Investing In Real Estate

On December 11th, 2008, I purchased another rental property, a duplex — nice that I finally got around to posting about it, I know. Sorry, I’ve been quite busy.

Anyway, I purchased the property from a real estate agent who had helped me with previous properties. This one, however, was his own personal property. He had owned it for more than 15 years. As I had been looking at a similar property on the same street as his was located, he mentioned to me that he wanted to sell his. It was the same exact physical property on the same street as I had already tried to buy but had been rebuffed by a different seller. The only difference was that my agent’s own personal property was more expensive than that of the other seller, and my agent’s property was in better condition and fully rented — definitely positives.

There were obviously a number of reasons why the agent would want to sell to me directly. First, he didn’t have to advertise it. Second, he knew that I already wanted to buy the same property a few houses down the street. Third, commissions for agents would not be an issue. Fourth, I would probably be a quick sell, and he already knew I could afford it.

So, we negotiated and agreed upon a price. I figured on a sale price of $85,000 or there about. The reason for that was because the property was generating about $1,010 in rental income monthly. For my area, I knew that an annual gross rent multiplier should be less than 8. This property came in at about 7.05, so it was a good deal in comparison with all of the other property in the area, as nothing else was under 8.

How did I figure out that the price was right? I took the total rent ($1,010 monthly) and multiplied it by 12 months. The total of $12,120 was the annual gross rent. I did simple division with the $12,120 and the $85,000 and found out that the multiplier was about 7.05. In comparison to all of the other properties in the area, this was fantastic. I would also add, for comparison sakes, that all properties were apples to apples comparisons; I was not comparing a property where one landlord paid all of the utilities with a property where the landlord paid no utilities, as that would introduce error into my formula.

Now, obviously, it wouldn’t have been a great deal if the property were to cost me tens of thousands of dollars to repair, or if there were other major problems with the property. That, however, was not the case. The property needs repairs of the lintels (those are the metal strips above windows in brick buildings that hold the brick up) and has a small retaining wall that is standing straight up and will eventually need repaired or rebuilt (they’re supposed to lean backwards against the earth to keep it back, not stand straight up).

I had a home inspection and a pest inspection. I went with the home inspector and walked around the building and asked him questions. I had an appraisal and a title search. I had an old survey as the property bounds were clearly marked.

As loans for multifamily properties nonowner occupied were far harder and more expensive to get than they were only six months ago, I went to a mortgage broker. The mortgage broker shopped around for me to find a loan that would be the best for me. He also kept his fees reasonable. I paid a 2% commission on the funds that he procured, but considering the market, it was worth it.

After talking to my mortgage broker, it was discovered that I was going to need 20% to buy. That was no problem, as that was what I was prepared to do. What I wasn’t prepared for was the rate, which was awful. After discussing options, the broker told me that if I put 25% down on the property, I could get a rate under 7%, fixed, for 30 years. I agreed to do so.

Unfortunately, 25% down would stretch me thin. It isn’t as though I’m made out money. No, I’m one of those people who make my money the old fashioned way: I work for it. Anyway, 25% percent down was more money than I had expected to pay, and because of that I needed to ensure that I negotiated a price with the seller that would make it possible for me to buy the property.

The seller and I finally agreed at $86,500. The seller would also give me 2% seller’s assistance, or $1,730 at the closing to help me pay my closing costs — that freed up my cash and enabled me to put 25% down. I also required the seller to give me all of the appliances that were in the property and also to provide a one year home warranty on the property — the warranty was somewhere between $600 and $700, I forget exactly.

After getting everything in order and waiting on the appraisal results, my broker called me to tell me that the appraiser had told him that this property was worth at least $95,000. “Did you know that?” my broker asked me. Yes, I knew that. I knew that 8 was a reasonable multiplier in my area. I knew that the seller had other reasons for wanting to sell quickly and he was also saving closing expenses so he was happy to sell to me at that price. I, too, was quite happy to buy for that price. I knew that the neighbor (next door) had sold the same building, though in better condition, for $115,000 two years prior. I knew that I was getting a deal.

The appraiser also told my mortgage broker to tell me that my rents were too low. I needed to raise my rent, in the opinion of the appraiser. That, I also knew. I figured that the property, at fair market rents, should be bringing in $1,110.

I’ll explain my rental philosophy in a later post. Suffice to say that I’m quite happy to have a profitable building that puts money into my pocket and already has tenants who are delighted to be paying too little rent.

Oh, but there is another thing to mention. Even though the building has positive cashflow already, I built wealth just by buying it. The building is clearly worth $95,000, not $86,500 – $1730 seller’s assitance and including appliances and a home warranty.

The bottom line was that fter paying ALL of the closing costs, putting the money down, and financing the rest, I added at least $3,000 of wealth to my net worth. Instead of buying and not making any money for the first two years or so as is common for many investors, I made money when I bought and I made money as soon as the first rent checks came.

And that, as they say, is why you make your money when you “buy.” It is absolutely true.

Oh, but one interesting side note. Talking to my neighbor — where I live, not near the property that I’m referencing here — he told me (and he’s never owned any rental properties) that now is a terrible time to get into real estate because the market is so bad. He said he hopes everything will work out for me, but that I missed my chance to get into real estate because the time to get into real estate was years ago when things were good.

Now, you did catch that I referenced that he never owned any rental real estate, right? Ok. Good.

Well, it is probably a bad time to be a speculator, I’ll say that, but it is a FANTASTIC time to get into income producing real estate because all of those people who bought too much house and lost it are now looking for places that they can afford to rent. That increases the supply of tenants, and that makes the landlord’s job easier. Also, real estate is not the same in all areas. You cannot buy into a declining area or one that is artificially pumped up — well, if you want a value.

What I mean is that the safe, measured, reasonable way to build wealth is what I just described. Be patient. Save your money. Pay down your debt. Wait for opportunities. Buy when everyone else is running around screaming that the world is going to end. That is how to invest in real estate.