Upgrading Our Home … To a Duplex

We’re in the market for a new house/rental property.  A friend of ours passed along a community for us to look into.  I figured it’s worth showing our evaluation approach (OK, it’s my evaluation approach.  My wife is much more interested in the big picture rather than how the math is done).

The community is in Fulton, MD.  (Montgomery county for those of you that read my last post on growing counties in MD). Fulton is a planned community under construction.  It has a Town Center with a community area complete with exercise facilities, a pool, and common spaces.  There’s a mix of neighborhoods, ranging from apartments, condos, and townhouses to single family “estates”.  The community is in the southern part of Howard County MD, so it definitely checks our box for good schools.

In a previous post, I talked a bit more about our requirements.  So, I’ll talk more about the math of evaluating a mixed use rental property where we live in one part, and rent out another.  While we’re not explicitly looking for a duplex, that’s essentially how I’m approaching this topic. Here’s two of my favorite bloggers weighing in on general rental property evaluation: Afford Anything, and Financial Samurai.  Finally, here’s an article specifically about duplex investing on bigger pockets, one of the biggest real estate blogs out there.

Let’s start with cash flow.  For a typical owner un-occupied property, cash flow must be positive to even think about moving forward (rents must be higher than expected costs).  For your personal residence, total costs should be less than some % of your gross income.  For better or worse, we’re looking to blend the two.  See how this seems different: we’re looking to buy a place with a portion of the costs offset by a renter.  If it was a classic duplex, we’d likely want to “live for free” such that the renter covers not only their portion of the costs but 100% of ours as well.  Somewhere between “live for free” and rents subsidize our lifestyle is the trade space we’re looking into.

With that said, the math ends up being pretty straightforward.  Here’s a link to the spreadsheet I’ll be using to evaluate potential properties that fit into this kinda-sorta-duplex.

  1. We can estimate what an individual property will cost us to own and operate/maintain as our primary residence.
  2. We can estimate market price point for a rental property that looks like ours.
  3. We can subtract the two to find out what our net cost of living will be.

Next, appreciation.  Zero (this one is easy).  I never assume we’ll benefit from any appreciation on a rental property.  There’s some good reasons for this: real estate tends to appreciate with inflation.  This keeps the math simple when evaluating prospective properties, and keeps me conservative.

Finally, taxes.  I figure out what the estimated property taxes will be so I can factor them into cash flow.  The source foe the tax information is either based on the listing (if available) or the historical tax records…You know those are all public records, right?  Here’s the MD website.  And, here’s a link to an online public records search site so you could look start your search anywhere in the US.  After that, any deductions, expenses, etc are all gravy.  I would never advocate buying a rental property just because of the tax benefit.  The underlying investment needs to be sound first.
So, how does Fulton stand up?

Here’s a nice 4 br/2.5ba single family home in this area.  It’s not built yet, so there’s some opportunity to increase costs.  Let’s just assume we stick to the builders “vanilla” house and get all 2894 sqft for ~750k (yowza)!  Median rents for a 1br/1ba are ~$1,900/mo.  Let’s assume that the HOA will take kindly to us turning this into a duplex.  Then, let’s run the numbers based on the information in the listing:

Fulton MD 4br/2.5ba single family purchase and recurring financials

Let’s start with the biggest red number on the sheet: $168,747.75.  Say it with me: one hundred sixty eight thousand, seven hundred forty seven and seventy cents.  If we were to put 20% down, that’s the amount of cash we would need for the down payment and for estimated closing costs.  Ouch!  Next, that big number to the right of Monthly Recurring Costs: $5,612.19.  Every month for ~30 years we would owe, escrow, insure, or maintain this sum in order to afford this lovely home.

Now the good news.  A 1 br/1ba in this neighborhood is also a pricey affair.  I saw $1,900/mo as the nominal rent for such an apartment.  So long as we don’t mind neighbors downstairs indefinitely, we could end with a net monthly cost of $3,468.19.  That’s still a big number, but it helps to illustrate why I’m so keen on having a rental property baked into whatever becomes our next home.  Note that I took a wild guess to arrive at ~20k to convert part of the basement into a rental unit.  Here’s hoping that’s in the realm of reasonable!  Because these numbers are still pretty big for us, I’m leery of making this kind of commitment without doing some serious homework.

What do you think?  Would you ever accept a long-term rental situation in order to afford a big honkin’ house?  Is there another way to make this kind of move and keep it affordable?

Panning For Rental Property

MD new housing starts 2000-2011Gullgraver_1850_California

I know.  In today’s modern world, that’s a pretty goofy mental image: some old-timer crouching over a stream and sifting for that one gold nugget.  And yet, that’s kind of what we did when we looked for our first rental property.  I estimated that we spent ~200 hours screening properties to find The One.

Now that we’re officially on the hunt again, I figured I would detail the process we’ve used previously and are planning to use (and evolve) again.  Although, this time we’re looking for something a bit different.

So let’s start with the master plan:

  1. We have a 2br/2ba condo that is a pure investment property.
  2. We live in a 4br/2.5ba townhouse with a low enough cost structure and in a very desirable neighborhood that it should also make for a good rental.
  3. We want a single family house close to my wife’s employer, in a neighborhood with good public schools, and with a dedicated rental space.

So, the goal is to keep house #2, rent it out, and add a third rental to offset the cost of our next place.  As always, our general philosophy is buy and hold.  I guess that means we have some pretty specific requirements.  Perhaps some of these characteristics reflect others’:

  • “Class A” (lots of folks have different definitions; this is close enough for my purpose)
  • Good k-12 public schools (7+ on greatschools.org)
  • Close (<2 miles) to public transit (for us that means trains into DC)
  • Close (<1/2 miles) to a community park, ideally with running/biking trails
  • Because we’re looking to use part of our house as a rental (e.g. a big chunk of a finished basement), we need to be near our target tenants’ desired location, have a separate access, and have utilities available for the rental space
  • We’re looking to offer our tenants a studio or 1br space for between $750 and $1000 a month
  • Modest appreciation, at least keeping up with inflation.  We’re in the buy and hold space, so we’re not looking for anything that requires huge increases in value to make our investment pay off.

I’ve been doing some digging on this topic since I listened to a podcast by Paula Pant over at Afford Anything where she outlined some of the key factors she uses to invest in real estate:

  • Price to rent ratios
  • Building permits (new starts and renovations)
  • Job creation
  • Infrastructure development

Over the next few posts, I’d like to dig into some of these factors a bit as I’ll be exploring them in more depth as part of our own search.  I know there’s lots of discussion out there about “big” data.  My goal isn’t to make this into a science project, but I do believe there’s some useful data available for real estate investors, and it is not limited to subscription only sources.

Let’s start with an example.  We currently live in MD, and we’re looking for our next property in MD.  So, I started at Maryland’s open data site.  There’s a bunch of data sets to geek out with.

I’ll pick the new residential housing units data set to start.  In theory, a county with lots of growth, would be likely to offer a good opportunity.  Here’s a quick snapshot of the 24 MD counties, their total new residential housing starts from 2000 through 2011 (I couldn’t find a more recent data source).  I also included a line chart view of each county over that time period to illustrate any trends.

It looks like the top three counties from this time period were Montgomery, Prince George’s, and Anne Arundel.  On each of their trendlines, you can see upticks in the last 3-4 years.   Thinking back to that era, the 2005 BRAC was in full swing.  While it may have caused significant challenges around the country, the Ft. Meade area and it’s surrounding counties (those three) benefited from a significant influx of DOD related jobs.

What do you think?  Do new residential starts portend a good rental real estate market?  Will this trend continue in the future?  There’s always talk of the DC “bubble,” although with the current president working to limit federal government employees, the real estate sector may be in for another shake-up in this area.  Drop me a line and let me know.

One Year Anniversary (Of Being a Landlord)


How did that happen?

A friend of mine said that I would be surprised at how quickly time would pass once our rental property was up and running.  He was right.

It’s actually been 13+ months since our first tenant moved in on November 20 2015 with a six month lease.  She left after about 8 months, and we were able to find another tenant before the unit went vacant.  In August, we signed a year lease with our current tenant.

I last posted on our invested effort in September.  At that the, we had logged 585.5 hours.  All told, we’ve now put in 593 hours since I started keeping track.  In total, we’ve grossed $22,350.  That’s $37.69/hr for those of you keeping track at home.  Of course, that ignores the approximately 200 hours we spent screening.  But, I think it still beats working for a boss.

Rent is due again on the first.  There will be ups and downs…I hope it will be a very happy New Year for us and for you!

Investing With Leverage: Whose Money Is It Anyway?

As the year starts to wind down, I spent some time reviewing our financial books for the condo.  I was adding up the income earned to date, paying required expenses, and thinking about what distributions we should take.  Then, it struck me: Once rental payments started coming in, we haven’t spent any more of “our” money.  Effectively, our tenants have been paying our mortgage, covering condo fees, and building our maintenance reserves.

So, let’s explore how much of our actual cash we’ve spent. I’ll use some rounded numbers to help illustrate this.  We spent about $65k to acquire the condo and get it rented.  Now, that includes all of our closing costs and renovations as well as our initial equity.  Npw, let’s break things down a bit further:

  • Down payment ~40k
  • Closing costs ~10k
  • Renovation costs ~15k

The down payment is not really gone assuming we sell at some point.  It’s counted as part of our initial equity in the property. But that cash is currently tied up, and we cannot use it for any other purpose (More to come on that). If the condo appreciates at all (we sell it for more than we bought it), that will be considered an increase in our equity also known as a capital gain.

The 10k in closing costs are essentially gone.  The allowed ones went into our business expenses and will be helping us to offset current and some future income.  So, these were “real” expenses to us.

We also spent about 15 k to renovate.the unit. You could argue that we had to spend real money to pay for countertops, appliances, and a new HVAC system.  Or, you could consider them as increases in the base value of the property.  Where applicable, that’s what we dis.  The big items were counted as increases in our cost basis, and they are being depreciated over their IRS directed lifetimes. So, an accountant might say the money is not technically gone.

That means we bought an income generating asset that meets the 1% rule.  And we did it for a total of 10k of real expenses.

Baring any major disasters requiring cash above our reserves, every other nickel  from fixing the garbage disposal to putting in new floors (again), will be paid for with other peoples’ money .  Now that’s exciting!

So, we have this great problem…what do we do with the excess cash once we’ve fully funded our reserves?  Pay down the mortgage?  Save for rental property number two?  Invest in Wells Fargo?

Rental Operations: 10 Months Of “Normal”

hot_watch_smart_watch_from_kickstarter_01

Last post, I talked about the time we invested to get our first rental property up and running.  As landlords, my wife and I may have an odd perspective on our tenants.  They are, in fact, our customers.  Our goal is to keep them happy enough to continue to occupy our property while paying the rent on time and causing as little wear and tear on the unit itself.  We’ve had 100% occupancy for 10 whole months (yes, I know that’s hardly a world record).  Starting up a rental, I knew we would be spending time and energy to keep our customers happy.  I didn’t know exactly how much it would take, so I kept track of our hours.  Let’s take a closer look at what we’ve done and how much time it took…

Our first tenant came to us on the recommendation of a great friend.  Even better, the prospective tenant was in a pinch and needed a place quickly.  It was November 15, and our place was almost ready. Despite a few missed milestones from Home Depot in delivering appliances and counter tops, we thought we could accommodate this tenant if she went through our application process.   Things checked out, and we settled on a 6 month lease with the intent of signing a new 12 month lease in the late spring during peak rental season in our area.  Because our tenant came to us, we didn’t spend much time or effort to “sell” our unit.  Most of our time was spent developing our lease and application process.  All in all, we spent about 40 hours preparing our lease, showing the unit, and signing the lease with our tenant.  I should mention that we used this e-book, The Everything Lease Addendum: How-to For Landlords by Elizabeth Collective over at reluctantlandlord.net to help us write our lease, and it was one of the most helpful resources we’ve found as new landlords.

lease-prep-1

We spent about 40 hours in November of 2015 preparing our lease and application process.

Our first tenant moved in while the unit was still being renovated.  We never took photos of the empty interior space.

Doh! <Smacks forehead>

We remedied this oversight in August 2016.  But, it was one of the more frustrating parts of trying to rent our unit.  Note to aspiring landlords.  Take photos.  Take great photos. Take lots of great photos.   If you don’t have a decent camera (by the way, your cellphone is not a decent camera) and a basic understanding of photography, hire a real estate photographer.  It’s almost impossible to get web traffic without photos.  And, great photos will set your rental unit apart.  Hopefully, the images will serve you for many  years to come.

Our first tenant left after about 8 months; she needed a larger space to accommodate her kids who were moving back in with her after finishing college.  So in August, we needed to go through all the tenant screening steps in addition to creating the marketing materials for our unit.  In total, we spent 33 hours taking photos, building a virtual tour, and updating our lease. We showed the apartment 4 separate times (about 1/2 to 1 hour each time).  So, our total to get the unit re-rented in July/August was just under 40 hours.

lease-prep-2

About 40 hours to re-rent the unit

So, what happened in between?

Remember how everyone who told you not to become a landlord cited not wanting to fix toilets!?  I can tell you that we didn’t fix the toilet ourselves.  Within two months of leasing the unit, we had a pipe inside our floor/the unit below ours start leaking. We spent 7.5 hours coordinating/supervising/figuring out who would pay for the repair in January of 2016.

Book keeping and taxes occupied a bunch of time in 2016: about 14 hours in April went to tax preparation & research.

Remember how I said we’re making about $20/hour when you include all the searching and renovations?  Let’s take away those startup costs.  We’ll remove the ~200 hours we spent searching for a rental property.  And, let’s remove the 400 hours we spent renovating.  Now, for some fun math: $17,000 divided by 200 hours of operations.

Wait for it

$85/hr!

Not bad for a side hustle.  That works out to the hourly wage of a hand or foot model!

Hands.  Photo Credit: Alex Tran

Hands. Photo Credit: Alex Tran

Real Estate Investing: It’s Not That Passive, But It Beats Working For Your Boss.

tick-tock

600 hours.

And that’s just what I kept track of once we had an offer submitted.

I’m going to delve into what I’ve experienced during the purchase, renovations, and management of our first rental property over the 2 years we’ve been involved in it.  Keep in mind that we’re brand new to this business.  There’s a lot of startup activity we’ve gone through to get to this point (and probably some more to come).

the-hunt

Even this ole dog can get up and move if properly motivated. An income stream for life? Let’s go!

On The Hunt

Let’s start with some data that I don’t have.  If you’ve read any other post on this site, you can probably guess that I like data. During our search process, we digitally screened North of 150 properties. I made 2 spreadsheets for this task.  One mimics the Multiple listing service but adds a few more columns.  With this first tool, I could see all inputs from the listing and get a rough estimate of cash flow.  For properties that looked interesting, I would fill out a more detailed sheet.

Spreadsheet#2 calculated several measures of profitability (or loss) based on some more specific details.  I filled out upwards of 40 of these detailed sheets.

Finally, we went to see about 5 places.  We made offers on two.  We were outbid on the first.  And, the second took 10 months from the time we wrote our offer to the time we actually closed.  I would guess we spent about 200 hours screening for our rental in 2014. Let’s amend my total at the start of this post to 800 hours.

the-grab

Ah, the thrill of the chase…is so much better if you get the treat at the end.

The Grab

In October of 2015, we found a short sale: a 2 bed, 2 bath condo that priced about 25% below market.  We walked through the unit and saw lots of potential.  No major problems, just an interior badly in need of updating.  So, we put in an offer almost on the spot.  We made a list of the major things we needed to do with 3 point estimates to complete each.  And then we waited.  We filed contact extensions.  We waited some more.  In summer, we went on vacation and then updated our financing pre-approval.  We found out we were pregnant…and filed another contract extension.  About 8 months from the time we put in our offer things started moving.  Finally!  All told, we spent about 20-25 hrs between the end of 2014 and August 2015 keeping the contract alive.

keep-contract-alive

Now, there were lots more forms to fill out from the sellers’ bank.  We coordinated the appraisal and the inspection.  The bank finally set the closing date for September 30, and things went more smoothly.  We made a more detailed punch list of our renovation activities and a schedule.  That’s the time you see in September: about 63 hours of effort to get us through closing and actually into the unit on the 30th.

the-flip

Sometimes you get in over your head. Almost.

The Flip

You bought it, you broke it.  … Or something like that.  I admit that at times it felt like we were barely keeping our heads above water.  We were both working full-time and then trying to renovate our condo and get it on the market ASAP.  We spent almost $15,000 taking our condo from ugly builder’s white and grimy to a chic penthouse apartment in one of the most desirable locations in the area.  In addition to the cash and contractors’ efforts, it took us about 400 hours of our time spread out over 2 months.  We contracted for the counter top installation, HVAC replacement, and appliance haul away/install.  We did every other bit of paint, flooring, fixtures, cleaning, etc. by ourselves or with the help of one great friend.  But, we kept our vision firmly in front of us and pressed onward.

reno

You might think that cutting floor boards on a Saturday is beneath you.  Or that you’ve progressed beyond replacing the fill valves in a toilet tank.  If so, you’re right.  Go work in your cubicle for another 30 years before you can retire.

For everyone else, I can tell you that there is no more liberating feeling than swinging a hammer to build your own system.  To quote Sam at Financial Samurai, “don’t be too proud to be rich.”

the-meal

Worth IT.

The Aftermath

Now that things are up and running (we’re entering our 10th month of having the unit rented), we are enjoying the result of all our efforts.  I’ll follow-up with more detail in future posts.  For now, our aggregate has been about 100 hours of total effort to handle rental operations.  Despite the monthly ups and downs, we’ve brought in a gross income of over $17,000.  Divide that by 800 hours, and we’re making $20/hr!  That puts us squarely in the basic Human Resources and Gaming Supervisor categories. Woo hoo!

savor

Before you scoff, remember this is income that:

  • Comes in whether I’ve had a bad day at work or not.  In fact, it comes in whether or not I show up to work at all.
  • Will get better over time (both the hourly rate and the annual gross).
  • Currently has a mortgage associated with it, taking a big chunk of the gross income.  Someday it will be paid off, and then we’re that much closer to financial freedom.  Better still, someone else is paying our mortgage for us.  All of our cash outlays are complete!  More on that in another post too!
  • Allows us to learn about and claim a number of potential tax deductions/business expenses.

Now this is a seedling I am excited to nourish.  Grow little money tree, grow!

How To Be Needed

Working within Corporate America, I see many folks who are enamored with the idea that they are needed.  Their employees should not make decisions without consulting them.  Need to take a business trip? Get an approval.  Need to be reimbursed for said business trip?  Get an approval.  Have an idea for a better way of doing your work? Get an approval.  Want to start your next project?  Get an approval.

It sounds annoying but still innocuous, right?

Wrong.

All these approvals are “No” gates.  They’re just speed bumps on the way to someone at some level saying, “no”.  Just try taking action without approval though.  The entire system is set up to slow down and stop any action or change.

One of the reasons I’m so intrigued by real estate is the potential for passive income.  However, I’m not on the right path yet.  I’ve started setting up a system where I’m needed for everything.  And, it’s hard for me to change, even though I know I’m the only one in my way.

Let me explain.  I suffer from several personality flaws:

  1. I’m cheap
  2. I’m too curious about how things work
  3. I’m slow to trust
  4. Did I mention that I’m cheap?

To illustrate: we bought our condo, knowing that the interior needed to be completely refreshed.  My wife and I (and one of our good friends) spent almost 500 hours in 2 months tearing up carpeting, sanding, painting, installing flooring, cleaning, painting, installing trim, changing electrical outlets, painting, and managing 3 sets of contractors.  And that was on top of our day jobs.  We used contractors for the HVAC replacement, countertop installation, and appliance haul away and replacement.  Otherwise, it was all us.  I schlepped 800 sqft of flooring up 3 flights of stairs… hardly passive income.  That’s personality flaws 1 and 4 coming through.  We stretched our means to buy the property.  We knew going into the project that we needed to stick to our renovation budget, and that meant doing a lot of work ourselves.

Tim Ferriss’s Four Hour Work Week, Robert Kiosaki’s Rich Dad Poor Dad,  Paula at Afford Anything, Sam at Financial Samurai inspired us to act (affiliate links).  And I know they all started small, but I learned a new appreciation for the word hustle during this project.  Here’s the thing: they’ve all made it.  We’re just starting.  So, we don’t yet have systems in place to do the work for us.
When it came time to look for a tenant, we were hesitant to hire that out too.  We were curious to know who would be enjoying our new place.  (Yes, we thought of it in terms of “our”).  And that’s an unfortunate byproduct of personality defect number 2.  As much as we followed our newly established process for screening tenants, there was still some emotion associated with our selection.  In the end, things seem to have worked out OK.  And, we’re again faced with a new round of tenant screening.

We know every inch of our condo, having spent so much time renovating the place.  In our area, the renting process can be contracted out for roughly one month’s rent.  Each property can be managed (as a contract) for roughly 10% of the gross monthly rent.  Add both of those together, and our unit becomes significantly less profitable.  There’s the added uncertainty around a property manager: will they care about our property as much as we do? Will they present as good of a customer(tenant) interface as we will?  See personality defect#3 at work (Probably # 4 too)?  So, as much as we would like to have a better system in place, here’s what we we’re doing:

1. A pre-screening phone call.  We ask 7 questions of each person interested in seeing our unit.  The questions are:

  • Why are you moving?
  • When do you want to move in?
  • Are you OK with us conducting a background check as part of the application process?
  • Do you have residential and occupational references we can contact as part of the background check?
  • Is your income greater than 3x the monthly rent?
  • How many people/pets will be in the unit?
  • Have you ever been evicted?

2. Once we believe folks are good prospective tenants, we set up a time to show them the unit.  Note: I would love to transition this to an open house type of showing.

3. If they’re still interested, they fill out an application form and we proceed with background/reference/income checks.  To protect everyone involved, we’re using  TransUnion’s MySmartMove. We really like that our tenant’s personal information is protected: we don’t have to handle their data or worry about processing their application fees.  We get to see a quick summary of their current financial obligations, payment history, and a prospective tenant score.

 

    TransUnion’s Resident Score Range.

4. From there, we conduct rental history, employment, and income verification checks.  If everything checks out,

5. We review and sign the lease.  At last.

Whew!  What a process!  This being our first time screening tenants since the unit was finished, we had to invest a bit more effort to obtain interior photos, put up a detailed website, and prepare our listing on Zillow’s Rental Manager site.  We’ve spent 13.5 hours getting that all set up.  Hopefully, we’ll be able to re-use this for years to come.  In terms of screening tenants and showing the unit, we’ve spent 3.5 hours and showed the condo to 3 prospective tenants.  The third family submitted an application, and we’re processing it currently.  Keep your fingers crossed!

In a future post, I would like to revisit more of the non-recurring effort/ongoing maintenance effort and costs that we’ve experienced thus far.  From my homework in preparing to purchase this condo, I really struggled to find good data on these topics.

So, any ideas how we can systematize our rental property further and make it more of a passive income generating machine?