Continuing the pursuit of wealth; rental property #2
July 5th, 2021 by D.C. Poc
Earlier this year I wrote an article, The path to early (Age 57) retirement; long-term rental properties, about my wife and I starting our rental property journey in the hopes that we can generate passive cash flow for retirement. In the time since, we’ve been scouring the local market looking for our next deal! After two months of searching, we finally found it and couldn’t be happier.
The first step to finding a property is knowing your budget. You should also have a pre-approval, which gives you an idea of what you can spend. Ideally, you should work toward developing relationships with various lenders so you can continue to count on them in future pursuits. By doing this, you are making the relationship more personal which will likely benefit you long-term. This will also make it much easier to get quotes quickly, which aids in analyzing the deal. We try to maintain a pre-approval of around $250-300k, knowing we’re buying properties that are far less than that. We feel this amount gives our offers more credibility when competing against all cash offers.
Once you have a budget and pre-approval, you’ll need to identify what types of properties you are looking for and what neighborhood(s) you want to buy in. For us, we try to hover around our local military base. This does a few things - first, the renters are always rotating because military service members typically transfer every three years, which means you’ll always have new prospective tenants - second, the military pays something called a Basic Allowance for Housing or BAH as it’s commonly referred. The BAH for my target tenant is $1377. Knowing things like this will help you adequately price your rental while running estimates. In our town, keeping rents in the $1,000-$1,400 range is a sure-fire way to limit vacancy.
Lastly, you’ll need to start looking at homes and making offers. Plenty of people sit on the sidelines for 20 years and never buy a single property even though they want to be RE investors. The only way to get started is to jump in head first - start browsing for properties, run the numbers, walk the property, and make strong offers!
Making sure the numbers work
I talked about this a little in my first article but want to touch on it again. Whatever method you are using to analyze a property, you want to stick to it. If the numbers don’t work, don’t buy the place. At the end of the day, making sure the numbers work is the best way to protect yourself financially.
We are looking for a ‘cash on cash’ return of 10% or greater. This is the single most important factor we analyze when buying a rental property. For other investors, they may value appreciation (Quicken defines as the growth of the property value over time), or they may value capitalization rate (Investopedia defines as the net operating income divided by asset value) more. Either way, know what factors you are using to analyze properties and stick to them!
For the property I’m going to talk about below, we calculated an estimated cash on cash return of 11.49% - above our 10% threshold. If we have low vacancy and maintenance costs for the year, this could be upward of 15%! Take a look at my final numbers using the ‘CDS Rental Calculator’ below, which you can download for yourself on Google Play or the App Store. The ‘CDS’ acronym stands for Chandler David Smith, a real estate investing guru, and clearly, the namesake behind the app.
Making the deal
Our first deal was a duplex that already had tenants on both sides. Because of this, we weren’t worried about renovations, placing tenants, or any of those other nuances you deal with when the house is empty. This time it was different.
My realtor/property manager sent me a text saying “MUST SEE”. I value her advice so I flew over there. The house was listed at $115k. It was 3 bedrooms, 2 baths, around 1300 square feet. Upon entering the house, I immediately thought the condition was much better than expected. The carpet was terrible, and it needed paint, but the interior was unexpectedly nice overall. Heck, the kitchen even had granite counters! The outside needed some work, including replacing the front porch posts and fixing some rotted siding. The rotted siding looked terrible, and I can see how this may have scared some buyers. Overall, I estimated about $7k in repairs prior to renting. These estimates are broken down below.
|Luxury Vinyl Plank (LVP) Flooring||$4,000|
|Full Interior Paint||$1,000|
|Front Porch Post Replacements||$1,000|
Long story short, we immediately put in an offer for $130k (yes, $15k over list price). We told them we wanted an answer that evening. Around 7pm, we were informed that they were accepting the offer! YES! We successfully went under contract on rental property #2!
How did it all work out?
We closed on June 24th. The flooring company had all of the carpet removed by noon on Friday. On June 30, the house had all of the necessary repairs completed. The total cost came in at $7,500, so about $350 over budget. That’s a total win in my book. After being listed for rent for about 12 hours we had 4 applicants. This house will rent for $1350, which is exactly the estimate used during the purchase.
Don’t assume everything will work out like this. This one went perfectly and I will certainly continue to prepare for hiccups in future deals.
Our pursuit of more rentals
This is an interesting property. We have a grand total of around $40,000 cash invested. The house, which we only paid $130k for, is now worth $170k+ based on neighborhood comps. This leaves two options - 1) we can ‘cash out refi' the house and retrieve our $37k in capital. This would lower our cash flow but give us more cash, which is always good. 2) We do nothing, enjoy the low mortgage payment of ~$460, and continue to save cash for the next deal. This won’t be hard considering we now have 2 rental properties which have cash flows of around $11,500 per year. If we do refinance, it will be in 2022, but at this point we’re undecided. It’s absolutely crazy to think that we can retrieve all of our cash and immediately be ready to buy another rental property. Who would have thought?
Our long-term plan is to continue shopping for deals. If we stick to our method of evaluation, we should avoid being over-extended by maintaining healthy cash flows with a solid cash on cash return.
D.C. joined the Marine Corps right out of high school. When he left active duty, after 5 years of service, he quickly earned a bachelors degree and an MBA. He got his first private sector job at a modest salary and quickly worked his way up through promotions. Once he started making decent money ($38k at the time) he quickly realized he needed to learn how to save to secure his future. After nearly ten years of research, he wants to share his knowledge and financial best practices so more people can become Wealthy Idiots!