I own 2 free and clear rentals, what should I do next?

Question

Hello BP world and happy holidays!

I'm new to BP and have been listening to one youtube video on my commutes to and fro work for the past 2 months. I own 2 free and clear properties in south Texas ( one is a solid 3/2 worth about $50k and the other is a 3/1 worth maybe $30k ). The 3/2 rents for $500 and the 3/1 for $400.

My question is "If you were in my position, what would you do next?" Here's a quick back story because I want anyone out there willing to give this new BP some advice that is thanking everyone in advance.

I'm 33 and work full time and can devote about 5-7 hours per week into real estate - for now. I make a decent living however, I'm the only income earner now so I have decided that now is the time to put these properties to work.

Here are my questions or options. Once again, any future replies to my first post will be much appreciated.

My plan so far is to get some type of loan ( need advice) against the 3/2 $50k house to fix some cosmetic's and maybe add a 2nd bath to the $30k 3/1 home. This way I can raise the rent to $500. I got an estimate of $5000 for this to be completed. If whatever loan I went with was around $35k that would leave me with $29k to invest in my next purchase.

What should I do with the $29k left over?

Do a small quick cheap flip?

Down payment on a duplex or triplex?

I'm sure you all will need more specific information as you read this but for now, lets' start here.

Excited to be part of the BP family and ready to welcome your advice.

Carl Dean · Answer

@Hector Resendez My honest and professional opinion is this. I would try to liquidate those rentals unless you live close to them and can check up on them.   Sell them to an investor and use the capital to purchase a higher tier asset that will rent for over $1,000 a month.  This lower end assets will prove to be a second job in the long run and won't cash flow like you expect or appreciate well considering they are most likely in C- areas.  Not trying to tell you what you don't want to hear but unless you live close to these assets and can constantly check on them, building a c class portfolio will only cause headache. C class asset that are not in your back yard perform as expected less than 15% of the time. I would finance a better asset and take advantage of this amazing appreciation while you still can for the next few years. FAR less headache and a more conservative and realistic return. It's the safe and smart play if your goal is to build long term wealth.

Account Closed · Answer

I've seen a lot of investors who have a good thing going, pull excess cash out of a property with a loan, and then, get themselves in a bind because the debt service on it becomes burdensome when something changes, like the tenant moving out.

Not only that, but you can mess up the ratios on your balance sheet compromising your ability to get financing in the future.

One of the beautiful things about rental real estate is that your tenants build your equity for you.  Why compromise that?

Another beautiful thing is owning a property free and clear.  Talk about cash flow!

If you have run the numbers and the cost of the improvement is justified by a higher NOI, then it probably makes good business sense.  If it doesn't, then the improvement probably doesn't either.

I'm a big believer in every property standing on its own. I am also a believer in running each property like an individual business.

Borrow no more than you need to make any justifiable improvements. Use the positive cash flow to 1) build a reserve for unforeseen maintenance you will need to do on the property in the future (like replace a water heater or AC unit) and 2) use the excess cash flow to accelerate the retirement of the debt on the property.

Use the equity you have in the property to build your balance sheet, and use the strength of your balance sheet to borrow money to buy another property not the equity in another property.  That is the way the pros do it, and I can assure you, will favorably impress any lending institution.

Jerry W. · Answer

@Hector Resendez, welcome to BP bud.  I know very little about your local economy, and maybe @Carl Dean knows a lot more about your area, I don't know how close he lives to you.  Here is my advice for what it is worth.

If you have owned 2 rentals for some time you have learned a little about investing in real estate and renting houses.  Before you can make an informed decision you need to learn a LOT more about your local real estate market.  I find it hard to believe that you make much money off a house that rents for $400 but that may be possible where you are.  I do have some apartments that rent that low and one single bedroom house at $450.  You need to look at your local area.  How much are properties selling for in the various neighborhoods and what are they renting for?  Use the rental calculators here on BP, figure out your expenses for mortgage and insurance, your taxes, projected vacancies, maybe 10% of rent for repairs and 5% for cap ex.  Do the math what will make you money?  How much?  Will B class properties make you more or less money?  In my area A or B class properties do not cash flow.  I make the bulk of my money from C class properties.  What areas are getting appreciation in your area?  What areas are not?  You cannot make an informed investing decision without learning your market.  You need to run the numbers on each potential investment to see how it will do.  If you can get good cash flow then use your equity to buy several more properties.  If you cannot get much cash flow then look for a fixer up property to either fix and rent or flip to get more money for investing.  I had to start with run down properties and fix them up in order to be able to afford them.  I really look forward to buying my first rent ready place.  Anyway I know this may not be the advice you were thinking of, but it is critical in order to decide where to invest, then you figure how.  Good luck bud.

P.S. Read through the education section above it has loads of great information.

Crystal H. · Answer

All great advice. @Carl Dean what is considered an A,B and C class property? Is there a reference to this somewhere?

Hector Resendez · Answer

WOW! Thanks @Carl Dean  for the amazing feedback. What a platform this BP family is. I cannot thank everyone enough. Here is a little more info which might help me determine which route to go.

Both properties are located in Harlingen, TX ( South Texas ) and considered to be B class properties due to the low crime rate. There also both one street away from each other and my sister and brother live less than 2 miles away. They have always been my eyes and ears with the rentals. When my father passed away in 2009 he didn't leave a Will and I helped my mom make sure she kept those properties. I've been paying taxes on both every year since then. The 3/1 house has had the same tenants for 15 years and for some reason we have been lucky with them. Maybe $400-$500 on some random maintenance repairs but that's it. I think they have paid rent late a couple times too but since they have paid off that house multiple times I have let it slide.

My mom now leaves in Mexico 8 months out of the year so I rented the 3/2 out about 2 years ago and so far so good. I wouldn't want to sell these homes anytime soon just because a small part of me thinks maybe my mom might change her mind and want to leave in it again when she can't travel. ( yes I'm a mama's boy ) I agree with it being a challenge that I leave 9 hours away from where I own these properties and maybe if you all understand "MY WHY" it will make more sense.

I make about 90k a year. However, my wife use to make 60k per year and when she decided to stay home with our 2 year old and new 6 month old it changed everything. I have a nice brand new home, still owe on two cars for another 3 years, and I pretty much sad to admit but break even every month. So my goal is to earn some additional income buy putting these two properties to work for me.

Now, with that being said, what would you all do to earn an additional 1500-2000 cash-flow per month.

1. Should I invest in a small multifamily outside the Dallas area where it is more affordable.

2. Use the money for down payment on a flip?

3. Use the money for a down payment on two buy and holds?

Once again, thanks to everyone, I was like a kid on Christmas when I saw all the notifications this morning :)

Have a great Friday!

Warm regards,

Hector

Carl Dean · Answer

@Crystal H. there really is no set in stone matrix. Considering each housing market is different in values. For instance a C class asset in CA could cost up to 400k and C assets in Texas will be in the 50k range. Each market is different, however, within each market it is easier to gauge these separation in classes. I am actually getting ready to record an educational piece on this and will have it on YouTube soon but until then here are the factors that are considered.

• 1.Age of the property
• 2.Demographic location and crime statistics
• 3.Average household income
• 4.Geographic and economic growth projections
• 5.Annual appreciation forecast
• 6.Monthly Rental income
• 7.Amenities

And here is a break down based on the Texas market.

A-Class – These properties are the highest quality buildings in their market. They are generally newer builds (usually built within the last 20 years), they come with higher end finishes that attract higher income earning tenants and low vacancy rates. The areas have little to no crime and offer better school districts and higher appreciation to secure a more solid exit strategy. A-class homes are typically professionally managed and usually demand the highest rent with little or no deferred maintenance. A-class investments generally offer a 6-8% return and are typically $120,000 or more. If you are an investor looking for a truly passive investment, I recommend going the A-class route.

B-Class – These properties are one step down from the A-class. These properties are generally older than A-class properties and therefor more prone to standard maintenance issues. B-class investments also tend to have a more “blue collar” median income tenant. The B-class investment will have your basic finishes and a low to medium crime rate. B-class investments tend to appreciate very little and generally offer an 8-11% NET yield. These B class investments range in price from $65,000-$100,000. Due to the higher risk involved with these type of properties you are usually able to acquire B-class investments in at a lower price point than your typical A class investment.

C-class- These properties are typically much older than 20 years and are located in less than desirable areas. These properties are generally in need of renovation or have been renovated very inexpensively. As a result C-class investments tend to have the lowest rental rates in the market. C-class properties have the highest rate of vacancy, late & missed rental payments and deferred maintenance. They are the most difficult properties to maintain steady cash flow and are not a good option for an investor who expects a passive investment. These investments are very “hands on”, and typically in high crime areas. It is also very rare that you would find a professional management company to manage these type of investments successfully. C-class investments generally offer a 12% or higher return but based on the elevated risk involved, these numbers are tough to achieve and even harder to maintain.

Hope this helps.

Carlos Altamirano · Answer

I would spend a hundred bucks or so getting educated. I am not too sure if you mentioned you have done this  or have a clear idea of how to analyze an opportunity, no matter how close or far that is. Some great authors that write about real estate are Garret Sutton, Tom Wheelwright and the Real Book or Real Estate by Robert Kiyosaki. Having said that, get an equity line of credit on those rentals to get more rentals that you are comfortable with

Willem Young · Answer

@Hector Resendez

I agree with @Daniel Sprague.  Just make sure when you calculate out the entire P & L and the opportunity you keep enough room in your numbers for maintenance so you don't ever find yourself too short to keep up with your property.

Daniel Sprague · Answer

If you are looking to use the equity from the two current rentals, and do not want to sell them i would suggest a commercial loan where the bank simply puts a lien against the properties you already own, say for the $30,000.  Then use that as an equity down payment on a $100,000 or so duplex or triplex.

I enjoy using these "equity grabs" for a couple of reasons:

1. I have no plans of selling any of them my current rentals as they were all bought correctly, and they all cash flow sufficiently (i realize this can change quickly but my bank will work with me)

2. it allows me to do 100% financing on my deals which means i am maximizing leverage with OPM (other peoples money) therefore your ROI is technically infinate.

3. i do not have to pay interest on an equity grab, it is just a lien against the property.  Now, obviously you pay more in interest on the new property since you are not putting money down, but in my opinion this is a way to greatly accelerate your trajectory with real estate, if that is what you are looking to do.

This may not be what you are looking to do but it has worked for me so i thought i would share.

Thanks and good luck

I own 2 free and clear rentals, what should I do next?

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