Welcome back to our real estate journey! As you read in the last two blogs, we chose quite the investment for our first rental. So far, it has worked out, and kept us hungry for more property! With our revenue stabilizing on #1, we began searching for another opportunity. This blog will take you down that path and how we maybe found a slam-dunk opportunity with infinite return on equity!
Maybe it's perspective, but are they playing on a 8 ft hoop?
Methodology
Our search began with some basic parameters (aka “buy box”) for our next property. We tend to look only at B/C class quality, and are very picky on location (both within an hour from our home and in an appreciating/appealing neighborhood). After some searching and analysis, we decided to focus on smaller multi-family properties. Based on our financial analysis, we realized investing in single-family was not conducive to the best returns in our area. Keep in mind – this was Spring 2022, where interest rates were starting to climb, yet home prices were not dropping yet. With our criteria dialed in, we began analyzing deals.
The Property
Similarly to our first property, this property came to us through a broker’s other listing. In this case, there was a duplex that caught our eye – in one of our favorite neighborhoods and across the street from our old church where we did our marriage prep. Thinking this was a sign from God – okay, maybe not quite that dramatic – I reached out to the broker. After some back-and-forth, we quickly realized the seller was not going to bring his price down to work in a higher-rate lending environment. However, the broker recognized we were serious buyers and started sending properties he had listed – and even some off-market deals – for us to consider. After reviewing 10-15 his firm represented, we found a great potential deal. It was a quadplex, located in a nice, quiet neighborhood that was walkable to amenities. The maintenance, insurance, and taxes were low, and the rents were solid and below market. While it did not cash flow day 1, I projected that it would once we were able to turn over leases (within the year). Property condition overall was good, with a few necessary touch-ups in two units and a full renovation in another. Given restrictions on STR's in this city, we planned on continuing with LTR's for all units. We negotiated back and forth on price, and found a mutually-agreeable price and terms that worked for both parties.
The Financing
Now the best part – our infinite return on equity! I say this with a bit of smirk, as it’s true, but not really unique to this property. We financed through two loans, so we essentially did not have to put new money into the deal. The main loan was a 30-year commercial at 5.5%, 70% loan-to-value, 3 years fixed-rate, and no balloon payment. After year 3, the loan will go to market rate and can reset each year. The strategy is that we refinance once rates settle out, sell to upgrade to more units via 1031 exchange, or continue with the same loan. If any of those terms are foreign to you, please don’t hesitate to reach out and I would be glad to explain. You may ask why we went with a commercial loan vs. residential? While we could still qualify for a residential loan (possible with up to 4 units), the commercial rate we got was 1%-1.5% better than any residential rate we found at the time. Also, we were able to put 30% down vs. residential lenders quoting us 35-40%. We always have the option of refinancing to a residential loan down the line, which can be lower and could get us a 30-year fixed rate. Of course, if you can avoid putting more money down, you have more liquidity to invest in other properties down the line.
The remainder (30%) of the payment came from our line-of-credit on our first investment property. While this loan was at a higher rate (6.5%), it’s paying off now as even standard residential rates are around 7.5%. Plus, because it’s a line of credit, all of our investment proceeds are being applied against this loan, which reduces our interest payments and gives us the flexibility to borrow more in the future.
How It’s Going and Lessons Learned
As of today, the property is in great shape. We have turned over all lease agreements, and are now cash-flow-positive including reserves for capital maintenance. Therefore, with positive cash flow and no cash in the deal initially, we essentially have an infinite return on equity! Before I get too carried away, saying this can be misleading. The property is not unique in this fashion as we likely could have found another property that would cash flow soon, and the money tree otherwise known as our line of credit will stop bearing fruit as soon as we hit our loan limit. And, there's always a risk (highly unlikely, but possible), that the loan gets called back and we need to repay - which would force us to sell a property or refinance. All that said, we plan on continuing to use the line of credit to finance future deals (and have done so again, as you will hear about in the next blog).
While the deal went great overall, we are only nine months into owning it. What I can say as a lesson learned is to trust your judgment and be conservative in our projections. My assumptions on renovations were higher and on future rents were lower than reality. Being conservative may filter out some otherwise good deals, but it ensures that in challenging times like now that you are on solid ground.
Thank you for continuing with us on our investing adventure! Next blog will get into our most recent property, a 5-unit in a funky tourist town!
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