Starter Home
My entry into real estate could be called accidental. It started when I was fresh out of college, living back at home, working retail, and looking for an apartment with my friend. Basically, I was living the classic Millennial situation mid-Great Recession. It did not take long to realize that we were each going to pay between $800 and $1000 to live in a mediocre 2-bedroom apartment together.
At the time, I was making $15.75 per hour and had about $12,000 in the bank. That money had been set aside for years to pay for a Mustang. I was still driving my first car, a 2002 Ford Focus, which was approaching 10 years and 85,000 miles. On the positive side, I didn’t have any student loans and my dad had given me my car for my 16th birthday in 2005, so there was no car payment. I had never really thought much about credit. My dad handed me a credit card when I went off to school that I was responsible for paying (although he put money in the account to pay it out of my college fund he so generously provided).
One day mid-apartment-search, my mom suggested I buy a house. My 22-year-old brain ran through my current situation (see above paragraph) and did not conclude that buying a house was possible, but off to the bank we went. It turns out I had 3 credit cards: the one I used every month, a Sears credit card, and one other that now escapes me. My last 4 years of being in school full time counted as work history. Voila. I was approved for an FHA loan (putting 3.5% down) and about a $125,000 loan. Walking out of the bank, my mom turned to me and remarked that banks must be desperate for loans. I tended to agree.
I ended up buying a $125,000 livable fixer upper. I put $6,250 down and borrowed $6,250 from my parents at 0% (if Fifth Third ever asks, that was a gift) and got a 10% conventional loan with a 3.375% interest rate. By the time the place was furnished I was down to around $1,000. My payment, including principal, interest, taxes, insurance, and mortgage insurance was $740. So, I rented out one of the bedrooms for $500 and split utilities 50-50.
Later, I learned this is sometimes referred to as a “house hack,” where you rent out part of your house (or the other units in a multi-family property) and live for either very cheap, free, or at a profit.
Trading Up: The American Dream
Fast forward 5 years. My income had tripled. More importantly, I was in a relationship with my soul mate. He had moved in and valiantly made a 45-minute drive to and from work every day, while I traveled 10 minutes each way three times per week, working at home the other two. He parked his SUV in the driveway while mine (an Acura – it turns out a Mustang wasn’t practical) was housed in the garage. My now-husband’s clothes were in the second bedroom. Mine were split between the master and third bedroom. We bumped elbows in the master bathroom trying to share the single sink.
Suddenly, my little starter home felt that way: small. The location wasn’t quite right anymore, either. Off we went looking for a slightly larger home, with more closet space, two sinks in the master, a two-car garage, and easier access to Tampa. We found one after looking for about 60 days, and I was ready to buy that one and sell my first house. (Since we weren’t married, we didn’t think making a joint purchase of that magnitude was a good idea at the time, so I would purchase it.) My dad was annoyed that I was selling my starter home and said I should keep the first house and rent it out. His idea wasn’t a bad one, but I wanted to put 20% down this time so I didn’t have to pay private mortgage insurance, like I had for 6 years on the first house. He said he’d loan me money again. I’d long paid him back the $6,250 loan from before and now I was going to owe him $28,000.
Wow! We’re Landlords
It was now time to rent out the 3-bedroom, 2-bath, 1-car garage starter home. I got it inspected and changed the insurance to insurance for a rental property. I elected to forgo an umbrella policy. My uncle, now-husband, and I spent a day making small repairs in both houses after we moved. I listed the property on Zillow for rent and scheduled back-to-back appointments one Sunday afternoon. We had a couple of no-shows and then got very lucky. One man came looking at the place for rent for his grandparents. They had sold a business and were selling their home in Tampa. It was time for them to move to St. Pete to be closer to him and his mom (their daughter). He sent me the rental application and a bank statement. They had over $200,000 in the bank and that was good enough for me. I did not even do a background check. They signed a 1-year lease and moved in a week later.
Here are the numbers on that rental:
Gross Income: $1500 x 12 months = $18,000
Property Management: $0
Water Bills: $90 x 12 = $1,080
Expenses: $200 x 12 months = $2,400
Insurance: $1300
Taxes: $1700
Net income: $11,520
Cap rate = net income/purchase price: $11,520/$125,000 = 9.2%
Initially, this was a great investment. We learned a lot about managing a property and the benefits of owning an investment property. Once we dug a little deeper, though, that cap rate was a bit deceiving. The house was actually worth about $225,000. If you threw that purchase price into the cap rate calculation ($11,520/$225,000), the cap rate falls to 5.1%. Additionally, after a year the taxes went up quite a bit. Even with all that, we probably would have chosen to hold onto the property if the tenants had stayed.
As the term was ending on the 1-year lease, our tenants re-signed for another year. Unfortunately, a few months into that second lease, the husband was diagnosed with cancer and died soon after that. The wife moved in with her daughter. We listed the property for rent and didn’t get as many hits as before. We think this might have been due to the time of year, with November being a more difficult time to rent a place out than April.
Note that throughout this time, I read a dozen real estate books. I looked for properties to buy almost every day for a year and a half. I made offers occasionally, but I couldn’t compete with the cash offers.
Selling the Starter Home
We made the decision to list the property for sale in the new year for three reasons: 1) we could put the equity to better use (by offering cash instead of financing on new properties), 2) the property was empty, and 3) since it was our primary residence two of the last 5 years, we would not have to pay capital gains. My gut told me we needed to redo the kitchen to get a higher sales price and our realtor disagreed, so the property sat for two months while I paid about $1,000 in mortgage, escrow, and utilities. Plus, I was paying my dad back for the $28,000 borrowed at $400 per month. The house was originally listed north of $250,000, then sat on the market for three months with a couple of price decreases before it sold. In hindsight, we should have done the kitchen while it sat in November and December. During that time, the expenses went up to $1,400 per month because of the increased taxes. Upon selling, over $100,000 was deposited in my account.
I took a couple of months off real estate reading and researching while I planned our wedding. As our gift, my dad wiped out most of the rest of the money we owed him (equal to the amount the wedding would cost). We then had to pay for the wedding as we went, but that basically replaced the payments I had been making on the other house.
Getting Serious
Two months after our wedding and almost 6 months after the sale of my first house, I found a property listed on the MLS for $175,000. It was a duplex located on the south side of St. Pete. The south side in general is an up-and-coming area of the city. There are, however, pockets that are gentrifying more quickly than others. This duplex was not in a gentrifying area. It would have to cash flow now so we could hold it for at least 5 (if not 10) years. It would primarily be a long-term appreciation play, though.
The duplex consists of two 2-bedroom, 1-bathroom units each about 700 square feet. It is a block building built in 1960. Each unit has a covered parking spot (with more room on the street), its own locked laundry room in the carport area, and fenced yard. Both units have central AC and stone countertops too. The AC’s each have some years of life left. The roof, which is flat, has been patched, but was originally replaced in 2013 and has at least 10 years of life left.
We – since we’re married at this point – asked our realtor to make a verbal offer of $150,000 cash. The seller had listed the property himself and got back to our realtor quickly. There was one cash offer and a few offers that included financing. This told me that the hard-core investors weren’t interested at this price point, but we had over $200,000 sitting in the bank getting 1.9% and I’d been at this for almost 2 years. We upped the offer to $170,000, which was supposedly less than the cash offer they already had, but our terms were desirable: a shorter inspection period, no other contingencies, and a two-week close. They accepted.
Now we had some decisions to make, the biggest of which was whether to create an LLC and close in the business’s name. The main benefit of closing in an LLC is the asset protection. If a tenant sues us, they would only have access to the assets in the LLC (this one property). The downside is that it’s difficult to refinance in an LLC, and even if you do, it has to be a commercial loan. One somewhat-shady option would have been to close in our names, cash-out refinance the property, then quit claim it into an LLC. It would be within the bank’s rights to accelerate the loan, meaning they could call it due because their loan is with us and not the LLC. In the end, we decided the cash was best served in the property, so we created an LLC and closed in it.
We closed on the property last week. It’s in great shape, according to both our inspector and our insurance broker. We spent some time there this weekend fixing some small issues. Now, we’re working through the details of property management, rents, appliances, etc.
Here are the numbers we looked at when making our offer:
Gross Income Unit 1: $1,000 x 12 = $12,000 Unit 2: $1,000 x 12 = $12,000 Total: $24,000
Property Management: 10% of gross = $2,400
Lawn: 50 x 12 = $600
Expenses/capital expenditure savings: $200 x 12 months = $2,400 (estimated)
Insurance: $1,700
Taxes: $3,500 (estimated)
Net income: $13,400
Cap rate = net income/purchase price: $13,400/$170,000 = 7.9%
As you can see, the numbers look good pretty good. With the property being in a less-than-desirable area, we’re going to have someone else manage it. Our biggest questions now are how high delinquency, vacancy, and evictions will be.
Looking Ahead
I have a special interest in real estate and my husband sees my vision as well. We are planning to put $1,000 per month into a real estate investment account to purchase another property in a couple of years. In addition, we’re going to start putting $1,000 per month into a non-retirement brokerage account. Our retirement savings will continue to be 15-20% of our income.