The best, and worst, I’ve done (with numbers)
You make your money when you buy. It’s an old saying in real estate, and I’ve always “known” it to be true… but now I REALLY know.
This is the story of both the best overall deal and my biggest failure so far in my career. Somehow the best and worst I’ve done are the same deal.
The numbers on this deal are incredible. It was a package deal of 17 properties with an asking price of $1,140,000. It consisted of 12 single family homes and 5 duplexes that needed a LOT of TLC. Only 8 of the 22 units had tenants and most of the vacant ones needed significant work before anyone could live in them.
I pulled out my best negotiation skills and worked it. After a lot of back and forth we eventually settled on a price of $790,000. The package appraised at $1,265,000. My net worth went up by nearly half a million dollars the day I signed the closing documents (Nov 2017).
BTW: Never Split the Difference is the best negotiating book I’ve read.
BUT WAIT, THERE’S MORE!!
Since I bought so far below appraised value, my bank only required 10% down of everything including closing costs. I had just sold a 6-unit building that net just enough to 1031 for the down payment on this portfolio. There was zero money out of my pocket to purchase the portfolio.
BUT WAIT, THERE’S MORE!!
Also (because of how far below the appraised value I purchased), I was able to write the contract as an $890,000 with a $100,000 credit at closing to help with the rehabs. It made no difference to seller since that still net them the same $790,000 we agreed upon. My bank escrowed the $100,000 credit and I made draws as work was completed.
To recap thus far: My net worth went up by $475k the day I closed, using a 1031 meant I didn’t have to come out of pocket for the ~$92k needed to close, and I was getting $100k of the rehab work paid for as part of the mortgage.
In June 2018, after all the ~$325,000 of work was completed and most of the units were rented out we did a cash out refinance. The new appraised value of the portfolio was $1,725,000! By spending $325k I added $460k in new value. Not counting closing costs or any carrying costs, my all total was $1,115,000. That’s $610,000 in equity in only 7 months.
The new loan was for $1,207,000. That mean I got back all the cash that went in and even factoring closing costs for the both loans and some early carrying costs I got to put ~$60,000 MORE cash in my pocket than I had before.
AND the portfolio brings in $19,000 a month in rent!! I should cash flow $2,500-$3,000 per month in the long run. That will be more in the short term since so much work was just done.
That’s the best deal numbers wise I’ve done. Tons of equity and net worth created. An extra $60,000 cash in my pocket tax free. And $30,000-$36,000 a year in cash flow. That’s an INFINITE CASH ON CASH RETURN since there’s no money in.
So how was this also the worst I’ve done???
Even though the numbers ended up being my best to date, this deal also incorporated my biggest failure to date. I initially thought the properties needed approximately $200,000 in work, but they ended at $325,000. Not only did I spend $125,000 more than expected, I spent that much more and didn’t even do one of the roughest, fully gutted units that was in one of the duplexes. My initial $200,000 was supposed cover that too so I was even much further off than $125,000!
How was I that far off?!?
Part of my negotiating was leveraging making it easy on the seller. The price was negotiated before I ever stepped foot inside any of the properties, and when I did go inside the properties I only got a few minutes in each one. But that still doesn’t account for the failure. I’ve purchased other properties in the same way, and have always still been accurate within a reasonable margin of error. However, a couple of these were more extensive renovations than I have typically done, and my ballparked numbers on those were way off.
It seemed that everything that could go wrong budget wise went wrong. The biggest project we had we knew was an old house that going to be a lot of work, but it just kept piling up. We ended up having to completely rebuild the roof and joists and rebuild 3 of the 4 outer walls… among many other things including about 1/3 of the house being an old railcar. We probably should have just leveled it and left it as an empty lot or built a larger place, but each time something new came up, enough money had already gone in that it made sense to keep going.
Then there was one unit that a hoarder had been in. I couldn’t see how bad everything actually was underneath all the trash and both bathrooms had to be completely gutted and rebuilt. On another property the city made us do some additional things that cost into five figures. Another unit we found mold underneath the house that had to mitigated to the tune of several thousand.
As we kept digging in, nearly every unit had something unforeseen come up. On several of them, correcting the unforeseen items made it worth it to go ahead and spend even more money on the property and take it to the next level to increase rents and therefore the value. In the end the combination of flat wrong estimating on my part, unforeseen issues, and changing/adding to the scope of work all added up to not being even close on my initial budget.
Sometimes things don’t go as planned. And sometimes they’re planned poorly. This was a perfect storm of both. The unforeseen issues and adapting the plan are acceptable overages. My massive failure on my estimation is not. It was way beyond a reasonable margin of error.
Lesson One: Don’t fail on what is in your control.
Lesson Two: You make your money when you buy.
Thank goodness I bought it so well that it could absorb my failure of estimating, the overages and changes to scope and still be my best investment to date!