What holes are in my strategy?

Question

Hello!  This is only my second post on BP.  I am a new investor from NE Ohio.  My husband and I recently purchased/are waiting to close on our first duplex (50/50 rule applies perfectly, making $600/mo profit or 300 each and we already have tenants lined up to move in).

elow is a summary of what we are planning on doing for our 7-8 year investment strategy.  I am not looking for suggestions on changing our strategy (since we all have our own strategies) I am just curious to know what I can expect specifically as far as financing loopholes or issues we may encounter.  I will preface this my saying both my husband and I work full time and have stable incomes.  I was raised in a real estate family with my mom owning her own RE firm and my dad laying floors for a living and has rehabbed his own investment property once.  My husband and I gutted and rehabbed (biggest job was a new kitchen) our first home ourselves (aka no hired help) as well so we are not afraid of getting our hands dirty.

year 1 - buy a duplex with 600/mo profit

year 2 - buy second duplex with 600/mo profit

year 3 - buy a third duplex with 600/mo profit

year 4 - sell all properties and use the cash and equity from them for 25% down payment on a small apartment building (550-600k selling price) with 4800/mo profit (10-20 units depending on the rent)

year 5 - ride it out and save the profit

year 6 - ride it out and save the profit

year 7 - sell the apartment building and use the cash and equity as a 25% down payment on an apartment community (2-2.5M selling price) with 14-20k/mo profit

We chose duplexes for a specific reason starting out because of the market in our area makes them a better investment than single family homes.  It is very easy to find duplexes in our area with a solid 50/50 rule while single families don't make as much per unit.  Once we get our third property, my mom is going to be our property manager and my dad and uncle will be our maintenance department (unless we have to go out of the area to find a property in which case we will hire help).

Jeremiah B. · Answer

Hey Sarah,

I've seen this plan many times.  It's loosely based on a 'how to get to a million dollars in RE' book - though I can't recall the specific title.

Overall - I like this plan as a high level guide.  It sounds like you have a lot more details behind the scenes, and while these details should not directly guide your decisions, they can guide your plan which will in turn guide your decisions.

Still, I do see some gaps:

Philosophically, I'm real uneasy with selling real estate during the portfolio growth phase.  Real Estate is expensive to buy and sell, and when you're turning property every few years, you're paying a big premium to do so.  I figure 5% of the house value to buy it/get it ready and 10% to sell it... those are big expenses that often don't make sense if you're holding a property for less than 5 years.

On a related note, I would at least not buy in year 3.

This plan is heavily reliant upon the market staying strong.  If we hit another dip and prices drop, you lose your equity and can't move up.

It looks like you're assuming forced or natural appreciation of your duplexes.  That's an aggressive assumption.

Be wary of taxes when you sell!  In addition to the cap gains, I think the gross profits affect your gross income on your taxes - in turn impacting AMT and other taxes.

Based on scale, those are some cheap duplexes with huge cash flow assumptions.  Not to be rude, but you may want to check your numbers on those.  I'm happy to be a second pair of eyes if you like.

Based on scale, those look like some old duplexes.  As such, expect to be hit with large expenses while holding them (just part of the game, and maybe you built that in).

I would change the gap between apt #1 and apt #2 to match the loan terms on apt #1.  If you can get a 5-year loan, you should keep apt #1 for close to 5 years.

The plan is non-diversified.  At three times, you are putting all of your eggs in one basket.

I don't mean to beat up the plan - just wanted to highlight some areas I see as relevant.

Happy hunting.

Sarah Miller · Answer

Thanks Jeremiah, that is a very constructive reply.  I do agree the scale of my duplex plans look a little off.  Canton is a very odd market with very cheap taxes (under 1200/yr) but with some areas with higher rents than expected (ours is pulling 600/unit for rent).  We looked at many with this same income.  Canton has pockets of nice neighborhoods with many duplexes like this.  We are getting ours for 75k (market value of 90k).  I was thinking of leaving a year or so between one of the purchases or right before we 'trade up'. Just wasn't sure what would be best or if I should just let the market determine the timing of some of this activity..

Sarah Miller · Answer

Thanks for the replies.  So I prefaced this by referencing our stable jobs and income.  We will be using personal savings to purchase our first 3 properties.  I have a degree in finance and my MBA.  I do have all calculations planned out in a spreadsheet but I don't want to share it because its not supposed to be a detailed plan, just a reference for myself for what-ifs.

I do not have this drawn out specifically and I don't feel like I am doing myself a 'disservice' by having a plan. What I meant by 'don't want to change it' meant I didn't want people telling me our strategy is the wrong strategy completely and telling me to buy and flip or something.  I am looking for suggestions that's why I posted this.......

I have 'duplexes bringing in $600/mo as a benchmark because those types of properties are EVERYWHERE in our market.  We looked at almost 25 of them bringing in that profit before we picked out the one we have.  Minimum I am looking for a minimum of $200/mo profit per unit.

When we trade up the first time in year 4, the 25% is specifically coming from the sale of the 3 properties and the cash from the profits of those 3 properties.  I have calculated available down payment to be approx. $100k (all RE fees, taxes, and everything accounted for).

Lastly, again my PM is my mother.  She will be giving me a huge discount on her services since she already does it as part of her RE business.  I have her fees calculated into my spreadsheet and she is very flexible with what I will be paying her so her payment is not specifically determined yet.

Tim Lindstrom · Answer

The 50% rule is a rule of thumb that states over time, and across multiple properties, Expenses tend to average 50% of rental income (excluding mortgage payment).

While it is a good first pass to identify properties,  you will want to put real numbers into determining your cash flow.  Deduct for Insurance, Taxes, Capex, Maintenance, Vacancies, PM, etc.

Relying on Equity build-up in your Duplexes for the down payment on the Apartment complex could be problematic.  Not much equity build up after only 1-3 years.   How are you coming up with the downpayment for the Duplexes?  are you using the "profit" to pay down the mortgages, or you are saving it for Down payment on next property?

Brent Coombs · Answer

You will be doing yourselves a severe disservice if you have written that strategy into stone. Please also ask:- "I AM looking for suggestions on (improving) our strategy"!? Cheers...

Joe Villeneuve · Answer

Biggest hole (and there are many) I see is you make no mention of where the new money is coming from for each new duplex purchase.

Hole number two, you can't simply say "in year #?, I will buy another duplex making 600/month".  What if that duplex isn't available?  What if your available funding doesn't match the needed funding?

Year #4 issue is assuming the cash (profits?) will be enough to buy the specific multi-family that you are wanting to buy at the time of purchase.  Where is the 25% specifically coming from?  Profit, equity build up (not much in such a short period of time), etc...

Hole number ?, not calculating the cost of a PM on every property from the beginning.

Last one of the holes I saw immediately:  What you have here is a series of goals, but no plan of how to achieve them.  Also, there is no mention of any end goal in dollars and cents.  You may have one, but it wasn't mentioned.  It is very important to have one since that sets the target for all of your decisions moving forward, and is (should be) the basis for developing the actual plan.

What holes are in my strategy?

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