Sometimes I over simplify my thoughts on investing in real estate…..
As a generalization, I have an ingrained rule of buying a rental property for $50k and selling it when it hits a valuation of $125k -with the thoughts of reinvesting the money into two more $50k properties. We are still able to purchase single family residential investment properties (although vary rare with multi-family investments) in our Charlotte, North Carolina real estate markets in this price range. I have found that when I stick to this philosophy (as simple as it sounds) I am able to achieve an every increasing cash flow stream while maintaining constant debt levels. I will also say that I believe in investing in neighborhoods that help drive Charlotte’s average appreciation rate.
Remember: targeting the above average appreciating neighborhoods in your city will help increase the power of compounding your rental investment both in the cash flow stream of rents paid but underlying market value too!
I must also add that it’s just not practical nor rational to constantly turn all of one’s real estate investment portfolio (especially when it consists of SFH’s and small MFH’s). Not to mention that one can pencil out how keeping their low maintenance, high rent appreciator’s, and correspondingly price appreciator’s makes sense. For the most part -my best performing rental investments have been my small multi-family’s in gentrifying neighborhoods where rent appreciation far outstrips the expense appreciation (such as property taxes).
So back around 2002, I found a distressed duplex (being run as a boarding house) publicly listed on the Realtor s MLS in one of my target markets of the plaza-midwood neighborhood. We’ll call it the Firth project. It was in a valley with a few other run down properties around it and vacant land. Traditionally, I don’t like investing in low lying properties as they tend to have less desirability (and thus lower value). However, I knew the neighborhood and felt that Firth would be a good long term rental investment as it’s street would improve as the others that surrounded it. Just a matter of time. So with a $70k purchase and $15k rehab, the Firth boarding house had been returned to its duplex condition with all the amenities that attract my ‘creative loafing’ target market. Unfortunately, I had somewhat missed the market by prematurely over estimating my ability to attract my ideal resident. I filled the units, had some turn, and basically hit my numbers knowing that over time that property would be on target for my market. However, by the time I hit my two year assessment period, I felt like this was not a property for my long term hold portfolio.
That was when I received a call from a developer that was buying the entire block. He wanted my property and was willing to pay a bit of a premium. We agreed to $125k and he agreed to giving me a 6 month window to find replacement property prior to our consummating the sale. This is the ideal situation when one is considering a 1031 tax free exchange with like kind real estate. In this case, I have investment property and was seeking to sell it and replace it with investment property via the 1031. Not only that -I had time as I was able to control the timing of the sale….
What did I find to replace the Firth Project?
Well when I knew I had a buyer, I started reconnecting with all my landlord and wholesaler contacts that may know of properties that might be available by nontraditional means (ie: not listed on MLS). At first, I did not find property that fit my parameters. In the coarse of my search, I contacted the seller of “Big Blue” (click on the Big Blue link to read my article “The Back End of a 1031 Tax Deferred Exchange…” article). When I bought Big Blue to perform another 1031 of mine, that seller was doing a 1031 too! We had cooperated at that time to assist each one in maintaining compliance with the rules. Guess what he said?! He mentioned that he was attempting to perform another 1031 and needed to sell a few more pieces in his residential rental portfolio and offered his list to choose from. Low and behold was a list containing two properties in one of my new emerging market neighborhoods (known as NoDa or the North Charlotte Arts District in Charlotte, North Carolina) where I felt high growth appreciation was in order. When I stated that I’d like to buy those two -his response was that I also had to buy the Fordham property. He obviously felt that I was picking two key pieces and required a ‘perceived’ lower performer in the mix….
Up until that point, I was a very methodical purchaser of real estate investments specifically targeting high growth rentals in gentrifying neighborhoods on the east side of Charlotte, North Carolina. Fordham was a lower income west side property that I wasn’t really interested in. However, it was the total price that made the deal worth doing. I had the Firth Property under contract to sell at $125k. I was able to pick these three replacement properties to complete my 1031 Tax Deferred Exchange for $125k. I was trading 2 units (in a duplex) providing total rents of $900 per month for 3 single family residential rentals providing $1,350 per month. Now, my duplex was freshly rehabbed and these places could use a good $7k to $15k per home in up-fits during a resident turnover to attract my target market and achieve market rents. Despite the work, I determined that this was a ‘no-brainer’ as those two homes in NoDa that I effectively bought for $42k a piece were easily worth $85k each then and would hit my $125k per home target in no time -not to mention attract my target tenant market of the creative loafer instantly versus what Firth was bringing in at the time.
In the Fall of 2004, I performed a 1031 via the Sale of the Firth Project and the purchase of these 3 single family residential rentals for the same price. Now to finish the equation, one should be asking if there was any debt? Yes there was. Fortunately, I was using a commercial line of credit. My bank simply allowed my swapping of the collateral so effectively my debt remained constant, costs minimized (due to modification versus obtaining new financing), and thus the payment (on the debt) remained the same while my monthly rents increased by $450 per month. From an expense standpoint, property taxes increased by @$120 per month so I achieved an effective increase in monthly cash flow of $330 per month.
Not a bad deal -huh?
Well it gets better. Let me mention two more points to the equation of this story. First off I learned a valuable lesson with what I term “Low Income Stable”.
What do I mean?
The Fordham property taught me a lesson that big money (primarily from buying right for cash flow) can be made with buying in the best neighborhoods of the lower income residential markets. I’m recommending neighborhoods that “DO NOT HAVE” dirt yards, dogs chained to trees, cars on blocks, nor a high concentration of men (or even scantily clad woman) walking the streets during work hours….. I’m talking about neighborhoods that primarily have single family homes with a pride of ownership feel -which by the way will point to a higher concentration of home ownership too. Yes -these neighborhoods actually do exist in the lower income strata! I would also recommend staying away from multi family in low income neighborhoods -especially for beginners. The cash flow looks great on paper -but that game is a whole other animal and worthy of an article by itself.
So what did I learn? You see I discovered that I bought Fordham with 26 year (husband and wife) residents in their 60’s. They loved ‘their home’ and took pride in it. They also understood the realities of life and that improvements could be made; however, must be made as needed and extras often may mean a higher rent. By the way, I inherited a 28 year resident in one of the NoDa homes too.
Their rent has gone from $400 to $465 per month since 04′ and they’ve received some nice improvements to their home. The husband has fallen ill this last year and has had trouble walking without a cane or walker… Fordham sits up on a hill and he no longer was capable of sitting out front to watch the day go by… My gift to him last year was a modest front deck/porch on which he can rest and enjoy the day as he remembers. The joy on his face was priceless. I feel that what comes around goes around as he has given me a gift too. You see Fordham has taught me the value of a home. The fact that their are target markets in all housing markets. That the best of the best families no matter what economic level their at -seek the best neighborhoods that they can afford and those neighborhoods that they are comfortable with. I’ve found that the lower economic families that work hard for a living haven’t succumbed to the ‘throw-away society mentality’ (as a generalization) that we often find in the middle and upper income echelons that we as landlords see with the rapid turnover and abuse found in homes more often than not these days. If the resident is happy with the neighborhood and home and there is a semblance of financial stability, I believe one has far greater odds of maintaining 5, 10, 15, 25, and 30+ year residents in low income stable neighborhoods.
Folks -these type of residents (long termers) will buy the homes for you and help further the compounding of wealth by dramatically decreasing your vacancy and turnover costs!!! Costs that can create a far greater drag on earnings than most understand.
What was the second point you ask!?!
Well as I mentioned two of those homes now have 30+ year residents in the place. Guess what I did with the third home (one of the NoDa homes) this past Fall of 2009? I sold it for $129.9k with a rough net of $116k after all expenses in less than 30 days on market. Not bad considering the pullback in our current real estate markets!
Do you see what else happened there? – I basically turned an $85k investment back in 2002 with the purchase of a duplex into TWO free & clear single family homes Seven Years Later with the sale of one of three homes that were purchased as replacement property of that duplex sale. Sure there’s some taxes involved. Sure there’s been some sweat too.
Do you realize how I sold that home for $129k during a down market! We have seen pricing pullbacks to 2003 to 2006 levels depending on the neighborhood in our Charlotte, North Carolina real estate market. The KEY: I bought it at the right price and didn’t over leverage it (I call it eating equity) giving me the ability to sell it.
This is something that everyone can do. Buy right, don’t over-leverage, manage it properly, defer taxes (Only when it makes sense) via a 1031, and let the power of compounding work its magic on your real estate investments over time.