New Investment Property…. FINALLY!

I FINALLY HAVE A NEW INVESTMENT PROPERTY UNDER CONTRACT!!!! If you have been reading my blog for a while, you know that I LOVE REAL ESTATE…. AND… That I’ve been looking for MONTHS. Yes, MONTHS. I have lost several bidding wars…. BUT! Finally, I have won. We will be closing on the property in less than a week. More importantly, this property will bring me one step closer to FIRE. Wahooooo!

Selecting a Property

Many real estate investors preach about the 1.0% rule when looking for a rental property. The 1.0% rule provides a simple way to screen properties. For example, if a property is listed at $100,000 you would want the monthly rent to be at least 1.0% of the purchase price, or $1,000. The midwest region of the United States is great for the 1.0% rule. Heck! There are even 2.0% properties out there.

Read more about the 1.0% rule here:

Paula Pant @affordanything: Why the One Percent Rule Matters

or

Coach Carson @CoachCarson: The 50% rule

However, for us investors that live on the coast, we generally do not have that luxury. I have adopted a different approach to screening properties for areas with high property values. Over the years I have developed a simple “back of the envelope” method to screening deals.

First, I never want a ‘thin’ deal with small returns or little room for error. There will always be unknowns and unforeseen costs/events with real estate I aim for a 20.0% return on investment (ROI). This means I am getting all my money back in 5 years or less. Also, compounding at 20.0% means I am growing my net worth much faster than the average investor can expect from simply owning stocks.

My ROI calculation is fairly simple:

ROI: Annual Cash Flow / Total Capital Invested

Annual Cash Flow: (Monthly Rental Rate – PITI) * 12

Total Capital Invested: Down Payment + any renovation or improvement cost prior to renting

PITI: Principal, Interest, Tax and Insurance (aka your monthly mortgage payment)

This may seem a bit confusing, but I will provide an example later in this post. The example will use REAL NUMBERS from my new property.

About the Property

The property is a duplex with one unit upstairs and the other down stairs. Both units have two bedrooms and one bathroom. The brick building was built in 1939, has been well maintained and was modestly renovated about 10 years ago. The neighborhood is experiencing gentrification but still has a long way to go. The area is safe but not a premier location. Renting the property will not be an issue. The units show well and are at an attractive price point.

Home Inspection

We conducted the home inspection a few weekends ago. The inspection took damn near three hours. Two units means twice the systems, twice the time and twice the headaches. I anticipated $10,000.00 of work/improvements might be needed prior to the inspection. Generally, I am conservative with my assumptions. And guess what… I was! The property does require some TLC… BUT with me doing some of the work and farming other tasks out to my crew, I will only need to spend $6,000-$7,000 (still a conservative estimate) and a few hours of my time. Big Win!

Also, my first mortgage payment won’t be until May 1st. This means I have over 50 days to fix the property up and find tenants. I might even have a full month of rents before ever my first mortgage payment. Can you say winning? I have already lined up most of my contractors to start work the day after closing. Time is money and I am racing against the clock to get the property turned around. I do not want to come out of pocket to pay the bills. That’s what tenants are for.

Repairs

So… What needs to be done? There is nothing overly scary on the list and there will be several $5-10 trips to Home Depot (why do I not own their stock yet?).

Unit 1:

  • Adjust plumbing underneath bathroom sink (poorly installed)
  • Furnace tune-up and install triple wall
  • Replace water shutoff for kitchen sink (old)
  • Replace water shutoff for bathroom sink (old)
  • Electrical tune-up in the fuse box
  • Installing new plugs for the stove & refrigerator
  • Adjusting front left stove stop burner so the flame is not a mile high
  • Apply weather strip to front door
  • Change the locks (who knows who has keys to the current locks)
  • Water heater (Still functions but past its useful life. not necessary but will delay headaches for 7-10 years)
  • Replace outlets that were painted over
  • Replace kitchen GFI
  • Smoke/carbon monoxide detectors
  • Fire extinguisher

Unit 2:

  • Refrigerator (this unit does not have a refrigerator)
  • Furnace tune-up and triple wall
  • Replace the toilet’s wax ring and tighten bolts
  • Tighten shower knobs to stop leak
  • Electrical tune-up in the fuse box
  • Installing new plugs for the stove & refrigerator
  • Filing down two doors to shut properly
  • broiler plan for the oven
  • Apply weather strip to front door
  • Change the locks (who knows who has keys to the current locks)
  • Water heater (Still functions but past its useful life. not necessary but will delay headaches for 7-10 years)
  • Replace outlets that were painted over
  • Replace bathroom GFI
  • Smoke/carbon monoxide detectors
  • Fire extinguisher
  • Replace internal window frame that has water damage

Building:

  • The building has flat roof and roof needs a fresh coat. This project will require two 5-gallon containers and a few hours of my time on a nice spring day. I will never be the gentleman Andy Dufrense (From The Shawshank Redemption) but I am capable of tarring a roof and drinking a cold beer or two. Doing this work myself will save $2,000-$3,000.
  • Paint wall caps and roof hatch to prevent rust
  • Secure roof hatch to prevent unwanted entry (doubtful occurrence but better safe than liable)
  • Reinforcing the back stairs case
  • Pointing/ touch up to the brick exterior
  • Repair a section of the walk way leading up to the house
  • Touching up the trim
  • Install new window trim
  • Install extended downspout to keep water from foundation walls
  • Replace gutters and down spouts
  • Removed old shed
  • Add fence to prevent people from cutting through front/back yard

What Do the Numbers Say?

Purchase price: $359,000

Down Payment: $71,800

Renovation Costs: $7,000

Total Capital Invested: $78,800

Monthly Rent/Unit: $1,600

My total investment costs will be $78,800.00. Each unit will rent for $1,600/month ($3,200 in total) and my carrying costs will be $1,650/month. This means I will have $1,550/month ($18,600 annually) in cash flow after paying for principal, interest, taxes and insurance (PITI).

A basic return on investment (ROI) calculation:

$18,600 / $78,800 = 23.60% Return on Investment

This means I will recoup my cash invested in 4.24 years ($78,800 / $18,600)

This analysis is overly simplistic. I self manage and do not have to pay a property manager (maybe one day once I hit FIRE). There were will be minor repairs and expenses overtime. Over the next 30 years I will have larger expenses as well. All repairs and maintenance items will be supported by the property’s cash flow.

My calculation also does not account for potential vacancies. For many, this is an unreasonable assumption. However, I manage over 50 properties and we only had a half month vacancy on a single unit last year. This vacancy was by choice. We had several people willing to move in on time. However, the ideal tenant and the tenant we went with could not move in until the 15th of the month. We were willing to sacrifice half of a month’s rent to obtain the “perfect tenant”.  Also, we are very efficient and capable when it comes to finding and screening tenants.

Summary

The new duplex will provide me with great a passive income stream and meets my return requirements. The repairs are minor and will take a week or two at the most to complete. The property supports itself 50% occupancy which provides room for error (though I plan to manage the property much more efficiently). Real estate investors should never invest in a ‘thin deal’ with little room for error. There will also be unexpected expenses and unknowns along the way. I will recoup all of my expenses in less than five years and might enjoy appreciation as the neighborhood improves. What do you think of my approach and analysis?

9 thoughts on “New Investment Property…. FINALLY!”

  1. Congrats on the purchase, Guy! And thanks for the mention!

    Sounds like a solid deal, particularly with it also being in a neighborhood with gentrification happening. Early in my real estate career I used to focus just on cash flow and returns and not as much on location potential. Mistake. But you seem to be balancing that nicely.

    I look forward to seeing some after reports and photos once you get it ready and rented out. Best of luck!

  2. I love your approach and appreciate that you’re not shying away from investing in a HCOL area! I’ve been thinking of acquiring a property myself. Did you put the 20% down in cash? Any tips on financing? We have an accidental rental property and want to find one that cash flows but wondering how much to put down and how difficult it will be to get financing.

  3. Congrats on your purchase. That’s a nice rate of return. At least you have a very low vacancy rate in your area so you don’t have to set much aside for it.

    I’m not investing in new rentals now but I usually set 5% of cash flow for vacancy in my calculations and 5 to 10% for future repairs, depending on how old the property is. If after inputting those numbers, and other expenses you mentioned, I still get a 10% return on my money than it’s a good buy.

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