We Bought a Third Rental House!

I can’t believe I’m saying this: Dear Readers, I’d like to introduce you to Rental House #3.

“But Paula, didn’t you just buy a house? A couple months ago?”

Yep, it feels fast to me, too.

Check out the pics, and meet me below the photos to hear the details.
(If you’re reading by email, click “display images” to see the photos.)

bought rental house - making repairs

We removed the 1970’s wood paneling from this room …

bought rental house - repair wall

We removed a closet to add more space to a bedroom …

bought rental house - repair kitchen

The kitchen is decent, but not amazing …

bought rental house - repair man

… so we’re adding a skylight to the kitchen. Hooray for natural light!

bought rental house - repair stairs

These used to be the steps to the front porch.

bought rental house - repair porch steps

These are the new steps to the front porch! Much better!

The LowDown

The basic stats are normal: 3 bedrooms, 1.5 baths, built in 1965, neglected and needs repair. Up to this point, the description sounds remarkably similar to House #2.
repairing the home
Its location sets it apart. Will and I have “stuck to our core competence” by only buying rental properties that cash-flow. We’ve diversified pretty heavily, though, when it comes to location.

As background: the Atlanta metropolitan area is encircled by a highway, 285, which we call “the Perimeter.” City lovers look for homes “inside the Perimeter,” while suburban-dwellers live “outside the Perimeter.”

Generally speaking (there are many exceptions), the suburbs north of Atlanta are more educated and moneyed; the suburbs south of Atlanta are less.

House #1, the triplex, is in the urban heart of the city, with a view of the skyline. House #2, a single-family home, is “outside the Perimeter” in the faraway suburbs to the south of Atlanta. (That’s why it only cost $21,000.)

House #3 is in a location that Atlantans would call “AT the Perimeter” — in that grey zone where urban meets suburban, within a mile of the 285 highway. It borders the suburbs to the north of Atlanta, in an area with good school districts.

Sorry if I’ve bored you with too much detail, but location is the most important aspect of this project. Many real estate investors decide to specialize in ONE location — sometimes limiting their search to only a few blocks — and there’s a ton of merit to that strategy. If I start flipping houses, I’ll most likely follow that approach.

Will and I are taking the opposite tactic for our rentals, because we’re buying-and-holding for the long run. Neighborhoods will fluctuate in unpredictable ways over the span of the next 40 years. By diversifying our buy-and-hold locations, we’ll defray the risk of holding a bunch of houses in an area that might experience a collapse. (Of course, if ALL of metropolitan Atlanta plummets, we’re screwed.)

C’mon, Get Talkin’ Numbers, Already

rental property - repairThis house went on the market in August 2011 with an asking price of $175,000. If that sounds like a lot of money for a home in disrepair — in a city where you can pick up houses for $21,000 — you can thank the location. This property sits on one acre of land, which is a rarity inside the Perimeter.

The asking price was a little high. The next-door neighbor’s house is currently on the market with an asking price of $155,000, and it doesn’t need repair.

So one month later, in September 2011, the owners dropped the asking price to $148,000. That’s in line with homes on that street that are in good condition, but this place needed a deeper discount to compensate for the work that needs to be put into it.

So in October 2011, the owners dropped the price again, down to $125,000, and that’s where the price remained when we stumbled upon the house in February 2012.

Negotiation Time

We toyed with our offer for a long time. We had a very strong sense that the owners would accept $115,000, and we were ready to pay that. But we wanted to make a smaller offer, so that we could “negotiate up.”
bathroom renovation
Will wanted to offer $105,000. I argued that we should offer $95,000. We volleyed the idea back and forth. We both worried that the “reverse sticker shock” of a less-than-six-figure-offer would cause the seller to dismiss us.

We consulted Mom and Dad. My dad, a tough negotiator, liked Will’s idea. My mom, an even tougher negotiator, agreed with mine.

Mom knows best: we submitted an offer of $95,000 and waited for the seller to retort with a counter-offer. To our amazement, the seller accepted it!

You know, real estate just blows my mind. You can “save” $10,000 just by asking for it. I don’t know any other area of life in which that’s possible, unless you’re running a major business.

We bought the house for $94,000, after getting another $1,000 concession when the inspector found mold in the basement. (It’ll cost $1,000 to treat the mold, so we’ll “break even.”)

The “REAL purchase price” is the purchase PLUS initial repairs. Our repairs are going to cost about $6,000, so the “actual cost” of the house is $100,000.

According to the One Percent Rule of Thumb, this house would be a good deal if we collect $1,000 per month in gross rent. ($100,000 x .01 = $1,000).

I estimate that this house can rent for $1,000 – $1,200 per month, thanks mostly to its zoning and its school district. The return on investment isn’t as hot as the $21,000 house, but the quality of tenant is likely to be much higher.

What’s Next?

rental house team sportThank goodness we’ve started delegating out the repair work: instead of sanding cabinets and hammering nails in House #2, we outsourced that work and used the extra time to search for House #3.

Plus, we forged great relationships with the contractors who worked on House #2, so we knew exactly who to call for quotes on House #3. This streamlined the process immensely, allowing us to coordinate the repairs much faster.

If there’s one lesson that Houses #2 and #3 have taught me, it’s that you’re only as strong as the team around you. Business is a team sport. My focus from this point forward is to build that team.

UPDATE, NOV. 2012: We rented out the house! Check out the final numbers.

The House is Ready to Go on the Market!

I’m coming off another jam-packed weekend of 12-hour days fixing up our foreclosure house. Between our weekend warrior efforts and the nearly $5,000 we’ve paid towards labor costs, this fixer-upper is ready to go on the rental market!

Want proof? You’ve seen the “before” video (if you haven’t, click here.) Check out these “after” pictures:
rental property investing for cashflow
cashflow positive rental property
foreclosure home investing
rental property
foreclosure property investing
real estate home investing

Haha - There's me taking pics of the house.

(Click “display images” to see the photos if you’re reading this by email.)

So how much did it cost us to convert an ugly duckling into a beautiful swan?

House: $21,000 *
Labor: $4,661.73 **
Materials: $3,576.98
Total Repairs (Labor + Material) = $8,238.71

Total = $29,238.71

* we also paid a couple hundred bucks for closing costs

** carpet and garage door (material + labor ) included in “labor” figure

This is enough to get it show-ready. We still need to replace the gutters and water heater and tune the HVAC, which will add roughly another $1,000 to the total.

This means that my gut feeling that the “total purchase price” (purchase + repairs) would come to $30,000 was spot-on.

Two important caveats, though:

#1: Count Your Time

Will and I spent every weekend and many evenings working on the house, and I spent many mornings and afternoons collecting quotes from contractors and checking up on the work. I didn’t track the total time we invested, but I’d guess that we roughly spent 100 hours combined on this project.

The value of our time should be added to this equation, especially since that time represents “missed opportunity” to earn money elsewhere. Time is money: Every hour we spend doing X is one fewer hour that we can spend doing Y.

It’s hard to make a precise calculation about how much our time is worth. At $50/hr, those 100 hours represent $5,000. At $25/hr, those 100 hours represent $2,500.

What metric do we use? I have no idea. That answer hinges on “what else would we do with that time?,” which is hypothetical. I just think its important to acknowledge that the time we invested translates into some financial worth.

#2: The One-Third Rule

Sooner rather than later, we’ll need to replace the windows, siding, bathtubs and roof. These aren’t urgent tasks, but they should get done in the next 3-5 years.

Why am I mentioning this? There’s the tough question of how people should allocate the cash-flow rental income that comes in. My favorite book on real estate investing, From 0 to 130 Properties in 3.5 Years, recommends the 1/3 approach:

  • 1/3 on improving the house and/or extra mortgage payments
  • 1/3 on buying more positive-cashflow real estate
  • 1/3 on chasing capital gains (stocks, ETFs, etc.)

It’s a great suggestion, but I’m going to tweak it a bit:

  • 1/3 on improving the house
  • 1/3 on buying more positive-cashflow real estate
  • 1/3 on building a thicker emergency fund

In 3-5 years, when I can switch from “fix-it” mode to “maintenance” mode, I’ll re-evaluate. But for the moment, this is my general strategy.

Update: The house is rented! What’s the return on investment? Find out here.

Investing 100% of My Income: March Update

investing income into a rental houseIt’s time for the latest Investing 100 Percent of My Income update – where did my money go last month?

(Note for new readers: Will and I are a couple who have pledged to invest 100 percent of my 2012 income while living solely on his income. You can read about the pledge here.)

In January and February, I dumped every cent I earned into my Roth IRA and came really freakin’ close to maxing out my $5,000 contribution limit.

(Last month I discussed how on an “accrual” basis I earned more, but on a “cash” basis I’m a couple hundred dollars shy of hitting the $5,000 mark. If you don’t know what those terms mean, you can find out here.)

My plan for the month of March was to finish maxing out my 2012 Roth IRA contribution. I’d “snowball” this savings goal, cross it off the list, and move on to the next item at hand.

But something unexpected happened: I bought a second rental home. I hadn’t planned on buying another house at that moment, but I spotted a deal that was too good to refuse. Will and I had been saving to eventually buy a second home, so we were prepared to pounce on it.

The house needs a ton of repairs. So every cent (and more) that I earned last month went into fixing up the place.

Here’s the breakdown:

  • Garage door – $576.73, including installation plus removal/disposal of old door
  • Carpet – $1240, including installation plus removal/disposal of old carpet

Labor Only:

  • Tearing down and rebuilding a 10×12 deck – $375
  • Painting the house interior – $900
  • Laying vinyl flooring in kitchen/bath – $200
  • Repairing laundry valves – $200
  • Patching drywall holes and painting garage – $200
  • Installing countertops in kitchen and bath – $150
  • Patching drywall throughout house – $100
  • Removing and re-hanging interior doors – $100
  • Sanding and painting kitchen cabinets and bath vanities – $250
  • Replace fascia and rotted roof decking – $370

Total: $4,661.73, mostly for labor. The only material included in this figure is the carpet and the new garage door.

In addition, we also bought materials such as paint, primer, caulk, drywall compound, vinyl flooring, decking, cement, roof shingles, screws, nails, and LOTS of wood. I haven’t processed the exact figures – you should see how thick my stack of receipts is! — but I believe this figure comes to roughly $2,000 – $3,000. I’ll post a more precise update once I spend a few hours inputting everything into a giant spreadsheet.

There are still more repairs needed: I need to replace the gutters and water heater, tune up the HVAC, take a few huge loads to the dump (or rent a dumpster), paint the fascia and termite-proof the house.

In short: I need to pour every cent into this house to get it rent-ready. Everything else is on hold.

Why Not Do It Yourself?

Our first rental building – the triplex in terrible condition – taught me that doing-it-yourself costs time. It’s dollar-cheap but time-expensive.

Here’s where we get into a quandary: on one hand, I believe in being frugal with time, not money. On the other hand, it’s tough to part with hard-earned cash.

Our happy medium solution is to do the most expensive things ourselves, like electrical work and plumbing, and to outsource the most time-consuming tasks, like paint and drywall.

(Update 2013: Now we outsource everything, because our time is more valuable than it was in 2012. Our businesses have grown, and that demands delegation.)

As I’ve discovered, collecting quotes from contractors and comparison-shopping for materials like vinyl and carpet eats up about 10 hours per week. Driving to the house to check on the progress eats another 2-5 hours per week.

Of course, that doesn’t compare to the time-cost of doing the actual work ourselves, which could eat away 60 hours a week if we were serious about finishing it quickly so that it can go on the rental market.

Opportunity Cost

The good news is that we bought this house in cash, so I don’t have the stress of needing to make mortgage payments while we repair the house.

The bad news? Lack of a mortgage is a double-edged sword. Without that stress, I’m less motivated to work quickly. I find myself putting off calling contractors for “just one more day,” until those days add up to a week.

Logically, I know that every month this house isn’t rented is costing me hundreds in the form of “opportunity cost,” or lost income potential. But humans are hardwired to be more motivated by losing actual money (money we’ve gone through the trouble of earning) than theoretical money (opportunity cost).

Setting deadlines helps: my goal is to get this house rented by May 1. Creating a reward for myself also helps: as soon as this place is rented, I’m rewarding myself with a flight to Austin, Texas to visit one of my good friends. That gives me the motivation to continue managing this project.

I Cringe at This Common Real Estate Mistake …

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I’m making a massive change in my search for my next rental house.houses and land criteria is different for flipping a house or buying a rental

I’ve spent the past year searching for another rental house within walking distance of Atlanta’s most vibrant city park.

It’s one of the most desirable neighborhoods in Atlanta, especially among young professionals who want to live in walking distance to martini bars and yoga studios.

We bought a great rental house in this neighborhood once; surely we could do it again, right?

It seems the answer is “no.” Every house I’ve looked at for the past year has a negative cash flow. This neighborhood is too desirable; the value of the underlying land is too high.

For Example …

One 4-plex in this area just came on the market for $400,000. If I put 10 percent down and locked in a 4 percent interest rate with 1 percent primary mortgage insurance, the mortgage would be $2,200 per month.

Each unit is a small one-bedroom with low ceilings, so I could collect roughly $750 in rent per unit, or $3,000 per month.

I hope you can already see that this is a losing deal. After insurance, water, trash, management, repairs, maintenance and vacancies, I’d be bleeding money every month.

The prices in this neighborhood simply haven’t fallen enough to make the rental income outshine the cost of ownership. The underlying land value is too strong. The house we bought, clearly, was the exception to the rule — the diamond in the rough.

Flipping a House vs. Holding a Rental House

When you’re “flipping” a house — buying for the sake of selling — a high land value is your strongest asset.
how to buy a rental house
When you’re “holding” a house — buying for the sake of collecting rent — you want cheap land value plus a great building in a tenant-friendly zone.

It sounds like a subtle difference, but trust me: this distinction is HUGE. It can spell the difference between success and failure in real estate.

That’s why it’s essential to know why you’re buying.

That’s why I cringe when I hear someone say, “I’d like to collect rent, but I also want the price to rise so I can sell it. And maybe I also want to live there someday.”

They’re really saying: “I don’t have a strategy. I want it all.”

If you’re buying a rental, you need to know:

  • Do people rent in this neighborhood?
  • What type of renters does this attract? (Students, families, etc.)
  • How many bedrooms are there? What can I collect “per bedroom”?
  • What are the monthly expenses? (Water, trash, taxes, etc.)
  • How does that compare to the average rental income in the area?
  • How soon do the appliances need to be replaced?
  • What repairs does this building need?
  • The focus is on the BUILDING, the number of BEDROOMS, and the TENANTS.

If you’re buying for the sake of price appreciation, you want to know:

  • Are people and businesses buying property in this area?
  • How quickly is this area growing?
  • Does this location have a competitive advantage that can’t be replicated? (Maybe it’s close to the city’s flagship park, or it’s in the best school district in the state.)
  • The focus is on the LOCATION.

You might get lucky and find the best of both worlds. I certainly did with my first house.

But when you’re evaluating a property, you need sharply-defined criteria. “I want it all” is not a business plan.

Looking at Cheaper Locations

In the past few weeks, I’ve expanded my search to other areas. I’m searching neighborhoods, frankly, that I would never want to live in: Far-flung suburban areas with long commutes. Cookie-cutter houses. Cul-de-sacs.

The houses are cheap because the value of the underlying land is next-to-nothing. You’re paying for the building, not the land.

At the same time, there’s strong economic vitality. There are fast-food restaurants, gas stations and beauty salons. There’s a shopping mall with a Macy’s department store.

In the particular area that I toured last night, every commercial shopping center boasts full occupancy — a promising sign.

Many of the houses in the area are “new construction” homes, indicating that other property developers are investing there.

In short: people want to live there, but they can’t all afford to buy. The rental market there is ripe.

This reminds me — again! — of that famous quote from Roman emperor Cicero: “Refusing to set aside trivial preferences” is one of the mankind’s most common mistakes.

In other words: Just because I don’t want to live in a particular neighborhood doesn’t mean I shouldn’t buy a house there. :-)


UPDATE 2013: Now I have 4 houses, totaling $30,000 a year in net passive income. Here’s the story of House #1, House #2, House #3 and House #4