Archive | 2013

2013 Recap – Adventures in Real Estate Investing

26 Dec

Season’s Greetings! As 2013 draws to a close, I wanted to take a moment to highlight some of my favorite rental realities from the past year:

Purchasing Our Second Duplex
We started January strong by doubling our rental empire. With a little planning and a lot of luck, we were able to buy a HomePath foreclosure at a great price. In retrospect, I wouldn’t specifically recommend buying a duplex with two immediate vacancies to fill, but it worked out alright in the end.

Duplex Interior

The Mystery of the Haunted Duplex
After some unexplained events, our tenant was reporting paranormal activity.

An update: our tenant borrowed an infrared camera, which is used to photograph wildlife – or in this case an active kindergartener who was keeping busy at night. And all issues disappeared completely while her daughter was spending the weekend at grandma’s – so worst case the daughter is haunted, which is officially outside of my obligations as a landlord. 😀

wildlife cam

Installing Staircase Handrails
It was a labor of love, but the new handrails came out great. We relied on the good graces of my in-law’s by occupying their garage (and sanding arms) for a few weekends straight.

handrails 3

Investment Property Bookkeeping
After leaving readers hanging since my original post in Nov. 2011, I finally finished documenting the rest of my bookkeeping process. This 3-part series discusses bank account organization and budgetingthe binder system, and monthly closings using Excel.

Binder

Here’s my 2013 binder after a year of managing 4 rentals, which has been upgraded to the 3″ variety – and even then it has become a little cumbersome to manage. I also added a 6th section for management company statements. Next year I’ll make a greater effort to fit more receipts on fewer pages.

Hiring a Property Management Company
After a few back-to-back vacancies wore me out, we hired a property management company to help out. The series includes the benefits, costs, selection criteria, and our ultimate decision.

Earn $1,000,000 in 13.3 Years with Investment Property
This BiggerPockets.com article provided the momentum we needed to kick-off our mortgage pre-payment efforts. I think people could dismiss this article on the surface as “too good to be true” but my own calculations support a lot of these assumptions. We’ve already trimmed a solid 7 months off the first loan and we’re just getting started.

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Our Investment Property’s 2012 Schedule E, Final Profit/Loss

18 Dec

From the department of things-I-meant-to-do-a-long-time-ago, I wanted to share the income and expenses portion of our 2012 Schedule E, which pertained to our first rental. In anticipation of the upcoming tax season, I’m looking forward to seeing how our numbers will change vs. last year.

taxes

(photo by 401(K) 2012)

This is basically the result of the bookkeeping worksheet, plus any category modifications made by our tax professional. I do wish I had more insight into what she changed and why, but by the time I was finally finished pulling everything together I didn’t care anymore.  🙂

Income Unit #1 Unit #2
Rents received $10,500 $10,500
Expenses Unit #1 Unit #2
 Advertising  $0  $0
Auto & Travel $159 $208
Cleaning & Maintenance $0 $0
Commissions $0 $0
Insurance $373 $373
Legal and other professional fees $200 $200
Management Fees $0 $0
Mortgage interest paid to banks, etc. $3,118 $3,118
Other interest $0 $0
Repairs $269 $899
Supplies $151 $151
Taxes $2,106 $2,106
Utilities $0 $32
Depreciation expense or depletion $2,843 $3,169
Other: HOA Dues $300 $300
Other: Office Expenses  $6  $12
Other: Transaction Fees $6 $15
Total Expenses $9,531 $10,583
Subtotal $969 -$83

Total rental real estate income or loss in 2012: $886

All that work and we only made $886?! Well, it’s a little more complicated than that. First, the depreciation on the property provided a tax shelter for 27% of the income – which gives me a realized net income closer to $6,500. Then imagine the potential of a mortgage-free property – which could happen in the next 5 to 22 years – and we’d net an additional $6,236 a year, almost doubling the income. Finally, consider the likely property appreciation and increase in rental rates 10-20 years from now and you start to grasp the real (albeit long-term) value of real estate investing.

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Home Mortgage Interest Deductions – Spending a Dollar to Save a Quarter?

11 Dec

Once in a blue moon somebody says they don’t pay down their mortgage because they’ll lose the interest deduction. There are certainly valid reasons to keep a mortgage around (like investing for higher returns), but a tax deduction is not one of them.

Sure, you’ll pay less in taxes, but you’ll pay more overall. I’ll break down the math below in hopes that I can save somebody out there a little money.

A quick caveat: “home mortgage interest deductions” apply to personal residences and 2nd homes, while the mortgage interest from investment properties is technically a business expense. I’m referring to both as interest deductions for simplicity sake.

Let’s imagine we have a 30-year fixed mortgage for $150,000 at a 4.5% interest rate. In the first year of the loan, we’ll pay $6,700 in interest – which we can claim as a deduction.

Deductions can be confusing because they do not offer 1-to-1 savings like a tax credit. For example, a $6,700 tax credit is worth $6,700 at tax time, but a $6,700 deduction is only worth a fraction of that amount. How much less depends on your tax bracket, and can be determined by the formula:

[Tax Rate] x [Deduction] = [Tax Savings]

Assuming a 25% tax bracket, that hypothetical deduction is worth $1,675 in tax savings. Viewed in a vacuum, this is fairly good news – until you consider that you paid $6,700 get it. Here’s how it works out against each tax bracket:

Tax Rate Interest Paid Tax Savings Net Loss
10% $6,700 $670 -$6,030
15% $6,700 $1,005 -$5,695
25% $6,700 $1,675 -$5,025
28% $6,700 $1,876 -$4,824
33% $6,700 $2,211 -$4,489
35% $6,700 $2,345 -$4,355
39.6% $6,700 $2,653 -$4,047

That’s why some refer to the mortgage interest deduction as spending a dollar to save a quarter. And lower your tax bracket, the greater your net loss.

If you have a home mortgage, then by all means take the tax deduction. But just realize that because your tax savings will always be a percent of interest paid, you aren’t coming out ahead vs. owning the property outright.

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Lease Renewal Letter with Reasons to Renew

5 Dec

Below is a recent letter we received from our apartment complex (who we rent from), with a heavier emphasis on discouraging move-out compared to our own tenant renewal letter. While the copy could use some fine-tuning, I found it an interesting approach and worth sharing.


 

Month DD, YYYY

^Rates and Lease terms subject to change.
Below rates are good through MM/DD/YY.

Street Address
Apartment #XX
City, ST Zip Code

Dear Name,

Our records indicate that your lease is due to expire at the end of Month DD, YYYY. At this time, we wish to reaffirm our commitment to you to provide outstanding service and to maintain your community as one in which you take great pride. We sincerely enjoy having you as a resident. It is our desire to make certain that you are happy in your apartment home and that you are receiving the best value for your rental dollars.

When considering your options please remember to keep the following in mind:

Moving is expensive! Costs include:

  • New application fees and deposits
  • Hiring movers
  • Transfer fees from utility providers
  • Taking time off from work

Moving is inconvenient!  Hassles include:

  • Lost mail (late fees from creditors)
  • Forwarding your mail
  • Packing and unpacking
  • Cost of moving $$$$$

Keeping this in mind we are pleased to offer you the following renewal options:

 12 Month Renewal Month-to-Month Market plus $250
$xxx $xxx

These rates do NOT include carport or pet rent. New rates are: $x monthly pet rent (per pet) & $x monthly carport (per carport).

The above rates will be effective Month DD, YYYY.

Please call or come by our office to discuss your renewal needs or circle your desired lease term and return this letter to our signing office. A copy of your renter’s insurance certificate carrying $100,000 liability coverage will be necessary when signing your renewal.

Please remember you MUST sign your new lease by January 15th. If you have not renewed your lease prior to the expiration, effective Month DD, YYYY, your lease will go Month-to-Month.

Please remember that should you decide to leave our community (and we certainly hope you do not), a 60-day advance written notice is required.

We appreciate your residency, and look forward to being of service to you in the future. Should you have any questions or concerns, please do not hesitate to contact us at (xxx) xxx-xxxx or email@email.com.

Kind regards,

Name

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Our Investment Property Mortgage Pre-Payment Plan

8 Nov

This month we’re taking the first steps towards paying down the mortgage debt on our rental properties. I’ve been looking forward to doing this for quite some time, but we’ve been focused on building a rainy day savings since purchasing our second property earlier this year.

To Pre-Pay or Not to Pre-Pay?
One financial philosophy discourages the pre-payment of low-interest mortgages if other investments offer higher returns. I agree with the math, but tend to share Dave Ramsey’s concern that it does not reflect the additional risk. If rental rates crash or a unit isn’t habitable for a period of time, I want a stronger financial cushion than what we have now – though a larger emergency fund could serve the same purpose. Truth be told, I get personal satisfaction knowing something is paid in full, so I’d even be willing to take a small financial hit for the peace of mind. I’m also inspired by my earlier calculations on how reinvesting cash flow affects return rate.

Our Mortgage Today
We’re tackling the smaller of the two loans for no better reason than we want to see progress faster. With no pre-payments, the $108,000 loan will cost $83,265 in interest for a total cost of $191,265 (~33% more than the $144,000 purchase price).

Our Mortgage Pay Off Strategy
Over time I’ve built a $10k savings reserve for rental property expenses and emergencies. Instead of following my usual balance sheet, each month I’ll replenish the reserve back to $10k (as needed), set aside HOA and income tax savings, and then apply any additional cash flow towards the mortgage. It should also provide an interesting perspective into what the positive cash flow actually is vs. what my balance sheet says it should be.

The amount will vary depending on income and expenses for any particular month – some months won’t have any pre-payment at all. My first extra payment was a meager $93.72. It doesn’t seem like much, but even small amounts make a noticeable difference for 30-year loans. Every $1.00 now saves $2.46 in interest – though this ratio will decrease over time because of the amortization schedule. Applying $93.72 every month moving forward reduces the mortgage by almost 7 1/2 years and saves $22,734 in interest.

prepay

Not too shabby, but I expect to do significantly better than that. This last month had some irregular expenses like a leasing fee and related costs to prepare the unit for the new tenant. I’ll be documenting my progress with the Vertex42 loan amortization schedule in Excel. I’m a big fan of this file because I can apply different extra payment amounts each month while it keeps a running total of time reduced and interest saved.

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BiggerPockets.com Article: Earn $1,000,000 in 13.3 Years with Investment Property

10 Sep

I wanted to share the article, “How to Create a Million Dollars of Wealth in 13.3 Years,” which was originally published on BiggerPockets.com.

The initial premise assumes you have $365k in liquid capital to invest, a message for investors who already have a nest egg but are frustrated with their returns in the stock market. Even if this doesn’t apply to your situation, bear with me – I’ll show you why the math is still relevant for smaller investors.

(photo by PT Money)


The $1,350,000 in 13.3 Years Plan

Imagine 9 properties valued at $150k each are purchased at 25% down using 15-year loans. At the end of the 15 years, you would have $1,350,000 in property ($985,500 gain). The author takes it a step further and applies the positive cash flow to the mortgage debt, decreasing the timeline to 13.3 years. By this logic, $364,500 is turned into $1,350,000 (3.7x initial investment) in 13.3 years – returning 20% per year on the initial investment.

Too Good to Be True?
I decided to test our actual numbers against his assumptions. The comparison isn’t apples-to-apples because we have 30-year loans, and I’d wager he’s using single-family homes (instead of duplexes) that have hired a property management company to outsource all repairs and make ready work.

Like his plan, both of our properties were purchased with 25% down:

  • Property #1: $45,350 down payment on a property valued at $181,350
  • Property #2: $36,000 down payment on a property valued at $144,000
  • Total: $81,350 down payment on a property valued at $325,350 (4x)

So in 30 years, we’d quadruple our investment – returning 10% per year on the initial investment. The returns are spread out over a longer timeline, which decreases the annualized return rate.

How Reinvesting Cash Flow Effects Return Rate
Next, I looked at the ramifications of accelerating our mortgage payments using the positive cash flow from both properties.

His assumptions maintain that nine $150,000 investment properties will yield a total of $8,100 in positive cash flow each year. Our 2 duplexes generate significantly more per property: $9,732 in combined cash flow each year. This is possible because of several factors I mentioned before: 30-year loans instead of 15, duplexes vs. single family, doing a lot of the repair and make ready work ourselves, and managing one of the properties on our own.

Let’s assume we begin applying the $811 in monthly positive cash flow to Property #1 starting Jan 2014 – that would result in our first free-and-clear property in November 2022, shrinking the 30 year loan to 11 years. Then we’d debt snowball the original $811 plus mortgage #1’s principal/interest payment of $699 to mortgage #2, resulting in a second free-and-clear property in Sept 2026 – finishing off that 30 year loan in 13.6 years.

Since we are purchasing as we go, instead of buying all of our properties at the same time (read: we don’t have a $365k nest egg either), our timelines are staggered a bit. Most of those 11 years for property #1 and 13.6 years for property #2 overlap, but property #1 did get a year and change head start. So total timeline is approximately 14.7 years.

By applying the cash flow to the mortgages, the same $81,350 has now turned into $325,350 worth of free-and-clear property in 14.7 years instead of 30 – returning 20% per year on the initial investment. Holy crud that’s cool.

Investment Property Gravy
If anything his financial estimates are conservative – that $1,350,000 doesn’t include appreciation or rent inflation. He does mention almost as an afterthought that that after his 13.3 year plan is complete, his 9 properties are now generating $11-12k/month after expenses. By comparison, our 2 paid off duplexes would generate about $2,050/month total ($24,600/year) after expenses.

I found his comparisons between real estate and stocks a little sugarcoated in respect to comparable effort – real estate is simply not as passive an investment as stocks. Then again, if I were to rely entirely on a property management company, I could see how there would be less hassle and cash flow, while still being satisfied with the returns of the 13.3 year plan.

The Takeaway
To the naysayers who prefer to focus on why this strategy wouldn’t work for them: dismissing the advice because you don’t have $365k to invest is missing the point. The author only uses 9 properties in the example because it generates a nice, round million dollar number for the article’s headline. There is nothing here that can’t be successfully applied to a smaller investment, even an “underwhelming couple of rentals” as the author phrases it.

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Tip: Matching Touch Up Paint to Existing Wall Color

29 Aug

We faced a dilemma recently when our rental property needed make ready work, including touch up paint. The color on the walls and trim when we purchased the property was an off-white color, which meant a pure white paint off the shelf would stick out like a sore thumb.

We couldn’t leave the walls in the condition they were in, we didn’t know what color the touch-up paint should be, and we didn’t want the expense of repainting the entire room (or unit) the same color.

I had observed a similar situation at work, where a painting crew literally cut out a square of the dry wall to determine a color match. I was less confident in my own wall patching ability.

My sister-in-law came up with a clever solution – remove a hidden section of trim and bring it to the store instead.  After searching inside closets, we couldn’t find a strip small or inconspicuous enough.  We did find a small door.

Door

Our git-r-done paint sample

The door belonged to a HVAC closet, which could be removed and replaced using standard door hinges. This particular door was not full sized, which made it easier to transport.

After some chuckles, The Home Depot paint department reconfigured their equipment to accept a door-sized color sample, determined the existing sheen, and created a quart of touch-up paint.  A test run was applied to the door and dried with a hair dryer before leaving the store – a perfect match!

Custom Color Match

We now have the codes required to order this color again in the future. If you aren’t the sort to file away paint codes, The Home Depot lets customers register custom colors under descriptive names (for example: duplex living room) that can be referenced later using a cell phone number.

I hope this tip saves somebody else unnecessary headache and expense!

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Property Management Company Decisions, Part 2

26 Aug

This is the 4th installment of my Property Management Company series. The previous posts focused on the benefits and costs, followed by our selection process and company decision.

A Change of Plans

Contrary to our original intent, we decided to hire a property management company for only for our second investment property, for several reasons:

  • Compared to our suburban property, our rural property is farther from us and generates less gross rent – which equates to cheaper property management fees. We’ll be exchanging more hassle reduction for less property management cost = better value.
  • Because this property has higher margins, we purchased with the understanding that we could afford a property management company.
  • A significant portion of the leasing fee pays the commission for the broker who brings the new tenant, which would be cost-effective for our rural property. However I believe it is likely wasteful for our suburban property, which rents quickly. Thus far I don’t see a lot of flexibility adjusting the leasing fee based on whether an MLS listing is necessary.
  • There is nothing stopping us from including the other property later. Until then, we’re going to beef up our rental emergency fund with that additional positive cash flow. So far we’ve been successful with our goal of paying all expenses directly from rental income, and we’d like to keep it that way.
  • By continuing to manage our first property, we can keep growing our own skills (and blog) at a slower learning curve.
  • We have difficulty finding independent contractors to work the rural location. The company we chose already manages other properties in the same area, and has an established network of plumbers, painters, etc.

Cost Breakdown

  • Management fee – $1,745 rent/mo. = $174.50 fee/mo. = $2,094 fee/year
  • Leasing fee – $537/vacancy = $1,074 assuming 2 vacancies
  • Releasing fee – $268.50/renewal = $537 assuming 2 renewals

At those costs, hiring a property management company will cost us between $2,362 – $3,168 a year depending on vacancies and renewals.

To put it into perspective against our balance sheet – that would subtract $197-$264 per month, leaving about $547-$614 in positive cash flow.


Price is what you pay. Value is what you get. – Warren Buffett

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Property Management Selection Criteria and Decision

22 Aug

This is the 3rd installment of my Property Management Company series. The previous posts focused on the benefits and costs of hiring a property management company. 

Comparing Property Management Companies

We focused on the criteria most important to us:

  • Cost – management fee, leasing fee, renewal fee
  • Ability to manage both rental property locations
  • Option to perform our own repairs to save costs
  • Positive reputation / trustworthiness
  • ACH rent payments & distributions

We started with the hardest factor – which property management companies will service both of our rental locations? Our second property is somewhat rural, so that eliminated many companies immediately. I also used their websites to make an initial judgment about the professionalism and legitimacy of each business. That left us with 3 serious contenders – we’ll call them Company A, B, and C.

Company C had the lowest management fee at 6%, and I liked that they had an in-house maintenance company to provide low-cost repairs compared to hiring independent contractors each time. However, Google reviews indicated 2.7 out of 5 stars (7 reviews) and highlighted a bad habit of yelling or hanging up on tenants in frustration. This was enough for me to eliminate them from consideration entirely.

Here is the high-level, side-by-side comparison of Company A & B:

 Criteria Company  A Company B
Management Fee 10% 7%
Leasing Fee 60% 75%
Renewal Fee 30% $150
Contract Details Contract cancellation
w/ 30 days notice
1 Year Lease
Req. Liability Insurance $100,000 $250,000
Reputation Google Reviews
4.8 stars out of 5
(21 reviews)
No online reviews

Our Decision

We chose Company A, the more expensive option. Our bet is that the higher cost and positive review history will result in a better experience and property care. I have heard enough first-hand property management horror stories to be wary of choosing the least expensive option, compounded by lack of 3rd party reviews for Company B.

At one point I asked Company B whether the broker commission was mandatory for our fast-renting property.  Could we split what we would have paid a 3rd party realtor between us instead? He replied:

“As a management company we have to be fair to all of our owners and treat each one the same as the others or risk having problems with the Texas Real Estate Commission.  We can’t waive the fee for one owner and not for others”

That doesn’t smell right to me – his own contract says he can change the commission amounts without notice, and will provide “up to 50%” of one month’s rent to the tenant’s broker.  I notice his leasing fee isn’t “up to 75%” – I suspect he only offers a finder’s fee when he needs to, and pockets the brokers fee the rest of the time. It really put a bad taste in my mouth about Company B’s trustworthiness.

In short, I’m willing to pay a premium to hire a company that I trust. Imagine I was deciding who would manage $150k in cash instead of $150k in property – this duplix is still a significant investment that needs to be managed well.


Trust your own instinct. Your mistakes might as well be your own, instead of someone else’s. -Billy Wilder

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The Costs of Hiring a Property Management Company

19 Aug

This is the 2nd installment of my Property Management Company series which details my selection process and hiring experience.

Now that I’ve explained the benefits of hiring a property management company, it is only fair that I lay out the costs too – in all its painful glory.

The actual numbers will vary by company, but I’ve included some ranges that I’ve personally encountered in my research. Property management companies make money at least a few different ways:

  1. Property Management Fee – 6%-10% of monthly rent
  2. Leasing Fee – 60%-100% of monthly rent
  3. Lease Renewal Fee – flat rate of $150-$250, or 20%-30% of monthly rent
  4. Late fees – keeps 50%-100% of late fees collected
  5. Interest – earned from holding security deposits in a trust account
  6. Evictions – the time to prepare and defend in court is included for some, but I’ve seen $25 an hour for others
  7. Other – the cost for mileage, copies, and other miscellaneous items is included for some, but passed along for others

For this hypothetical, I’m going to assume the most expensive company we’re considering for both of our properties. Your mileage may vary.

Property Management Fee (10%):

  • Property 1 – $1,745 rent/mo. = $174.50 fee/mo. = $2,095 fee/year
  • Property 2 – $1,905 rent/mo. = $190.50 fee/mo. = $2,286 fee/year
  • Total: $365 fee/mo. = $4,380 fee/year

Note: some companies don’t charge the property management fee when the unit is vacant, since a 6%-10% of monthly rent is $0.

Leasing Fee (60%):

  • Property 1 – $537 fee/vacancy
  • Property 2 – $597 fee/vacancy
  • Assuming 4 vacancies a year = $2,268 fee/year

The leasing fee is only applicable when there is a vacancy; this compensates the company for additional tasks like make ready work, MLS listings, photography, broker commission, showings, lease negotiations, and move-in coordination.

Lease Renewal Fee (30%):

  • Property 1 – $523 assuming 2 renewals/year
  • Property 2 – $571 assuming 2 renewals/year
  • Total (assuming 4 renewals) = $1,094 fee/year

The lease renewal fee is half the leasing fee. Needless to say, this will change the approach used when determining future rent increases. A renewal tenant has always been valuable, but is more so now.

Late Fees:

  • $50 initial fee + $10 for each additional day, paid by tenant

This isn’t much of an “expense” for me personally because we have yet to collect a penny in late fees. Most of our tenants pay automatically using eRentpayment.com.

Interest:

  • I hold $3,650 in security deposits when at full occupancy
  • At .75% interest I would have earned $27/year

The Bottom Line:

Looking at only the primary predictable costs: property management fee, leasing fee, and lease renewal fee – hiring a property management company for both properties will cost us between $5,475 – $6,649 a year depending on how vacancies and renewals shake out.  Ouch.

To put it into perspective against our most recent balance sheet –  that would subtract $456-$554 per month, leaving about $257-$355 in positive cash flow.


“Time is money says the proverb, but turn it around and you get a precious truth. Money is time.” -George Gissing

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