The tale of the rundown row home that turned into a gold mine.
Flash back to the spring of 2015. I was still working at MegaCorp and house hacking in my starter home. At this point in my life I was saving every penny I could find. This meant biking to work (which was awesome) and making all of my meals at home.
One afternoon, I was sitting on the couch updating my budget and net worth with Personal Capital, which is is something I always do at the end of the month. My net worth was nothing impressive at the time and definitely less than $100k.
Also see: 6 Steps to Saving a 6-figure Net Worth
Curiosity got the better of me and I was wondering what it would take to become a millionaire by age 30. Running some random scenarios, I realized that I would need a miracle to join the two comma club by thirty.
First, I ran a scenario of what if I saved and invested $20k/year? Not even close.
Ok… What about $40/k a year? Still short….
How about $50k/ a year? Nope.
$70k/ year? Fuck! Still short
This caused me to to jump into action. I wanted to find a way to increase the gap between my income and my expenses. My spending was minimal and could not go much lower since I was playing strong defense. So, I decided to focus on growing my income.
By increasing the gap, individuals are able to save/invest more. As such, this creates a snowball effect and the funds being saved/invested start to grow exponentially.
[Side note: Now, just to be clear, I currently do not believe I will need $1 million dollars to retire. Back then I was less educated about Financial Independence; Retire Early (FIRE). I also thought I wanted to live a ‘baller’ lifestyle.]
Having tons of free time, limited cash and being comfortable with leverage (debt) led me down one path… You guessed it, MORE REAL ESTATE. Oh, and a side hustle as a property manager learning from someone with almost two decades of management and investing experience. But let’s focus on the real estate part today.
I wanted to find a multiunit (2-4 unit) or single family home that was worthy of its own HGTV show. This type of property would provide me:
- Better value for my money
- Increase my purchasing power
- Allow me to build equity through my renovations (sweat equity)
- House hack and have positive cash flow while living at the property.
Often, these properties allow for the owner to live in one unit for free while the rents from other units cover the mortgage. The owner can even make a profit while living in the building. This is one of the best forms of house hacking.
This lead me to look at 2-4 unit apartment buildings which have many benefits. One of the biggest advantages is that you can buy a building with 4 units or less with a 30 year mortgage and only a 3.50% downpayment (FHA loan).
My first property taught me many lessons. These growing pains laid the foundation to make my future investments better. For example, renting to your friends and charging below market rents is a nice thing to do but its not a savvy business decision. I wanted my next property to provide STRONG cash flow regardless if I lived in the property or not.
Unfortunately, developers in Washington, D.C. also love 2-4 unit buildings. Why? Well, the condo market is hot and developers convert these apartment buildings into condos to make BIG BUCKS.
As you might expect, I lost out on a few multi unit buildings. I had a higher offer one property but lost to lower all cash offer. Many properties sold for more than $50k above the list price.
My 3.50% down, FHA financing offer was not attractive to many sellers; especially when there were all cash offers with no contingencies.
As a result, this lead me to expand my search to single family homes. This type of property can also provide options for house hacking and great investment returns.
The Rundown Row Home
Throughout my search, I also kept an eye on single family homes. There was an old rundown row home (in DC we call a townhouse a ‘row home’) in an up and coming neighborhood that was
way extremely overpriced.
The property had been listed for sale for several months. The seller also reduced the price three times and still could not sell the house.
Light bulbs and alarms were going off! I called my realtor to check out the house.
We went by the house the next day. And… well… the house did not show well. Four generations of a family were living in the house, there was junk EVERYWHERE and the property was not well maintained. Mold was clearly visible in the basement. There was no central air. The list goes on and on but I am not going to bore you with all the details… You get the idea…
Most people were scared away by such things. Which was… AWESOME! At least, for me it was awesome. The house was down right disgusting and I understood why no one wanted to buy it.
This was my diamond in the rough. Where others saw disgust, I saw beauty and opportunity. Also, I saw a seller with limited options and decided to make a lowball offer. The offer was accepted.
The Rehab Loan
The house was barely ‘livable’ and I planned to completely gut the entire place. Remember, I did not have a lot of cash so I needed to get creative.
Thankfully, I had a good mortgage broker (very important member to have on your real estate team). We used an FHA 203K loan which allowed me to use loan dollars (debt) to buy AND fix up the house. The best part? I only had to put 3.50% down.
This type of loan required a licensed general contractor (GC) and a budget for the renovations. The approved loan budget was $66,615.00 and there was a $9,992.00 contingency reserve fund for cost overruns. In total, the loan would provide up to $76,607.00 towards renovating the property.
The actual project would cost north of $100,000.00 which means I had needed to get creative and find a way to fund the difference. As a result, I opened three credit cards that provided zero interest for the first 12-18 months.
The renovation would take 3-4 months and I knew the house would provide strong cash flow once my future roommates moved in. The balance of the three credit cards peaked at around $25,000 in total. This debt was daunting to look at every month it essentially was an interest free loan; a loan that I paid back in 8 months without having to pay a single penny of interest.
Scope of Work
So… What kind of work did was needed? And you are probably wondering about the numbers (hang tight). Everything was from the 1970s (if not older). The house was originally 4 bedrooms and 1.5 bathrooms and I converted the place to 5 bedrooms and 2.5 bathrooms.
A few of the renovations include:
- All new electric (wiring, switches, lighting, outlets etc.) and a heavy up
- All new plumbing
- Installing an HVAC system
- Brand new kitchen, cabinets, countertops, and appliances
- New floors for all three levels
- 2.5 brand new bathrooms
- Removing all interior walls on the main floor to create an open floor plan
- All new windows
- Treating the basement for mold
- Creating an awesome fenced in back yard patio
The Hustle To Get It Done
I interviewed a half dozen general contractors. Most of the GCs gave me extremely highball offers and thought I was just ‘some dumb kid’ they could take advantage of.
Little did they know, I spent several years working/volunteering with Habitat for Humanity (amazing organization). I knew their pricing was unreasonable and at one point even told a guy to go fuck himself.
Some say, all is fair in love and war. I say, “all is fair in love and business is a war.”
Anyway, I about had it with GCs but my loan required that I have one. Thankfully, I found one guy who would GC the project, let me sub out the work to my guys, and do some of the work myself. The kicker was he got to collect a fee for doing almost nothing and had to sign off on the work.
Managing the rehab felt like bit of a full-time job in its self. Many mornings I was waking up at 5:00am, grabbing my cup of coffee and hitting the road so I could make it to Home Depot when they opened. I was constantly selecting or picking up materials for the house. Frequent phone calls and in-person meetings with contractors were necessary to manage the workflow.
So, the part y’all been waiting for.
Drum roll please…… Here are the numbers for Property #2.
My lowball offer of $400,000 was enough for me to get the property under contract. Additionally, this was almost $100,000 less than the list price at the time and about $200,000 less than the original price.
Purchase Price: $400,000.00
Total Loan: $469,500.00
Down payment: $17,028.49
Additional equity for rehab & carrying costs: ~$32,700.00
Total Equity Contributed: ~$49,750.00 (let’s call it $50,000.00 for analysis sake)
Monthly Rent: $4,000 (plus I live here for free. The place would easily rent for $4,500-$4,700 if I moved out).
My total investment costs of $50,000.00. The house easily rents for $4,500/month and my carrying costs are $2,408.57/month (my mortgage payment after I refinanced the construction loan). This means I will have $2,091.43/month ($25,097.16 annually; $19,097.16 while I live in the house) in cash flow after paying for principal, interest, taxes and insurance (PITI).
A basic return on investment (ROI) calculation:
$25,097 / $50,000 = 50.19% Return on Investment
This means I will recoup my cash invested in 1.99 years ($50,000 / $25,097)
This analysis is a bit 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. Thankfully, everything in the house is BRAND NEW…. Literally.
Buying a fixer-upper can be a lot of work, but it can also be very rewarding. My second property provided much stronger cash flow than my first home. I also found a way to eliminate my housing costs while getting PAID to live here. The property appraised for significantly more than what it cost to buy and fix up. A few months of hard work for a life time of cash flow seems well worth it.
What is your experience with renovating properties? Do you have a success story of your own? Or, perhaps you want to start rehabbing homes? Please comment.