by James Miller
When I started in real estate I did what I am guessing most investors who are just starting out do. I started looking on the MLS for houses I thought would make good rental properties. I scoured the listings until I found a few gems and called the listing agents to go take a look.
The 1% rule
I was using the 1% rule to prescreen the potentials. I knew that as a rule of thumb the numbers on a rental property were likely to be close to working of you stick with homes that had a monthly rent that was roughly 1% of the purchase price. It is wrong to make the assumption that a deal that fits this criteria is an automatic winner, as many other factors such as vacancy, maintenance, what utilities are included, can vary greatly from property to property. It is a good tool to prescreen fast , then do cash flow analysis on the ones that look like winners. The rental type homes in the area we were looking to do business had values in the $80,000 to $120,000 at the time, while most rents fell in the range of $400 to maybe $800. This made it really tight to try to get a positive cash flow on a single family rental home. I decided that if I can find or create a two unit property, we can probably get enough in rent to cover the outgo with a bit left over for us.
The first property
We found an old house that had been used as a group home for the mentally handicapped. It was a three bedroom one bath house with a one bedroom apartment on back. We paid $104,000 for it. It took my partner and I a month to get the one bedroom apartment rentable and about a year of rehab to get the house side in rentable condition. We completely overfixed it, but it did look very nice when we were done. We were able to get $725 per month for the house side and $425 for the one bedroom side. The only utility we had to pay for was water, as it was going to be prohibitively expensive to split that so we could have the tenants pay it. With that income, our substantial improvement to the property, and after owning it for a year, we were able to refinance out the entire amount we had spent on repairs. After all was said and done, we ended up with about a $100 a month positive cash flow.
At least it went that way until the underground water line between the house and the curb stop broke. I always thought that my responsibility for the utilities started when the pipes met the basement wall, but after a few phone calls and $1500, I learned that wasn’t quite the case. In case you are wondering, no, Insurance doesn’t cover that type of thing either. Apparently a break like that is rare,but a great example of what can potentially happen. Thank you Mr.Murphy.
$1500 is more than a years worth of cash flow on that house. What was worse is that we had a 20% down payment buried in it property and we had just refinanced, so it was too late to try to wrap the cost of the repair into the loan.
This has been quite a few years ago, since then we have replace the furnace in the house along with several other things and are probably due for a water heater any day now.
In all fairness, this property has been good to us overall. We currently have a good set of tenants that pay on time and require little from us.
But how could this have been better?
First off, I was fishing in a pond that already had a lot of fishing poles in it.
By going to the MLS, I was looking at houses that everybody else knew were for sale. I was competing with everyone from the dead broke tire kickers and those that can pay all cash. Regardless of their financial situation, their interest continually help to keep prices at a “retail” level. In our first home I think I negotiated the seller down about $16,000. I thought I was pretty Savvy back then, as the standard home sold for a 3 to 6% discount from listing price. I got over a 10% discount. Today especially in this market you should be able to get a 30% to 50% or more discount off of the price at which a Real Estate Agent would list the property.
While we still search the MLS and we still work with Real estate Brokers and Agents, as part of our marketing we advertise for sellers to call us directly.
Most of our advertising is simple, classified ads and handmade fliers that read:
“Need to sell your home? I buy houses.” or “Investor looking to buy homes in [your area], any price, any condition”
While we talk to a lot of people where there is no deal. We do eventually find the gems; Seller’s who need to move quickly due to job relocation, or people who don’t want to, or can’t pay a 6% commission. Sellers who call us asking us to buy their home are usually sufficiently motivated. They aren’t listing their property to see what they can get for it. They don’t want to wait six months to see if it will sell.
They want to strike a deal now.
We are fishing in a pond that the rest of the world doesn’t know about. Sure the Sellers friends and family know, but they aren’t in the market, or it would have been sold to them. We are the only ones with a pole in the water. We can quickly pick the deal, be it price, terms or both, that we are looking for.
Back when I started if I had been advertising that I buy rental property. I probably would have come across a deal that would have required little of our cash, while unforeseen expenses can always occur. I would much rather have the $20,000 we put down on the hose sitting in an account ready for expenses like that, then buried in the property, completely inaccessible.
While I may not have gotten the exact house we started with, I could have found one like it that may have required none of our credit and little of our cash.
The key to finding great properties is simply to:
Get sellers to call you.
Advertise until they do, cherry pick the best deals from them and dismiss the rest.