How I Got Into Real Estate Investing
For most of my adult life, I have been reluctant to “invest” in real estate. Just to set the stage for this post, when I refer to a real estate investment, I’m not referring to purchasing property as your primary residence (unless you’re also renting out rooms or sections of your place). I purchased a place for me to live (i.e. my primary residence) at the age of 24, but this was not a pure investment even though I “hoped” and expected to make a profit when I was ready to upgrade in 7 years given prices only go up, right…unfortunately, this was not the case. A real estate investment is a property purchased with the intent to generate money from it via renting as a landlord, selling for a gain as a flipper, running it as a short-term rental (e.g. AirBnB, VRBO, etc.), etc.
A majority of people share my reluctance and never really look into getting into real estate investing. The common reasons are that it is too hard, it takes too much money, it’s a hassle being landlord, etc. Ironically, my grandmother was a real estate investor and should’ve been a model for me. That said, I distinctly recall her complaining about dealing with tenants, having to spend money fixing something tenants messed up, dealing with ridiculous city inspections. Consequently, I shied away from real estate investing (REI) as it seemed like a big hassle. I was so much against REI that I turned down an early opportunity from a co-worker at the time (more about him later) who was investing. I was more interested in stock investing.
So fast forward several years as I was searching for ways to increase wealth and gain financial independence, I started listening to BiggerPockets (BP) podcasts (https://www.biggerpockets.com), which profiles various guests in the REI space across a spectrum of investing strategies (e.g. rentals, flipping, wholesaling, note investing, etc.) or roles (e.g. agents, lenders, mortgage brokers). The theme I saw was that there were people REI and building passive income or successful real estate-related businesses that had achieved a level of freedom very few people have…freedom to spend your time doing what you want rather than needing to go to work. After listening to BP for a couple of months, I substantially increased my knowledge (and therefore comfortability) with REI. I joined a local REI networking group to further my education and to meet other local investors.
Within a year of listening to my first BP episode, I was visiting properties. I started looking locally but found out that my immediate market didn’t have sufficiently low purchase prices to produce the cash flows I was looking for. So with the help of a real estate agent, I started looking within a 40-minute radius of my home at investor markets with lower price points and better cash flows.
Eventually, I put in an offer for a two-family property for $90k that ended up falling through due to the concerns raised in the inspection report. I was venting to my investor friend (the same co-worker who presented me with my early opportunity that I turned down) and he casually mentioned that for the price I was willing to pay I could’ve bought multiple houses in where he invests. I paid attention because my friend was a fairly seasoned and successful investor. At the time, he had been investing for over 10 years and owned more than 180 doors and had a sizeable cash position based on his years of investing. He had become well known in our circles as the “Real Estate guy”.
Just to back up a little, a couple months before I put the offer in on the property, my friend had mentioned that he was looking to sell some of his multifamily properties to diversify into another region in the country. I, as the good friend I am, was trying to connect him with some of the contacts I had made who said they were looking for properties to buy. Unfortunately, none of those contacts never seemed to follow up on my recommendation to call my friend. Up to that point, I hadn’t considered purchasing anything from my friend as I was trying to not mix business and friendship.
In light of my frustration with the property that fell through, I began reviewing the properties my friend was looking to sell, which were located in PA over 2 hours away from my residence. My friend was very transparent and kept fairly detailed expenses on rents, property taxes, insurance and utility expenses, which he happily shared. Based on what I had learned on the BP podcast, I added additional reserve amounts: 10% for property taxes, 10% for vacancy, 10% for maintenance and 15% for capital expenditures (covers big ticket and long-term items such as roofs, furnaces, water heaters and windows). I projected a 25% downpayment with a 25-year amortization at a 5.5%.
After applying these assumptions, I looked to see how much profit (per unit/door and in total) there would be and ranked all his properties in order of profitability. Out of the roughly 20+ properties he had available, there were about three that provided a decent return of over 10%. I convinced my wife that this may be a good investment for our family and made an offer on a 7-unit brick multifamily property listed for $185k with the following characteristics:
~$3,880 in monthly gross rents with some units under market,
all separate utilities (except for sewer), which was helpful to minimize utility expenses and
~$800 bucks in cashflow after expenses and ~15% return on investment.
To sweeten the deal, my friend offered 5 years of free property management if we purchased at his listed price, which equated to a savings of over $20k over that period. So, agreed to the price and went under contract to purchase the property. There were several issues noted in the inspection, which my friend agreed to remediate. Another hiccup was that 2 of the 7 units tenants would be vacating by the time we would take ownership, which would mean two units not paying rent and additional expenses to make the units ready for next new tenants that we weren’t counting on needing so soon. Lastly, the insurance amount that I was using turned out to be grossly underestimated as we weren’t as fortunate to receive the rate my friend got on his property. That costs an additional ~$2500 per year. Ouch!
On the positive, we were able to put down 20% instead of 25%, but same 20 year amortization and 5.5% rate, which is set to reset every five years as commercial mortgages typically do. The 20% down payment was $37k. We also incurred an additional ~$5k in closing costs and attorney fees. When adding the ~$7k it took to rehab the two vacant units, we had invested roughly $50k into this property within the first month of ownership.
The two vacant units were rented for $650 a month within five weeks of taking ownership, up from $550 and $580. I expect a stable return on investment to be about 20% for the first five years, which should allow us to recoup our investment within 5 years as we expect rents to continue increasing as some of the existing tenants move and new tenants come in at a higher rent. When property management starts to kick in, I expect the net rent would still be higher than the original gross rents of $3,880 we purchased at. That’s a win!
These were a couple of key lessons I’ve learned as part of the process:
Most fears as they relate to real estate can be overcome with knowledge and processes. Listen to REI podcasts and talk and network with people who have successfully invested in real estate.
Run your numbers and be disciplined with your expenses. You should build in reserves whether that means setting aside a set amount or gradually saving a portion of rent (rather than taking it as profit) to account for vacancies, maintenance, capital expenditures and property management. Don’t take provided expenses at face value. Verify to the extent what YOUR expenses will be.
When analyzing properties, select properties where you have the ability to increase cashflow or value. In my case, I recognized that rents were under market and would add another ~$500 in monthly gross rents as those rents were gradually increased to market rents. That translates into a $6000 addition to gross rents, which equates to roughly $48k based on a 12.3% cap rate. The formula is $6,000/12.3% = ~$48k.
Understand your tenant base. I had all these grand ideas about automating rental collection and applying these high screening standards, which was intended to reduce late payments and get a good quality tenant. The majority of the potential tenant pool wouldn’t be able to meet those eligibility standards or have bank accounts. Eh…you live and you learn.
Keep things in perspective. Yes, unexpected things will come up to reduce your profits/cashflow from time to time; however, there will be positives to take the sting out of those losses. Over the long term, provided you did your homework, stuck to your numbers and used realistic assumptions, you’ll fare well.
We still continue to look for more properties; however, given my required rate of return and application of fairly conservative reserves, we haven’t found any additional properties that meet my criteria. That said, we are undeterred. This is a long game, people! Feel free to leave any comments, questions, etc. Even as a newbie investor, I’m happy to share what I’ve learned.