How I used $38k to generate $17k per year with $26k per year potential

[Michael Mcguniess]

For years I have read about real estate investing but never had the funds to get the ball rolling. I finally had some extras cash laying around and needed to put it somewhere so I decided to pull the trigger and buy my first investment property.

The house that I found was 15 years old, had been on the market for 2 years and was valued around $280k. It was multiplex with a total square footage of around 5000. Upon further investigation I found out it was a foreclosure.

The bank was asking $150k. The house was not maintained at all and had many small issues such as leaky sinks, paint, deck issues, exterior doors, leaky gutters etc. I sent the bank a low ball offer of $75K. They responded with a counter offer of $100k, final offer. I accepted.

Once we were locked into contract I spent 6 hours with an inspector, looking over every square inch of the house. After confirming that there were no major structural issues I proceeded with the deal.

Being an investment property, the bank wanted 25% down ($25k). My closing cost were around $5k.

After closing I spent 8 weeks and $5k fixing everything in the first 2 units. In the meantime I started marketing the house with for rent signs, news paper ads, Craigslist, and several other internet sites. By the time the first two units were completed I had 2 well qualified grade A renters paying $725 each per month.

The third unit is currently being renovated with a total renovation cost of $3k. This unit will rent for $650 per month.

With $700 total in operating expenses and $2,100 per month coming in, this house will be generating $17k net income this year.

This deal gets even better. There is currently an integrated garage that is set up to be finished off. The total unfinished square footage is 1700sqft. I estimate that it will cost around $25k to finish off and will generate an additional $650 per month. I plan to use the rental income generated for 1.5 years to finish off the basement.

When it is all said and done, I will have a total of $38k of my own money and $25k of my renter’s money generating a whopping total net income of $26,600 per year!

I can see how real estate investing can be addicting!

[J Scott]

Originally posted by Michael Mcguniess:

This would make my expense ratio around 38%

Am I forgetting anything here?

Yup, lots of stuff...

What about capital costs (depending on the area and property, you'll likely spend at least $20,000 every 20 years to replace roofs, HVAC units, water heaters, etc)?

What about maintenance costs (fixing leaking toilets, etc)?

What about turnover costs (when a tenant leaves, you'll likely have to paint, replace some flooring, repair or replace cabinets/countertops, etc)?

What about utilities (when the units are empty, I assume you'll need to pay for these)?

Then there's lawn care, CPA/attorney costs, termite treatments, etc. And any extra surprises that you assume can't happen (like evictions).

In general, operating expenses plus vacancy and capital costs will fall somewhere in the 45-55% range (based on both my experiences, experiences of others I know, experiences of others I've heard about and national averages I've seen). This does *NOT* include debt service.

A lot of times here on BP, we talk about "the 50% rule," which is basically just shorthand for assuming all expenses will come in around 50% of gross rents. Could be more, could be less, but over a long period of ownership, it's a reasonable estimate.

So, if your gross rents are $33K/year, your NOI is likely somewhere in the $17K/year range. Subtract debt service (P&I), and I'm guessing your cash-flow is somewhere in the $12-14K range.

Your all-in costs to generate that $12-14K in cash-flow is your $38K investment plus the $25K to finish off the fourth unit, or a total of $63K.

That puts your cash-on-cash return at somewhere around 20%. Not a bad deal...