rental property

There are two huge benefits of this blog (actually the two reasons that keep me coming back and I haven’t sold the site for good).  The first is that I can think through an issue while I write it out.  Sometimes that just leads to a garbled mess and other times it allows for clarity to present itself.  The second is that I get to read my mindset years and years later.  For example, it is always funny to me when I look back and review my first thoughts on starting an investment club (which is still active by the way), and then all the subsequent updates.

Well this feels like one of those pivotal moments in my financial life that could change the trajectory of my finances so I might as well sit down and right down some thoughts!!  I have been talking about owning rental property for years (and years).  For a variety of reasons nothing ever came to fruition, until last month!

Why I Want to Own Rental Real Estate

As part of my main job, I have looked at a lot of balance sheets and have run a lot of retirement runs over the past 12 years, and real estate does something pretty amazing to both of those reports.  Almost every high net worth balance sheet that I have seen has one or two (if not both) line items – Real Estate and a Business.  Trading your time for money is a very slow way to retirement nevertheless building intergenerational wealth.  Since there is no larger than average business in my future real estate is where it is at!

I have always wanted to build multiple streams of uncorrelated income, and rental income seems to be a fantastic addition.  One day I’ll be able to turn on that income which is likely uncorrelated (or a very low correlation) to whether I have a job, or whether the market takes a 2008 like hit.  Similarly, I look at my dividend stream of income as uncorrelated to whether the rental market in my area undergoes a correction.

How I Came to Own my Current Rental Property

When we decided to move, The Wife and I had a very specific semi-lateral move in mind that would keep my housing costs in check.  Keeping our housing costs near what we had was important to both of us as neither of us wanted to be “house poor.”  We enjoy the flexibility in our discretionary spending.  FIRE is not, nor has it ever been, a goal of mine (or more specifically the RE part).

Well as the saying goes, “Men Plan and God Laughs.”  I did not get the number I wanted for my home, but while we were realizing that fact The Wife fell in love with the new house.  As such, my “waiting it out” period became significantly shorter.  Knowing that I always wanted to own rental property, The Wife came up with the idea of leveraging the new house in favor of keeping the old house up and running as a rental.  Whenever rental properties came up she was a little apprehensive, so for her to push it was exciting to me.  Deep down I think she pushed it so I wouldn’t completely freak out on her about the move, rather than her actually loving the idea.  Regardless, I was all in!

How I am Going to Run OUR Rental Real Estate Property

First thing I did was put the idea out to about 8 buddies.  I gave all the facts:

• Monthly nut was about $3,100 – $3,200 (Mortgage, Taxes, HELOC and Insurance);
• I already found a renter (newly/nasty divorcee that wanted to keep herself in the school district);
• Since I was 6.5 years into the mortgage every time a mortgage payment was made there is about $800 or so in equity build up;
• Roof may go inside the next few years;
• I am not negotiating on price; and
• I was willing to sell up to 49%.

These particular buddies showed an interest in investing in real estate and are local.  While I plan on being the face of the operation there may be times where I need someone to lean on.

There were two in particular (JT&Jx2 – put here for my purposes) that I thought would jump at the opportunity, they did not for their own reasons. JT, wanted a bigger project/better cap rate.  In my opinion he is more of a high risk high reward, hit the home run kind of guy rather than slow and steady.  Jx2 is going to have a liquidity need (new, bigger main residence purchase) in the next 4 to 6 years and I obviously couldn’t guarantee a buy out before that.  The two that jumped in were one of my siblings and a life long friend.  I put these two on the deed, so they are true owners (10% each).  We had a joint venture agreement drafted and executed so common speed bumps that may occur have predefined outcomes prior to said speed bump (i.e. a minority partner passes, someone wants out, I want to sell, expense occurs, etc.).

Since I have 2 partners it becomes very important to keep good records.  When discussing how to run the operation for the foreseeable future this is what we came up with is using all current positive cash flow to pay down the HELOC.  This provides two benefits.  The HELOC is going to serve as our “emergency fund” it has a cap that we are near.  The quicker we pay that down the quicker we build that cushion should anything go wrong.  Second, the quicker we pay it down the faster we are growing our equity (with less money going towards interest).

I am not exactly sure where this whole adventure leads us but I am excited to find out!

I think the major difference (for me) between buying equities versus buying real estate is the complexity of the deal.  I was very excited about my recent possible real estate deal, it felt perfect! Financing was done, the home had equity built in and I even had a tenant that cared about the home…and then I had an inspection done on the home.  Given the title of the post, I am sure it is evident that this particular deal didn’t work out (again).

Not only is real estate local with regard to understanding value, market, etc., the customs when it comes to closing and contracts is also very different from State to State.  In New York, when you are buying a residential property from another owner you don’t get any warranties from that owner.  I know this sounds completely foreign to people in other States or Countries.  It used to be caveat emptor and then in the early 2000s the law changed to make disclosures mandatory, or,

pay a credit of $500 to the buyer at closing. While the PCDA requires you to complete a standardized disclosure statement and deliver it to the buyer before the buyer signs the final purchase contract, in practice, most home sellers in New York opt not to complete the statement and instead pay the credit.

Well, who wouldn’t just credit $500 instead of opening yourself up to litigation? It is the best insurance one could buy! I can tell you one person who didn’t, my mother in law when she sold her mother’s property upon her death.  I pleaded with her that a $500 was well worth the price of admission. She didn’t listen.

This little nuance in NY law didn’t really matter much as the home I was going to purchase was a short sale. A short sale is a,

a sale of real estate in which the net proceeds from selling the property will fall short of the debts secured by liens against the property. In this case, if all lien holders agree to accept less than the amount owed on the debt, a sale of the property can be accomplished. A Short Sale is not to be confused with a Short Settlement.

A short sale has two intrinsic and inseverable components. A Short Sale is successful when (1) The Lien holder(s) (a.k.a. Mortgage Company) is agreeable to net less than the amount owed on the note (debt) as the result of (2) an arm’s length sale at or below the Appraised Value for that property. The agreeable selling price is intrinsically defined to be at or less than the appraised value allowing the process to be attainable. A prudent buyer will not pay greater than the appraised value, and a Bank or Finance company will not provide a mortgage for greater than the appraised value, thus limiting the Short Sale proceeds to a maximum gross yield of the property’s Appraised Value.

Basically the bank is trying to avoid the long, costly process of a foreclosure and kicking people out on the street. So, they will take a lower sales price and usually pay the occupant to get the hell out.  A short sale never comes with any warranties so the inspection was extremely important, and mine did not go well at all.  Just some of the problems the inspector came across:

• Brick work problems that most people could live with, but a tenant or a tenant’s guest may trip on;
• Water damage in almost every single room – one was so bad that I put my finger into the hole and felt dampness;
• An extension not built to code;
• 3 layers of roofing already laid and there is still warping in the 3rd layer;
• Almost every windowsill had rotting from the outside;
• Skylights looked like they were original from the 50’s and did not look like they were great shape; and
• These are the problems that I saw! Who the hell knew what was behind the walls that was already patched up!?

I just imagined the moment ownership was in my possession getting a phone call about all the water problems that the current owner/new tenant has had for the past however many years he has been living there! All of a sudden I open up a wall to fix it correctly and I find a wall of black mold that is now my responsibility to fix.

The Future of this Particular Deal

Given the terrible inspection, at the current asking/bottom line for the bank, the deal didn’t feel like a first time landlord’s rental.  To be honest, and a bit frustrating, the deal feels like a pretty good flip for someone who can control costs and fix things pretty cheaply.  There is a lot of work to be done on the house, and I just don’t feel like a bring a lot of value when it comes to that area of real estate.

Notwithstanding all these problems, I came back with a counter offer of $50,000 less than what the bank agreed upon already.  I figured what the hell, at another $50k less I can deal with some headaches! In the end this will be another dead deal, but I’d rather 22 dead deals than 1 shit deal that gives me headaches for the next 10 years.

I have wanted to own a rental property for a long, long time.  If there is a “cool” thing about having a blog is that I can actually look up moments like, when I first brought up owning real estate (6 years ago) or when it actually came up as a business plan, I actually looked at a house or two (or when that second possible deal failed).

Why it is important for me to own a Rental Real Estate Property?

I have discussed the idea of multiple streams of income, and why they are important to me since almost the beginning of this blog.  I was able to reinvigorate my feelings on the topic when talk to my older brother this past weekend when I was telling him about this deal.

He asked me, point blank, why I wanted to get involved with real estate.  We both saw our father go through hell with some of his tenants over the past couple of decades.  My father owns a mixed use property (2 units and commercial space) that my grandparents bought when they came to America from Greece, as well as his first property that is also 2 units (he used the equity from that home to purchase their main residence that they have owned for the past 30 years or so).  Both properties are in the boroughs of New York City which are notoriously anti-landlord.

Notwithstanding my father’s experiences, creating a real estate portfolio is extremely important to me.  My brother is a lieutenant in the FDNY and his wife is a NYC teacher.  One day they will wake up and have an income stream for the rest of their life.  It is my goal to create those streams of income that is not predicated on the selling of principal for future Evan.  I can’t see any path I would take at the age of 37 that would take me to a stream of income like that other than real estate and my dividend portfolio.  He seemed to completely understand as soon as I explained it that way – so that may help someone else out there.

The Possible Real Estate Deal

About a week or so ago my friend, boss, and what I would consider a mentor (although I don’t think he’d appreciate the title) came to me with a deal.  A banker’s broker he has worked with a few times before on short sales brought a deal to his attention.  The deal was too small for him to deal with all the inherent headaches (described below), but he thought if there could be a deal for both of us where he would be the moneyed partner and I would handle all the day to day headaches.  To say I was appreciative would be an understatement. We spent the next two weeks or so ironing out details.

It was at the end of that second week that he sat me down and said that he had an alternative arrangement.  He would fund the entire deal but it would be all mine.  He would be my very generous bank but a bank nonetheless with all the rights thereto.  After talking to a few people I said I was in!

Estimated Costs and Income of the Home

The home is a short sale and with the help of the aforementioned friend is at the rock bottom price of $350,000.00 – all cash deal.  From what I researched I would estimate there is probably an estimated $50,000 to $100,000 of equity in the home (i.e. there aren’t many homes in this town that sell for less than $400,000).

The current occupants are the soon to be ex-homeowners.  This is great and terrible at the same time.  First the bad news, they were obviously not able to pay their mortgage, so who is to say they are able to pay me! The good news, they have indicated to parties involved they want to stay and that they have kids in the school district.  Interestingly, when I did a creepy drive by they had newly planted plants and the sprinklers going.  I thought this was a really good thing – it shows they care about this house.

As of this post, I have not had the opportunity to sit down with them.  Hopefully that is happening in the next day or two.  My plan is to sit down with them, have a background check done (knowing the credit report is going to come up terrible) and discuss how much they plan on paying me.  These numbers are estimates as this post is in the middle of a lot of balls up in the air.

Income from Property – $3,000/mo (Going to try and negotiate $3,250)

Interest Only Monthly Payment – $1,666/mo ($20k/yr on $400k borrowed)

Taxes – $600/mo (approx)

Homeowners Insurance – $150/mo (approx)

Leaves me with working capital of about $500 – $600/mo of positive cash flow.  I am not going on with blinders this deal is unlikely to be a lottery ticket to an early retirement, however, I am looking at it as a very low risk way to get my feet wet into real estate as an asset class for my family.  If I absolutely hate it, then lesson learned, I sell the property, payback my friend and walk hopefully with a few dollars for my troubles. If I love it, then I slowly eat into my unbelievably low hard money borrowing rate and continue to be thankful that I have met amazing people in my life that allowed me this opportunity.

What Could Still go Wrong with the Deal?

I could have held this post off until closing, but I have been doing that too much lately and then never getting around to writing something when it doesn’t work out.  For example, last week The Wife and I put an offer on a new main residence! By the time the dust settled we were outbid, and as such, I lost all motivation to write a post.  I know for anyone reading this blog still it doesn’t matter, but now, that deal will be completely lost from my memory.  While that one will be gone from my memory, fighting with The Wife about what we offered, how much we got out bid, etc., this rental property will be memorialized even if it doesn’t work out…and this is far from a lock!

First thing that could derail this deal are the tenants.  As alluded to earlier in the post, there are just no guarantees that we are going to ‘vibe.’ The bank has made it clear that for a deal to go through they are my problem meaning they aren’t dealing with the foreclosure which leaves me to an eviction process  Evicting an individual in my county is much easier than in NYC but it is still a process nonetheless.  I don’t think I want my first 6 months as a landlord to be spent in court trying to evict a family (with children) from the home they thought was going to be their forever home.  To minimize this risk, I am going to have a sit down with them to try and figure out how this is all going to work out! That meeting hasn’t happened yet, but if there is no way they can afford $2,000 nevertheless the $3,000 that is my final offer, I am not sure where that leaves me.

The second thing that could kill the deal is the inspection report.  Similar to evicting a tenant, I don’t want my first 6 months (or even year) as a landlord to be dealing with major problems.  If there is a roof issue, boiler, etc., I just would rather hold off till the next one! To minimize this risk I need to set up an inspection from an agent that has absolutely no relationship with the broker or bank, and as such, does not care if the deal closes.

Looking into the Future

I obviously does not know where this one is going to end up! I am hoping in 60 to 90 days I’ll be able to say that I am a landlord with great tenants! Could the deal fall through? 100%. Could I be stuck with terrible tenants? 100%. Could this be a terrible mistake? 100%, however, there seems to be such little downfall risk that I have to at least try it out! Even if shit completely hits the fan I really believe that this could be a quick flip after I work on evicting the tenants.