Residual Income Property Number 2
We bought rental property number 2 in 2014. This property was the first time we bought a rental to be a rental. You can read more about how we became accidental landlords here. As for our second property, color us crazy, but we bought it without ever seeing it in person! Initially, it was just to diversify our investments and savings. But purchasing this property soon taught us about the amazing concept of rental cash flow. Keep reading and we will tell you why this sight unseen purchase wasn’t as risky as it sounds. We will share the things we did to make this purchase a success and post our nitty gritty numbers!
In 2014 we were living in Virginia and we had been debt free for a couple of years. We were contributing to our retirement accounts and saving up a separate nest egg to do some other investing. The problem was we weren’t sure exactly what to invest in. We thought another rental property in our hometown might be a good way to diversify our investments and income.
Finding Our Next Investment Property
This part ended up being ridiculously easy. Mrs. College Rental began browsing Zillow, and a few days later found a house that looked promising. We did NOT expect to find anything so quickly, and it’s probably a bad idea to buy something when you haven’t been looking at a market very long. But, we had a basic idea of the market because we had grown up in the area. We didn’t have set criteria for an investment property (at this time), but this house immediately stood out from the other properties for sale. It also helped us to define what makes a good deal.
The property listing features:
• The house was undervalued compared to similar listings
• It was blocks from the local university
• Its commercial zoning allows four non-related people to live there
• It had four bedrooms (so it could fit the max number of students the zoning allowed)
• Judging from photographs the inside was dated, but in good condition
We arranged for someone to look at the house for us. (Keep reading for more on that). And once we talked to them about what they saw we decided to make an offer.
What We Did Well With This Deal
The seller was a lady who lived in the house for a long time and was looking to downsize. She priced the property based on what the house might sell for as a primary residence. Based on that we bought it for a fair price. But we looked at the house as an investment property. We saw that it would follow the 1% rule rented to a family (the house could command a monthly rent that was roughly 1% of the asking price). If rented to college students, monthly rent could be at least 1.33% of the asking price.
Cash Back at Closing Reduced Our Down Payment
We made an offer for $3,000 under asking price, contingent on getting financing. The seller accepted, and we did a conventional 20-year commercial loan with a 25% down payment. Our real estate agent did a great job of representing us. He got us $4000 back at closing – Win!! He did this by pointing out a basement wall needed repaired. The seller agreed to provide the $4000 to us at closing to go towards the cost of repairing the wall. The seller did not give us $4000 in cash. The $4000 went towards our down payment. In other words, we paid $4000 less than we expected at closing!
We still haven’t done the repair. Yes, the repairs need to be done. No, it isn’t so bad it’s urgent. So far, we have not been able to duplicate cash back at closing on other deals. But I hope we can! It was a great way to reduce the amount of cash we had to come up with to close on a property.
Completing the long-distance paper work to buy a property while we were hundreds of miles away was a greater pain than long distance land lording. We signed all the paperwork in front of a notary. Everything was mailed certified by the quickest method possible. This meant an extra trip to Fed EX and paying for a speedy overnight service!
Timing is Everything: Renting the Property ASAP
We were very eager to get a closing date and originally settled on a day in October. But we became concerned that the tenant applicant pool moving in November or December would be small. So, we moved the closing to September 26 in hopes the house would rent for October. A few days before closing we posted the house for rent. We made sure every applicant understood we were in the process of purchasing the home. Of course we did NOT sign a lease before we closed. However, we started reviewing applications before closing. That way, once we closed we were ready to quickly arrange showings.
It was too late in the season to rent to college kids – classes had already started. We conducted phone interviews with potential renters and selected a young married couple looking to start a family. On October 1st, they signed a lease beginning that day. Four days after closing!!!
Where We Went Out on a Limb
When you purchase rental property, you should always try to limit the amount of risk. We did this in several ways.
• The purchase price was low enough that we were confident we wouldn’t be in negative cash flow
• The property’s location was going to make it easy to rent
• Because it was a turnkey property we could start collecting rent ASAP
One major risk we did take was buying the house sight-unseen when we were using a good portion of our savings to buy it. A Donald Trump-type multi-millionaire real estate investor can easily absorb one bad purchase, but a small time investor with a small nest egg could really be set back by a bad purchase. Had the house unexpectedly ended up needing a lot of work before we could rent it, it would have been a bad financial blow.
We Leveraged Our Network
Here’s why buying this property didn’t feel risky to us. We had helpers onsite and we felt we could trust their experience to provide us with the information we needed to make a good decision. Mrs. College Rental’s parents have rental properties and live near this house. We asked them to check it out for us. They have developed their own criteria for what makes a good rental property. So they already knew what to look for when purchasing an income property.
We were confident in Mrs. College Rental’s parents’ judgment and sure we had a good deal. We also knew our relationship with Mrs. College Rental’s parents could suffer if we resented buying the house based on their evaluation. To prevent that outcome, we knew we had to take responsibility for the decision good or bad. It was our deal. Fortunately, all turned out well. A few months later we saw the house in person. Mrs. College Rental thought the house looked shabbier inside than Zillow’s pictures or her Mom conveyed. However, we are still thrilled with the purchase.
We do not recommend you or anyone buy a house sight-unseen like we did on this deal. This is just our story for this particular house, and in most cases buying sight unseen would be super risky, especially for a new investor. The buyer has to know what he/she is getting before pulling the trigger, or at least ready and able to accept the consequences if the purchase turns out poorly. If you do end up with a lemon only you are to blame. Buying a home is a major purchase. In the end – Good or Bad – the decision is ultimately the buyer’s responsibility. Anyone who looks at a house for you – a good friend, a relative, a local handyman, or a paid home inspector – is always providing their personal or professional opinion. But AGAIN, the buyer is always responsible for their purchase.
Think Ahead—Plan Your First Lease Term to Sync With Local Turnover
We really wanted this to be a college rental, but we rented to a family first. This got income coming in quickly. We signed a short lease that would be up the following spring when college students’ leases were also up.
At the end of their short lease the married couple moved out. We were able to rent the property to four college students. It has remained a college rental ever since. After the 1st year two of the original renters moved out, but those staying found new roommates. So far it has been easy to keep it fully occupied.
Specifics on Second Rental Property
The home has been a great rental because it is in good shape. I only made a few minor repairs to the porch and screen door to fix normal wear and tear. I also had to install a railing around the deck at the request of my insurance company. And we repaired a leaky sewer pipe in the basement. The interior is dated and it will need to be spruced up in the future. Overall the property is physically in good shape. The tenants are college guys, who haven’t complained about the dated interior. In return, we’ve kept the rent in the low-mid range. The house is within walking distance of the local university and the college bar area. Eventually we would like to update the interior and hopefully raise the rent a little.
Cash Return on Residual Income Property Number 2
Four college students rent this 4 bedroom, 1.5 bath property for $1000 per month. It cash flows $376 after expenses. The home has a full unfinished basement and attic and a nice front porch. There is also plenty of parking for the tenants and their friends.
Once we started cash flowing over $350 a month on this house, our eyes were opened to how profitable college rentals could be. We’d only cash flowed about $100 renting to the young family. Hmmm. Easy choice to rent this house to college students, huh.
Our cash on cash return (yearly return on our cash down for the property) was now 32%! Wow.
Here is a breakdown of our annual expenses and cash flow: