all of my demands (high­ly unlike­ly), I’d still walk away. $500 is a drop in the buck­et in the grand scheme of life. You know what’s a much big­ger deal? Writ­ing a check for $22k and then being on the hook for tons of repairs.

I’m not about that life.

Shout out space:

Thank you SO MUCH to the fol­low­ing peo­ple for all the encour­age­ment, inspi­ra­tion, and prac­ti­cal advice. I lit­er­al­ly could not have done it with­out these amaz­ing folks behind me. I high­ly rec­om­mend read­ing all of their stuff on real estate, as this is every­thing I used to find and buy my prop­er­ty. (and Big­ger­Pock­ets. Can’t for­get them!)

Paula Pant @ Afford Any­thing: My OG Real Estate inspiration
Chad Car­son @ Coach Car­son: Super use­ful posts on RE from a guy who owns tons of rentals and a super nice guy to boot.
Guy­on­Fire @ Guy­On­Fire: A sup­port­ive and con­struc­tive voice to lis­ten to when nav­i­gat­ing the murky waters of rental purchases.
J @ Mil­len­ni­al Boss: for being my awe­some co-host and a steady­ing influ­ence in my life
Erik @ Mas­ter­mind With­in: for walk­ing through the gnarly house and being a sound­ing board for ideas!

Thanks for read­ing! Have you walked away from a big deal? How’d it work out for you? Any desire to get into real estate?

Reader Interactions

Comments

  1. $80,000 look in expen­sive until you have to throw 25% down!
    That is a lot of cap­i­tal — deal should be a home run for that much of an invest­ment down.
    I have been able to find lenders who will go 20% for invest­ment prop­er­ty here in MA — maybe a few more phone calls — small­er cred­it unions.
    — Also have you thought about mov­ing? House hack­ing again to take advan­tage of own­er occ financ­ing? FHA, 203K
    — Love the blog keep us updated!
    Jim

    Reply

    • I mean, 9 what­ev­er per­cent is good.. but I think with the repairs it needs this is not the prop­er­ty for me. My ini­tial plan was to keep house hack­ing… but then I meant my man and well.… yeah haha. Thanks for com­ment­ing Jim!

      Reply

  2. Take your time and avoid over­lever­ag­ing your­self. Lever­age increas­es risk. I’d feel bet­ter if you paid off your cur­rent mort­gage ASAP and use cash­flow from prop­er­ty #1 to pay off prop­er­ty #2 while col­lect­ing a W2. This also gives you more flex­i­bil­i­ty to pay for cap­i­tal expens­es like new roof and fur­nace. The low effi­cien­cy fur­nace is not as big a pri­or­i­ty as you think giv­en fore­see­able trends in nat­ur­al gas prices (low). Defer both expens­es until forced. The bath­rooms (& kitchens) need imme­di­ate atten­tion so you can get bet­ter ten­ants who’ll pay high­er rents. (I have to do this now with one of my apartments.)

    The bal­loon mort­gage might be fea­si­ble if you could pay it all off before the bal­loon popped. Of course, you’re get­ting good advice from smart peo­ple. I wish I could find a house that cheap in the neigh­bor­hood where my rentals are.

    Reply

    • The kitchens looked pret­ty good minus a leaky sink and evi­dence of crit­ters. The bath­rooms are hel­la ugly and would prob­a­bly require a com­plete over­haul with the water dam­age they’ve got. I did con­sid­er the bal­loon mort­gage but I could­n’t find a rea­son­able way to pay it off in time right now.

      Reply

  3. This is sol­id work on your part, the big ques­tion comes down to do you want to man­age a con­struc­tion project and cash out­flows at this point in time. A rental with less main­te­nance is a much bet­ter fit.

    Btw – I think your Cap Rate is actu­al­ly 9.7%, you don’t include any cost of cap­i­tal (mtg pay­ment) in the expense calculation

    Reply

    • I do not want to man­age a con­struc­tion project and cash out­flows right now. I will need that mon­ey to live off for the near future. Good call on the cap rate! Looks like I for­got how to cal­cu­late that in the year since I bought my first one :/

      Reply

  4. My wife and I are cur­rent­ly look­ing at rental prop­er­ties to buy our first. I will def­i­nite­ly be keep­ing this in mind when we go look­ing this week­end. Good idea to try and get a sec­ond prop­er­ty while you still have W‑2 income though, but if you are unable to find the right prop­er­ty before your quit date will you con­tin­ue to work until you can get a sec­ond prop­er­ty? Just curi­ous on your approach.
    As always this is great! I can’t wait to read more on your rental buy­ing adven­tures as we start our own as well. 🙂

    Reply

    • No my last day at work is cement­ed now that my replace­ment has been hired. I gave them like, 6 months notice and I’m glad I did!

      Reply

  5. Well done on the research and the decision. 

    Cash flow real­ly is king for most every­thing. You can have poten­tial income, but that means noth­ing if you can’t eat now. 

    Sounds like a good learn­ing expe­ri­ence, and some lessons were tak­en away from the first one. 

    PS — $80k for a 2 unit apart­ment build­ing??? Thats less than the down pay­ment on a stu­dio con­do here?!?!

    Reply

    • Admit it, Mr. Wow, there are advan­tages to liv­ing on the mid-coast! Not many, but this is def­i­nite­ly one of them 😀

      Reply

  6. I did the exact same thing back in April of last year. Con­tin­gent on Inspec­tion is SOOOOO key. With the earnest mon­ey, there are ways to get around pay­ing that and have it deposit­ed after the inspec­tion — anoth­er great way to get around cash out of pock­et upfront.

    Glad you got out of it! 🙂 

    Those waf­fles were real­ly good too…

    Reply

    • I think you should be glad you walked! I know I am for sure. I’m not wor­ried too much about the earnest mon­ey. I’d pre­fer to get it back, but $500 is a small price to pay for get­ting out of that mon­ey pit!

      Reply

  8. Mr. Shirts is right — you would­n’t include your mort­gage pay­ment in the cap rate cal­cu­la­tion. Cap rate does­n’t include any debt ser­vice since (mort­gage pay­ments) since it would skew the rate for investors depend­ing on their financ­ing options (say, all cash ver­sus 25% down + loan). There­fore, a prop­er­ty has the same cap rate across the board for all poten­tial investors, regard­less of financ­ing options.

    Debt ser­vice is, how­ev­er, impor­tant to con­sid­er in your cash flow cal­cu­la­tions, which you have done.

    So add $392 back to your cash­flow val­ue and you get $663. $663 * 12⁄81,500 = 9.76%

    Con­grats on the sec­ond property!

    Reply

    • Thanks J. Savvy. 9.76 bumps it from awful to ok. I think at this point I want the cash more than I want to tie it up into more equity.

      Reply

  9. Woah con­grats on what ulti­mate­ly sounds like the best deci­sion. I was all excit­ed for you to buy what sound­ed like a fan­tas­tic rental prop­er­ty, but I’m so glad you got that inspec­tion done and don’t have to deal with anoth­er headache of a property!

    Reply

  10. Sounds like a good deci­sion! We also don’t like any­thing that will take a ton of work. We just had our offer accept­ed on what should be our sec­ond rental prop­er­ty. The inspec­tion was very good, so we’re going for­ward with it. Now we’re in the midst of the ridicu­lous­ly annoy­ing mort­gage process.

    Reply

    • Also agree about not includ­ing the cap rate. I made a spread­sheet that works all this out for me so I can com­pare prop­er­ties, and so I don’t have to fig­ure it out every time, but it looks like I don’t include it. Our new place should be 9% cap rate.

      Reply

  11. Oh damn! Well I’m sor­ry the whole thing did­n’t work out! But hey, good on you for walk­ing away from what you knew was a bad deal. The sunk costs are noth­ing com­pared to tak­ing on a mon­ey pit.

    Reply

  12. Hi there. The cap rate is a bit wrong. Think about cap rate as the unlever­age prof­it you will get if any­one is going to buy the prop­er­ty outright.
    Its list­ed at 69k and the own­er real­is­ti­cal­ly need 12.5k to fix up so anoth­er lady would buy it at 81.5k

    Your net prop­er­ty income is the rental rev­enue — oper­at­ing expens­es. Your expens­es includes all the con­ser­v­a­tive esti­mate (good job there) which comes up to 500++.

    I agree with the rest the cap rate is near 10%. This allows you to com­pare the prop­er­ty against anoth­er with­out the advan­tage or dis­ad­van­tage of poten­tial priv­i­leged loans. 

    To put it into per­spec­tive, a recent com­mer­cial build­ing rent­ed out to a mix of ten­ant in new jer­sey near Man­hat­tan has a cap rate of 5.1% and one near New Jer­sey sub­urbs is 7.5%. this let’s you appre­ci­ate how good the cap rate is ver­sus oth­er segments.

    Hope this helps.

    Reply

  13. Haha, what a roller­coast­er article!

    We once put in an offer that was accept­ed on a near­by con­do and walked away after the inspec­tion. It was noth­ing hor­ri­ble, but the own­er refused to change any­thing or put in $$ for the rel­a­tive­ly minor repairs because he said “the price nego­ti­a­tion part is over.” XD

    The con­do was also in a build­ing that was con­vert­ing into own­er-occu­pied (major­i­ty not at the time), mean­ing get­ting a mort­gage and sell­ing in the future would both be more dif­fi­cult. Finan­cial­ly it prob­a­bly would have been the bet­ter move, but I’m hap­pi­er with the apart­ment we’ve lived in since then.

    Reply

    • If I learned any­thing, it’s that noth­ing should make the mort­gage process more dif­fi­cult. It’s already hard enough!!

      Reply

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