Archive | June, 2014

An Unexpected Opportunity – We Bought a 3rd Duplex!

30 Jun

Big news – our rental empire just got a little bigger! We weren’t actively looking for another investment property, but we stumbled upon this little beauty and decided it was too good to pass up.

The Property
Compared to our investment property wish list, it checked off all the boxes:

  • Duplex – for easier cash flow and diversified vacancy risk
  • Expected monthly rent is at least 1% of purchase price (a.k.a. 1% Rule)
  • Newer construction – ideally built after 2000
  • Reasonable driving distance from where we live (trying for a 20-mile radius, but we’ve made exceptions before)

Both sides are rented with long-term tenants, but they are each paying significantly under market rent (~$400/month total). That means the 1% rule doesn’t apply just yet, but the long-term outlook is solid.

I also like that the duplex is in a 3rd city – just in case a certain part of town appreciates better or worse than others. We’re generally optimistic in the growth of the area – plenty of shopping, freeways, and the town is being considered for multiple industrial projects (*crossing fingers*).

Current Rent: $1,700 total
Market Rent: $2,050-$2,190 total
Purchase Price: $201,000
Current Rent-to-Purchase Ratio: 0.84%
Future Rent-to-Purchase Ratio: 1.02%-1.09%

A Calculated Risk
We found ourselves in a bidding war with 2 other buyers, both making cash offers. In order to be competitive with a mortgage, we paid slightly more than asking because we still saw value in the rent-to-purchase-price ratio. Additional funds were required to make up the small gap between appraisal price and purchase price.

We had the better part of a down payment already set aside for a single family home, so that was reallocated plus a little more from our personal savings. It was a bit of a financial stretch, but it worked out alright.

Down Payment: $61,500 (30.6%)
Mortgage (30 year fixed): $139,500

Next Steps

  • Get Units to Market Rent – We don’t have the luxury of keeping tenants significantly below market rate right now, so we’ll be upping the rent when leases expire – and dealing with the resulting vacancies.
  • Address Repairs – some minor issue were found during the inspection that can wait until we have a vacancy, but we don’t want to let them linger longer than we have to.
  • Replenish Savings – we like to have at least $5k per property set aside for a rainy day, so we need to beef up that account to $15,000 – ideally $20,000 if we can swing it.

Between the additional emergency savings, our recent make ready work, and this purchase, our mortgage prepayment efforts have come to a screeching halt. With all the moving parts, we feel a little financially exposed – so you might notice an uptick in money-related posts as I keep a closer eye on cash flow. 😉

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2013 Rental Profit/Loss Statement (Schedule E)

16 Jun

Now that taxes are behind us, I have a fresh look at our profit/loss statement for 2013. This version includes an additional duplex, so the interest of space each column is summarized by property instead of unit.

Income Duplex #1 Duplex #2
Rents received $23,703 $16,334
Expenses Duplex #1 Duplex #2
Advertising $29 $53
Auto & Travel $292 $1,364
Cleaning & Maintenance $553 $810
Insurance $772 $822
Legal and other professional fees $188 $187
Management Fees $0 $1,154
Mortgage interest paid to banks, etc. $6,134 $3,890
Repairs $996 $3,181
Supplies $524 $588
Taxes $4,154 $3,482
Utilities $58 $416
Depreciation expense or depletion $5,684 $4,284
Other: HOA Dues $600 $1,104
Other: Office Expenses $115 $233
Other: Transaction Fees $33 $15
Other: Meals $0 $2
Total Expenses $20,132 $21,585
Subtotal $3,571 $-5,251

Actual Cash Flow vs. Estimated
For tax purposes, we reported a passive activity loss of $1,680, compared to a net gain of $886 in 2012. In actuality, depreciation provided a tax shelter for 25% of the income, or almost $10k. This means actual cash flow is $8,288, which averages out to $690 per month.

Compared to our last balance sheet, we’ve not too far off from the $811/month cash flow estimate. I attribute most of the discrepancy to three things:

  • Purchase Expenses – 1-time costs incurred when buying duplex #2 – including the appraisal, inspection, etc.
  • First-Time Vacancies – I have a theory that the “first-time” vacancies for a unit are relatively expensive since we’re usually addressing deferred maintenance and getting things the way we like them. We had 3 in 2013, and expect another 3 in 2014 (whew!).

We’ve incorporated more property management fees in 2014, so I’ll be interested to see how well rent increases offset that additional expense. As long as we remain cash flow positive before depreciation, I’m happy, because I still believe the long-term benefits are more valuable than short-term cash flow.

Tax Implications
Generally, only passive income can be offset by passive losses, but there is an exception that allows up to $25,000 of the passive activity loss to be applied against other income. It begins to phase out depending on adjusted gross income, so we were only able to realize a $583 loss in 2013.

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Sending a Security Deposit Accounting Letter to Tenants

10 Jun

Security deposits are a necessity, but they also require proper documentation to keep everything on the up-and-up. According to the Texas Property Code, landlords must provide a refund of the security deposit (if any) and an itemized list of all deductions within 30 days of the property being surrendered.

Security Deposit Deduction

An important caveat: the tenant must provide a forwarding address (in writing). In absence of one, we send the letter to their old address using certified mail, return receipt requested. It isn’t common, but there have been tenants who intentionally “disappear” so that it is harder for us to collect for excessive damages. The post office will either forward it on to them, or we’ll have documentation showing delivery was attempted.

Below is the template for our security deposit accounting letter. There are two variations for the “Resulting Balance” section, depending on whether the deposit was sufficient to cover any deductions.

Today’s Date: [MM/DD/YYYY]

Tenant’s Name: [Name]
Rental Property Address: [Address]
Lease expiration date: [MM/DD/YYYY]
Move-out Date: [MM/DD/YYYY]

Dear [Name],

The purpose of this letter is to account for your security deposit as detailed below.

Credits Received
• Security Deposit – $x
• Itemize any additional credits – $x

Total Credits – $x

This is notice that the owner of the leased premises is deducting the following charges and expenses from your security deposit:
• Itemize individual deductions here – $x
• Itemize individual deductions here – $x
• Itemize individual deductions here – $x
• Itemize individual deductions here – $x
• Itemize individual deductions here – $x
• Itemize individual deductions here – $x

Total Deductions – $x

Resulting Balance
The balance due to resident of $x will be returned via [enter payment method].


If deductions exceed the deposit, use this text instead:

Resulting Balance
The balance due to Landlord of $x must be paid upon receipt of this statement.

Please make checks payable to [Name].

Mailing Address:
[City], [ST] [Zip Code]

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