We’re “real” landlord! I know that sounds funny but our primary house is a duplex and although we technically have been landlords for more than 4 years renting out the other half of our property I feel like buying a completely separate investment property somehow makes us “real” landlords. Even since we bought our current home the plan was to buy another investment property and low and behold, we have done it! We just closed on a duplex yesterday.
The past couple of weeks have certainly been stressful for both of us. Although you can make decent money investing in real estate there are also an equal number of horror stories out there. We have done the research, saved a bunch of money, and waited patiently for the “right” property so hopefully all of this will pay off. But signing that paper transferring so much hard earned money over to cover the down payment and closing costs was certainly difficult and makes my palms sweat a little.
Why invest in real estate? We live in a city where rentals are a hot commodity. Vacancy rates are about 1% and therefore rents tend to be high. Unfortunately the flip side of this is the real estate itself is expensive. This is part of the reason it took us 4 years to save up enough for the down payment. But knowing that there will likely always be renters looking for places gives us some assurance against having a vacancy for a long period of time. Our hope with this property is to give us a somewhat steady income stream that we can at some point use towards our financial independence. For now, we will be just saving the additional income. As I am Type A and like to over-analyze everything, I will go over all of the numbers, important details, and why we finally decided to pull the trigger on this property.
Price when buying anything is always a big variable but with real estate the numbers are just that much bigger. And as the cost of living in our area is not cheap, finding something reasonably priced and that we can afford proved to be a challenge.
I follow many PF blogs as well as being a part of a real estate investors community Bigger Pockets and am often envious of real estate prices in other parts of the country. We could almost buy a property outright with the amount of money we needed to save in order to get just a 25% down payment and closing costs where we live. But that being said, I would not change where I live as our community is wonderful. Initially we were hoping to stay close to a $300,000 purchase price but we ended up increasing our search to properties up to $400,000 (a real stretch at that price).
This property was listed at $388,000 and was more than what we wanted to spend. But we went in with a low ball offer and she countered with a pretty reasonable offer. As our city has the property database online I was easily able to go online and see what the current owner had paid for the property back in 2013 and calculate that based on a 6% sales commission she was just breaking even and was really her lowest offer. So with a final price of $365,000, we went for it.
Directly correlated to the price are the numbers and how things look on paper. I have a simple spread sheet to input the basic numbers and then a more detailed one to evaluate a property once we have looked at it. Now some numbers we use are complete estimates, such as maintenance, but others we can get either from real estate listings or can estimate from what we pay for our current property (ie: trash removal). When inputting all of the numbers I tend to try to shoot for a cap rate of 7-8%. We also look at the cash ROI%, total ROI% and the net expected profit per month. There is one property for sale currently for only $229,000 but would only net an estimated $175 per month. The replacement of just one appliance would eat a few months worth of profit and something big like a new furnace could eat an entire year’s worth of profit and didn’t leave us enough wiggle room to feel comfortable.
I calculated the estimated cap rate for our new property is 7.22% with a cash ROI of 10.35% and total first year ROI of 23.32%. I only inputted a vacancy rate of 3% which in some markets would be way too low but as the vacancy rate in town is 1% this gives us a little wiggle room and is probably fairly accurate. Our hope, based on my estimates, is that we can net $1,000 per month from the property. This allows for $2,000 per year in maintenance which is always the big question mark but as nothing major came up during the inspection and we had the seller take down the diseased tree in the yard, I think this is a reasonable estimate at least for the first few years. Saving this extra $1,000 per month will greatly accelerate our financial independence date but only time will tell if this is accurate.
The most important part of the location was finding something in town. Although properties get less expensive the further you get from downtown, as we are a one car family we needed something that was a bikeable distance. This means that Mr. SFF can easily check it out when needed.
Next important was finding a property in the right neighborhood, which in this case means not too close to the university as well as not in the “ghetto” neighborhoods. I am sure there are responsible college students out there but we looked at one duplex which was clearly a party house with beer signs everywhere. We realized that taking on the additional risk of renting to college students was not one we wanted to make, even if the numbers were actually better on that property. We will not discriminate if college students applied to live in one of the units but the likelihood is decreased because it is a very long walk to campus.
We also chose our current location as it is a little further from the university but very walkable to everything. Our new property is actually just a few blocks from our current house, actually about .2 miles. This means maintenance should be easy and we can easily keep an eye on it without having to go too far out of the way. My mom actually lives even closer to the property than we do so she can let us know if anything looks fishy when she is out walking her dog. Although we are not certain, we think most of the tenants are post-grad individuals.
Condition of the Property
A little maintenance here or there is not a problem but we are not currently in a position to spend thousands of dollars and hours of time renovating a property. Many properties in the area are older and the reality is there are often things that need to be taken care of. Also, there are many slum-lords who don’t take good care of their properties. We walked away from one which had at least $10,000 of work that needed to be done just to get the apartment up to what we would consider safe/liveable conditions and as you have to take over the leases of the current tenants we wouldn’t have even been able to do it.
The inspection on this property really didn’t uncover any major issues, just little things that we could easily take care of over time and that won’t cost a lot. Honestly, the condition of this property was in much better shape than our current property when we bought it. There of course is always the unexpected which is why we will build our cash buffer back up but our hopes are that it will be a while before any big surprises arise.
Oh the things you see when checking out a property! As I mentioned above, you have to take over the leases of the current tenants unless you are moving into the property, which we were not. Now as we can’t do the screening of the tenants we have to go on gut feel based on the apartment condition (how messy they are) and possibly any interactions we might have when looking at the property. One of the most interesting things we have seen when looking at properties was a large, live, marijuana plant. It was the size of a small appliance! I am not sure if it was for personal use or if they were selling, but we didn’t purchase that property.
More than once we looked at apartments where the tenants were sleeping. Our showings were usually on our lunch hours and the tenants get a heads up that people are coming so when there is more than one sleeping person at 1:00 in the afternoon, this does not give me good vibes about them being good tenants. To be fair, they could work the night shift but it was probably more likely lifestyle in these cases.
One of the units in this property is a 2 bed renting for $1,350. There is just one single guy living there and both during the showing and inspection he was home. He was working quietly on his laptop and seemed like a hard working professional. There are 4 guys living in the other apartment. Although the apartment was cluttered it was not trashed and there were no pot plants this time. We chatted briefly with a couple of them when doing the inspection and no alarm bells went off for either of us. So although we really only had this limited knowledge to go by we were comfortable enough with the current tenants. Also, since both leases were in the middle of their terms, if they turn out to be horrible tenants we just won’t renew this summer.
Where’s The Shoe?
It’s sort of funny that throughout this entire process I have been waiting for the other shoe to drop. You know when you keep expecting something to go wrong but it doesn’t? Yup, that feeling. My hope is that since we have done our due diligence and research that we are going to be OK and this will turn out to be a good investment. We sent emails off to all the tenants last night with our info and a copy of the new lease (which matches the old one but has our names on it) and we already heard back from the guy upstairs in the two bed and confirmed he will be paying rent via bill-pay. Here’s to hoping the shoes don’t appear and that all works well.