There’s a company in Virginia that offers $0 closing costs for refinances. That applies to personal residences being refinanced. They still cover most of the closing costs associated with investment properties, but there’s an investment property fee that we need to pay. They also have a fee associated with taking cash out as part of the refinance. Another stipulation is that the new loan has to be at least $100,000 after the refinance. I spoke of the initial details in a post last month, and now I can discuss the details and results of the refinance.
We first talked about taking $50,000 out for each Property2 and Property3. Then we added Property8 into the refinance. The opportunity to use this company to refinance a loan is only available in Virginia. We decided it was best to pay off both Winchester, KY houses instead of just one. The appraisals came back higher than anticipated, so we decided to increase each loan to the max amount of 60% loan to value ratio.
Note the change in value on these houses. We’ve owned 2 and 3 for 5.5 years, and we’ve owned 8 for just over 4 years. The value of these houses have more than doubled in that time, with minimal effort on our part, all the while having a tenant cover the mortgage and maintenance costs.
CASH FLOW
At first, the thought of going from $60-70k to $123k-138k worth of loan payments is an overwhelming sight. I’m a visual person, so I broke it down to a place where I felt comfortable with this move. That comfort is in the cash flow.
With the $190k cashed out, we paid off two loans. Due to a huge issue with our insurance payments, our escrow accounts were substantially negative. Therefore, the payoff required making the escrow accounts whole. Our bank that held these loans used to have such a great online system. Through the course of 3 updates, they killed it. They took away loan history in an easy-to-view format, they took away options to make principal-only payments same day, and they removed the payoff request concept (they had made it difficult in the last update by making it a request that you would have emailed to you, and then in this update, they took it away all together, forcing me to call an automated system that just kept telling me about covid-relief options….. I’m not bitter).
After these two loans were paid off, we were left with just under $50k in cash. This will be used for a downpayment and closing costs on a new rental property, which is a search underway.
To the cash flow part – the removal of those two loan payments was worth $1,184.62. The three properties refinanced had their mortgage payments increase by $1,117.70. The change in my monthly cash flow is now $67 more than I had been netting. I’ll note that the cash flow also involves one of the houses going from a 20 year mortgage to a 15 year mortgage, which increases the monthly payment disproportionately to just an interest rate change.
That’s the black and white, month-to-month change; there are some caveats though. Previously, Property2 hadn’t been escrowed, so I was paying that on my own. Now, with the two houses paid off, I’ll need to pay those previously-escrowed costs on my own. When I factor those details in, my annual cash flow actually decreases, and my out of pocket costs for the year increase by about $700.
While the monthly cash flow increase of $67 isn’t a drastic difference, the fact that we have cash left over and $50k of the new loan balance will be used to create more cash flow with the purchase of a new rental-producing property benefits our portfolio.
MANAGING BILLS IMPLICATION
With the payoff of the two houses in Winchester, KY, I now am responsible for paying the taxes and insurance on the properties (instead of escrow). In October, Kentucky sends the owner as of January 1 of that year the tax bills (meaning, if you own the property on January 1, 2020, then you receive the tax bill on October 15, 2020). It’s frustrating. It’s on the old owner to forward to the new owner if there was a sale during that year. They also send it to the owner even if there’s a mortgage with escrow. So every year, I need to call the mortgage company and make sure they received the bill themselves. Even though I need to stay on top of paying the taxes and insurances now that there’s no escrow, it’ll actually save me time because I won’t have to call these companies to make sure they received the current tax bill. Oh! They also give an incentive for paying early, so I’m always worried that the escrow payment won’t be released to give me that incentive and that they’ll focus on the due date.
Property2 had not been escrowed. There was a screw up in the paperwork that I capitalized on because I don’t like that escrow keeps my money tied up without any incentive to me. Well, Mr. ODA thought I had said I preferred things to be escrowed, but I don’t remember ever definitively saying that. I may have said a comment like “gosh, it’s nice to not have to remember to pay this bill,” but not that I’d prefer to see my monthly payment go up each year because of an escrow reanalysis (I feel like I wrote a post about this……). Property 2 is now escrowed through the refinance.
I removed two tax payments to Virginia and one insurance payment, but then I added back 4 tax payments and 1 insurance payment for each year. The one insurance payment for two properties is what caused me to have an escrow fiasco, so now we’ll avoid that mess by paying it ourselves. Plus, when we pay the insurance ourselves, it can go on a credit card where we earn cash rewards.
SUMMARY
In 4-5 years, we’ve more than doubled the value of these houses that we purchased. While that isn’t immediate cash in our pockets, that’s a substantial increase in our portfolio’s net worth. That increase in value costs us more in taxes in each year, but it also provided us with this opportunity to refinance and take cash out to purchase another property. With two houses paid off, we have also increased our monthly cash flow by about $67. On top of all the near-term gains for this transaction, there’s also the interest payment gains we received. All 3 loans dropped their interest rate, and one loan transitioned to a 15 year loan from a 20 year loan, which decreases the interest owed as well.
There’s a company in Virginia that advertises no-closing-cost-refinances. If it’s your personal residence, then this holds true. For investment properties, there are some closing costs, but it’s cheaper than the usual refinance. We used them for two other loans – one at the beginning of the pandemic when we signed the paperwork in a tent in the parking lot, and another where we signed the paperwork at our kitchen table in Kentucky with a traveling notary (that’s a thing!).
There was a threshold requirement in order to qualify for this refinance, and that was the new loan had to be at least $100,000. Only 2 of our houses had a loan originated for over $100k originally, so that limited our abilities.
Mr. ODA came to me and said he wanted to do a cash-out-refinance. This company had changed their policy, and they’d allow a cash-out-refinance to get us to the 100k threshold. The first two Virginia houses we purchased (2016) had balances of about 70k and 60k. We had enough equity in these houses that we could take a substantial amount out in the refinance, but Mr. ODA chose $50k each.
Here’s a run through of the thought process on how to do this and why it’s a benefit. I personally like seeing the details behind other’s decisions, so hopefully this will help someone or help make the concept click and open up an opportunity. This process was only just initiated, so I’ll do an update after we execute the plan to see how it changed.
The original goal was to use that money to pay off another loan. We’ve made our decision on which loan to pay off based on the highest interest rate. Right now, our highest interest rate is a loan with our partner at 5.1%, but this is also the loan that we’re actively paying off (leaving a balance right now of 26k, which we’re responsible for half). Since we need to time our principal payments to be matched with our partner, we can’t just dump money into this loan without really complicating things. So our second-highest interest rate is 4.625%. This loan originally was $89k in 2017 and has a balance of $62k. If we paid this off, that would leave about $35k in cash (based on the other two loan refinances that we’d take $50k out of each) that we could use to pay towards another loan or earmark for another purchase. As this discussion happened, Mr. ODA pivoted.
This company is only available to refinance loans in Virginia. Instead of paying off that $62k loan for a Virginia property, what if we also refinanced that loan and paid off one of two loans remaining on our Kentucky houses? I’m a visual person and needed to see how this would actually play out.
The terms were that if we picked a 15 year loan, that brings the interest rate down to 2.5%. With a 30 year loan, it’s 3.125%. I compared the current amortization schedule to the proposed amortization schedule, and here they are. Note that the interest isn’t a one-to-one comparison because we’ve already paid 4-5 years of interest on these loans.
HOUSE 2
The original loan terms were a 20 year at 3.875%.
The new terms would create a new 15 year loan, reduce the rate to 2.5%, and increase the loan to about $123k (pay off old loan, fees for closing, and $50k cashed out). This decreases our monthly cash flow, on this property, by $294.38.
HOUSE 3
The original loan terms were a 15 year at 3.25%.
The new terms would create a new 15 year loan, reduce the rate to 2.5%, and increase the loan to about $113k (pay off old loan, fees for closing, and $50k cashed out). This decreases our monthly cash flow, on this property, by $155.89.
HOUSE 8
The original loan terms were a 30 year at 4.625%.
The new terms would create a new 30 year loan, reduce the rate to 3.125%, and increase the loan to about $ (pay off old loan, fees for closing, and $35k cashed out). This is slightly off because the new loan isn’t showing at exactly $100k, but for all these the final numbers will be slightly different. This decreases our monthly cash flow, on this property, by $84.87.
In these projections, we’ll receive $135,000 cash in hand. With that, we’ll pay off the higher loan in Kentucky, which has a balance of about $81k. That mortgage has a monthly payment of $615.34. These three loans have increased their monthly mortgage payments by $535.14 in total. Since we’ve eliminated a monthly mortgage with the cash from these new loans, our total monthly cash flow actually has a net increase of $80.20. In addition to this net positive cash flow, we also have over $53k in cash in our account.
Now, if you know us, cash in our account isn’t a preference by any means. In my last monthly update, you can see that we have almost 20k in cash and that’s abnormal. Add $53 to that, and that’s just too much money sitting in a checking account. At this point, the goal is to buy another house. With the way the market is, we’re probably not going to hit the 1% Rule we strive for (the expected monthly rent will be at least 1% of the purchase price – $1000 rent for $100,000 purchase), and we’re not going to see the margins that we’re used to. It’s going to take a lot of effort to get our psychology right for this next purchase. We’ll have to hold strong in knowing that our other houses have great margins, and at least it won’t be negative cash flow.
At this point, we’ve started the refinance process by signing our initial disclosures and providing all the many, many documents needed to originate a loan.
We paid off a mortgage! Reaching this accomplishment was threatened once again when I was told another rental property needed the HVAC replaced ($3,900), but we were able to cover the cost of the unit replacement and pay off the last $3,000 on the mortgage. This gives us $391 worth of positive cash flow each month going forward.
Our two usual suspects are late on rent. One said that her bank account was frozen, and she has no idea why. With a history of forgery, fraud, and domestic abuse, I can’t imagine how this could have come about (sarcasm..). The other just casually emails us and says “Rent will be late. Sorry for the inconvenience.” Lovely. They also don’t pay the late fee, although I’m tracking that to be able to recoup it from the security deposit.
Last month, I mentioned that we had credit card rewards expiring without our knowledge. After several unanswered phone calls, it was resolved through a checking account credit.
Utilities: $420. This includes internet, cell phones (we pay quarterly, so this is a big bump from last month’s total), water, sewer, trash, electric, and investment property sewer charges that are billed to the owner and not the tenant.
Groceries: $590.
Gas: $327. We traveled to Virginia this month, so that caused a higher use of gas. Mr. ODA’s work trip also caused an increase in gas usage, but that’s covered through his employer.
Restaurants: $275.
Entertainment/Travel: $1,167. But this includes $485 worth of Mr. ODA’s work hotel that was reimbursed. This also includes $535 for our hotel stay in Virginia for 5 nights.
Investment: $1,100
Rental work cost us about $150 in supplies, and I paid one house’s quarterly HOA dues of $240.
Our net worth has increased again this month thanks to the stock market and property values. We’re down to 7 mortgages. We’d like to pay off one of the houses that our partner holds the mortgage on, but we need to re-evaluate our finances together first because that equates to about $20,000 for each of us.
ANNUAL TRACKING
I don’t love the format of these posts, so I’m brainstorming ways to share updates going forward. For now, I created a chart to show our spending so far this year and how it has changed month-to-month. I have a feeling I’m not categorizing our spending consistently after seeing this information, so I’m going to dive in deeper. At the end of each year, Mr. ODA asks me what our spending by category is, and I need to recreate that information each time. I thought I was being better about it this year with these monthly updates, but I’m not.
That’s my lesson learned for this month – while tracking your spending, track it consistently and look back at previous months. I thought $300 in gas was consistent with previous spending, but now I see that it’s much higher. While we did travel to Virginia this month, is that really representative of such a drastic increase? We may be ok with the entertainment that driving more has given us, or we may decide we want to scale back our spending in this category. It’s also important to know that some spending is seasonal. While our gas usage is high during the summer, we knew we were planning several trips and wanting to be out of the house more than we were over the winter.
Overall, I don’t feel like I have a good grasp of our spending after seeing this graph, and I plan to dig deeper into the costs. I’m glad I looked at it in this format halfway through the year, before I would have to go back through all 12 months of spending! It’s easy to see an increase in net worth and be complacent, but I’d rather be more intentional with our spending than we have been over the last few months.
The common goal in the FI/RE (Financial Independence, Retire Early) community is to reach a point where your net worth is 25x your annual spending, meaning your expenses are 4% of your net worth. This is an extreme oversimplification of things because of the number of variables associated with where your net worth might be, and how to access it. For example, retirement accounts have requirements to be met before drawing funds; while you may have hit the 4% expense to net worth ratio, it may not mean that you have that money liquid to cover your spending.
When the ODAs started down the path of FI/RE, we did it with a real estate rental portfolio. This path of net worth growth really doesn’t fit the traditional mold. It provides regular cash flow, rather than an account with a balance that’s drawn down.
As mentioned in previous posts, there are numerous ways to make money in real estate. The path we have taken is probably one of the simplest and most repeatable for anyone. We own a portfolio of single family rental houses, most of which were bought straight from the MLS. These basic properties are in basic neighborhoods with regular tenants. Nothing special. We acquired these properties by focusing on the 1% rule in real estate – try to secure 1% of the property’s purchase price in monthly rent. Another oversimplification of how things really go, but if we were able to find a $100k property that rents for $1,000 a month, we know we’re going to make money long term.
For these properties, we typically put 20%-25% down and finance the rest through a conventional mortgage. We find a tenant, and then the 4 ways to make money in real estate go to work for us: appreciation, tenant mortgage pay-down, tax advantages, and most importantly for our situation and FI/RE – cash flow.
I want to talk about how we can reach a FI/RE number through real estate cash flow differently and more quickly than using traditional stock market investing.
The $100k house had a 20% down payment and mortgage rate at 5% interest, which brings the monthly principal and interest payment to $429. Add another $121 for taxes and insurance (using round numbers here!), $100 for maintenance and capital expenditures savings, and $100 for a property manager; this comes to $750 worth of monthly expenses. At $1,000 per month of income, you have $250 per month of cash flow in your pocket. $250 per month equates to $3,000 per year of cash flow. With the $20,000 down payment and about $5K in closing costs, it means that our $25k investment nets us $3k per year in cash flow.
Circling back to the 4% rule for stock market investments, $3k in cash flow requires a savings of $75k. But we only had to invest $25k! We’re banking on the monthly cash flow, rather than a “stagnant” savings.
We took that math and ran with it. Our rental portfolio has 12 houses in it. While we’ve shown in prior posts that each house’s numbers aren’t as clean and simple as this example (some better, some worse), if we take that $3k annually and multiply by the 12 properties, we have $36k in annual cashflow for only $300k invested.
What would you rather need to produce $36k income – $300k or $900k?
Can you scale a rental portfolio to reach enough annual cashflow such that you can live off the cash flow?
Rental property investing is not completely passive. We have tenants to manage, properties to maintain, property managers to manage, income and expenses to track for taxes, lending efficiencies to explore, and the list goes on. But if you’re willing to put in a little work to reach financial independence (the FI part), you can do it substantially faster by finding strong properties to provide significant cash flow than if you were to take the totally passive route of simple stock market (index fund) investing.
Note, there’s nothing wrong with that – we have a substantial position in the stock market due to the tax free growth benefits of retirement accounts. The power of real estate investing saw our net worth grow faster than we’d have ever dreamed since we bought our first rental in 2016. The proof is in the pudding and we advocate to anyone to just get started!
This is a good one. This is the one we use when people say “how can you handle all those properties,” and I respond, “if we survived this one tenant, we know we can handle whatever gets thrown at us.” Hoarding, mice, court dates, eviction. But its not always like that. The sun shone down on us for the current tenant though, who signed a two year lease and take care of the house (like, even power washed it on their own accord). The stories below show that you need a thick skin and a smooth temperament to be a landlord. Treat this as a business.
LOAN
This house was purchased ‘as-is,’ but we still had a home inspection contingency in the contract. It was listed at $139,500; we purchased for $137,500 with $2,500 in seller subsidy. We went under contract on 8/14/2017 and closed on 9/22/2017. The appraisal came in at $141,000, so we were content with our decision.
We refinanced the loan in May 2020. Our original loan had a balance of $105,800 at the time of the refinance. We rolled closing costs into the new loan and cashed out $2,000, making our new loan amount be $111,000. The refinance reduced our interest rate from 4..875% to 3.625%, shaving $104.25 off our monthly payment. I went into detail about the refinance in my Refinancing Investment Properties post.
Following the 1% Rule, we would be looking for $1,340 in rent (net of seller subsidy), but we haven’t received that yet. The first tenant’s rent was $1,150 and the second at $1,250. For the third potential tenants, we listed at $1,300, but the new tenants negotiated to $1,280 for a 2-year lease.
TENANT #1: OUR WORST
The application. It’s hard to not give someone a chance when their application is borderline, but I suggest letting the information on the screen speak to their character. Before the official application was run (which includes a background check), she admitted to a felony that she served 2.5 years for, and she filed bankruptcy due to a stolen identity while she was incarcerated. It seemed like she paid her dues and was building a new life. We got her application about two weeks after closing, so it wasn’t like we were desperate to rent it at that point. But she was quick to fill out an application and provide necessary documentation, so we decided to give her a chance. She moved in on 10/1/2017 with her 3 children, one of which was born days after she moved in. Her rent was $1,150.
We didn’t have any unreasonable situations with her in the first year. We did have a maintenance call for a leak under the kitchen sink, and we noted that the house wasn’t tidy. It seemed like she was a coupon-er, where she stocked up on a few items and probably resold them, which supported how she kept wanting to pay us in cash. The house wasn’t to my standard, but I didn’t look close enough to notice that it was dirty in addition to cluttered. I wanted to say something, but didn’t know my place at that point. Hindsight: I should have told my property manager and had her issue a written notice. This won’t matter down the road for legal proceedings, but perhaps we could have saved ourselves some headaches if she took the notice to heart; I was just afraid of offending her. But, other than that small concern at the time, we had no issue renewing her lease for another year.
The tenant complained about seeing a mouse around February 2018. We informed her at that time that pest control was up to her because of her living style that was attracting the pests. She claimed to have a quarterly treatment through Terminex. She complained further of mice in November 2018, but I wasn’t part of that conversation. It appeared to be that she was upset that there were still pest issues while she was paying Terminex. Well, that’s an issue to take up with the pest control company, not us. Our property manager gave her the information to our pest control company and shared that it would be a bit cheaper for the quarterly plan too. We heard nothing more until all hell broke loose in April 2019.
She sent pictures of mice poop all over the house on April 9, claiming that she had been out of the house from March 31 through April 8 and came back to this sudden mouse infestation and would be leaving the house. Well, that’s not how it works. She claims that was her ‘prompt’ notification, as if mice set up camp in a lived-in house that’s well maintained out of nowhere (news flash: it wasn’t well maintained and clean). She claimed that because of the living conditions (that she perpetuated), this would be her last month in the house. We knew we had the lease to fall back on, so we continued to remind her that this wasn’t on us and she couldn’t leave us with the financial burden and walk away. We had our pest control company go to the house as soon as possible, and we received their report on April 12.
But wait! While complaining about the condition of the house (that she caused), she wanted to know if she could buy the house!!!! Logic always seems to abound in these situations; it’s hysterical. We offered her to purchase the house from us at $148,000. She ignored it after that offer.
Both the pest company and our HVAC person noted a dog on the premises, which was in violation of the lease. HVAC was called out to fix a wire on the outdoor HVAC unit that the dog had chewed through. She also wasn’t taking care of the yard, and the City of Richmond was fining houses that violated their weed and grass clauses, which we notified her of on May 9.
She didn’t pay April or May rent, so we had a court date set for May 10. We had told her that she had to pay all overdue rent and late fees for us to cancel the May 10 court date. She didn’t pay, so our property manager went to court. The judge awarded us possession of the property, but since there was such outstanding rent and damages, another court date was set for July 1 to award us the money owed. In front of the judge, the tenant handed the keys over to our property manager, saying she was moved out. Immediately after leaving the court house, the property manager arrived at the house to do a walk through, only to find several people inside. She called the police.
The officer assessed the situation. He said that since they’re still moving things out (and there was a lot to move out), that it was a benefit to us that they were still working on it. He suggested asking their input on when they thought they would be done. One guy said at 3 pm. We agreed to let them stay, and I would go by after work to change the locks.
I showed up at 4 pm to change the locks, only to find people still coming in and out of the house. I called the non-emergency police line and waited for the cops to show up. It’s officially trespassing, and we were prepared to press charges. The officers knocked on the door and asked the people inside (none of whom were the tenant on the lease) to leave. One woman started a whole spiel about how she’s on probation and everything that she’s been arrested for, so she didn’t want to be arrested. The officer was funny to watch, and he just kept saying, “I’m not arresting you. I just want you to leave.”
After they drove away, the officers let me walk the property to ensure everyone was out. The place was destroyed!
By Virginia law, we are required as landlords to make every attempt possible to get the unit re-rented and let the old tenant “off the hook” for unpaid rent. Meaning, we can’t hold them to the entire term of the lease and have a vacant house. Regardless of this, we wanted to get everything fixed and replaced in the house so that we had an exact amount to claim during the July 1 court date.
The linoleum replacement was the critical path. She had destroyed it (looked like some chemical ate through it) beyond repair and it had to be replaced before we could re-rent the house. Home Depot’s timeline was really behind, and they weren’t able to get us scheduled for installation until June 20th (after she had “vacated” May 10th).
I compiled a list of lease violations with my documentation to support the claims in which she violated the lease on top of the obvious (e.g., dog on premises, smoking in the house). We had invoices from the pest company, the HVAC company, the trash removal company (over 40 cubic yards of garbage was left in the house when they finally vacated), and the “hazmat” cleaning company, all corroborating an unclean and unkempt living condition.
We went into court with a claim of $9,250. This was unpaid rent for 3 months, late fees, junk removal, pest control, HVAC fixes, professional cleaning that included a ‘hazmat’ charge, and all our paint and flooring charges.
We won the first judgement in court, simply because the defendant didn’t show up. We were awarded $9,250 plus the court fee and 6% interest. Well, somehow the court accepted her plea of needing another court date after not showing up to this one, and that was on July 10th. The judge that day reduced our rent and late payment owed by one month, and reduced our reimbursement total by a bit more than the security deposit we had already kept, bringing the judgement to about $6,600 plus the court fee and 6% interest.
Per the court process, we were required to work with the ex-tenant to develop a payment plan. We offered her a payment plan via email that was never responded to. From there, the next step is to retain an attorney for wage garnishment.
I contacted the attorney we use to help with wage garnishment, but he wasn’t experienced. He referred me to someone, who let me know that he’s already representing someone who has a claim against her. He said that he could still represent me, but I’d be second in line to any money they get from her. He offered me another attorney’s name to see if that one could help me instead, but that attorney said he couldn’t represent me because he already has another client looking for money from this woman. Interesting that two attorneys had different answers, but we went with that first. We haven’t seen a dime. Once the money was spent and we paid off the credit cards, it wasn’t on our radar anymore. Anything we get from this woman will be a bonus at this point.
TENANT #2: BLISSFULLY UNAWARE OF HOW LIFE WORKS
Two kids just out of college were our tenants that came in after that mess. They were great tenants, but a bit unaware of how the world works. They didn’t get the utilities into their name timely, so we charged them for the bills that came to us. After that, they paid their rent on time, and even when their restaurant jobs shut down at the beginning of the pandemic, they prioritized paying rent over other things they could have spent their limited income on; I was impressed. At the end of their lease, they were a bit lost too. Our lease requires 60 days notice of your intentions – either leave, or renew. Our property manager reached out to them at the 60 day mark, and they said they weren’t sure what they wanted to do, but were looking for other places. Since, realistically, we weren’t going to list the house for rent at 45 or 60 days, we told them that was fine. They came back after a week and said they were going to move out.
We moved forward with listing the house for rent and vetting new tenants. We had our property manager show the house on June 10 for what would be a July 1 lease. About a week later, the current tenants asked if they could stay longer because they didn’t get the place they were looking for. Sorry, but that’s not how it works and it’s already rented. The new tenants were OK with moving in July 15, so we allowed the college guys to stay until July 10. Then we hustled to get the house put back together before the new tenants. Specifically, one of the tenants was an artist, and he hung a huge canvas on one of the bedroom walls to paint on. Well, the paint bled through.
They also didn’t tell us that the range wasn’t working. When we asked about it, they said something to the effect of, “oh yea, we smelled gas, so we just cut it off. That was back in March.” Goodness!! So we quickly ordered a new range. We also had to have the carpets professionally cleaned, which was especially frustrating since they were only a year old. Luckily, the ladies who came to clean the carpets worked their magic, and they came out looking good as new. The microwave handle was broken off, and when we looked to buy a replacement, it was essentially the same cost as a new microwave, so we installed a new one.
While we were working in the house, we noticed that the air conditioner wasn’t keeping the house cool. We had an HVAC tech come out to the house, and it was either $1,400 to repair (after we had already previously put money into the HVAC unit), or $5,000 to replace it. We decided to replace it after it died shortly after the third tenants moved in.
TENANT #3: SOME OF THE BEST
These tenants have been wonderful. They’re both pharmacists at the local college and have been very self-sufficient. They’re great about alerting us of issues, but not in a way that it seems like they’re nitpicking. For instance, they wanted to store their lawn mower and other things in the shed out back, but the handle was broken off it. We told them that if they wanted to purchase a replacement, we would reimburse for the cost. Then they noted that the closet dowel was broken and they replaced it. I told them I would pay for that, so just take it off the next month’s rent. When they sent me the receipt, they had only taken the rod itself off the rent, but not the brackets to hang the rod. I immediately sent them the rest of the cost!
They’re one year into a two-year lease, and we’re very happy with them. They always pay their rent on time, they communicate regularly, and they’re taking care of the house.
MAINTENANCE AND REPAIRS
Since I’ve covered a great deal of the repairs we’ve managed in this house through each of the tenant stories, here’s a quick summary of other items.
Shortly after the third tenants moved in, they politely let us know that their dishwasher wasn’t cleaning the dishes. They very clearly identified the problem and the steps they had already taken to attempt to fix it, but it wasn’t working. We purchased a new dishwasher the day after they let us know. So in the matter of a month, we replaced the built in microwave, range, dishwasher, and HVAC. The only appliance we haven’t replaced in this house now is the refrigerator.
There was an electrical issue that we had sort of noticed before, but hadn’t pinpointed it without having things to plug into all the outlets. We had an electrician go out and fix the switches and outlets that weren’t working in master bedroom.
AN OVERALL LOOK AT THIS HOUSE AS AN INVESTMENT
Remember how real estate investing provides multiple avenues for wealth building? Here’s how they’re looking for this property.
Cash Flow – As we have had to replace nearly all appliances, including HVAC, and all the flooring among several other smaller issues, our total cash flow on this property is nearly nothing. But, like mentioned before, we shouldn’t have any big purchases coming and will start to be able to pocket the profits on this house once again.
Mortgage pay-down – The tenants have paid our mortgage for us, but due to closing costs of refinancing and choosing to take $2,000 cash back from that refi, our principal is actually higher than when we bought it.
Tax Advantages – We always depreciate the cost of the structure for paper losses that help offset profit on properties for tax purposes. All those repairs and appliance replacement expenses that eat into the profit margins are written off. So come April 15, the silver linings of those expenses are realized.
Appreciation – This one is good for us. This house is in a developing neighborhood and the area around it is being revitalized. Coupled with standard appreciation and the *hot* real estate market we’re in now, the value of the house is 150% of what it was when we bought, in less than 4 years.
SUMMARY
We’ve put about $10,000 into this house at this point. But that means we have a lot of brand new things in it. Now isn’t the time to give up on the house, since we should be in a position to not deal with many maintenance requests. Rent continues to climb, increasing our cash flow, while we just brought our mortgage payment quite low with the refi, and the property will continue to appreciate in value.
We learned a lot about the eviction process, even dealing with local police officers in the process. The court system and law enforcement are fairly simple to work with, as long as you are a fair and respectful landlord, keep documentation, and follow landlord-tenant laws. When the tenant doesn’t live up to their end of the bargain, justice will be served.
When we purchased the majority of our investment portfolio in 2016/2017, primary mortgages with excellent credit were sitting around 3.5% and investment property mortgages were about 4.5-5%. We thought these were amazing rates. Fast forward to a once-in-a-lifetime pandemic. A new baseline for low rates is created: We closed on our primary residence in November 2020 at 2.625% with nothing special about getting that rate.
Let’s go back to early pandemic days in the spring of 2020. Mr. ODA is always watching the market, but was particularly interested in the mortgage interest rates because we were coming up on the 61st month on our primary residence’s 5/1 ARM. Just a couple of months into the pandemic, we decided to move, so the ARM refinance (refi) became moot. But since rates were so low, he looked into refinancing our investment properties.
There are a few caveats. With the first company, we couldn’t refinance loans that had a balance less than $100k and be able to maximize the pricing structure they advertise so proudly ($0 closing costs). There was also an investment property fee, and took a long time for both of these to close.
As with the original loan, you’ll want to weigh the financial cost of refinancing against what the new rate will save you. When we looked at the variables, only 2 of our loans were worth pursuing a refinance.
In 2020, we refinanced House 9 from 4.875% to 3.625%. Our monthly payment went from $778.80 to $674.55.
The original loan amount on this property was $110k originated on 9/22/2017. We had paid it down to about $105,800 (shows how slowly the amortization schedule works for you in the early years), but with the closing costs rolling into the new loan (and cashing out $2,000), the balance became $111k. Eek, seems counterintuitive to refinance to a higher balance, but it’ll save us in the long run. We have greater cash flow each month with the lower mortgage payment, a larger percent of the monthly payment goes toward principal vs interest (amortization schedule again!), and we’ll save ourselves over $9k in interest over the life of the loan, if we make no additional principal payments.
We refinanced through a “zero closing costs” type entity. However, there are stipulations to what counts as $0, and investment properties aren’t exactly that. We had to pay an ‘Investment Property Fee’ of $2,358.75. The company paid the closing costs (e.g., credit report fee, title fees, recording fees) worth $548.91. We paid our prepaids, but also received a lender credit of $300. Essentially, we paid a slightly higher rate than the market would offer because the company rolls its closing costs into that rate, akin to paying points or receiving lender points to shift your rate up and down.
Mr. ODA initiated the refinance through an application in the beginning of March. We were quickly informed that we wouldn’t even be assigned a loan officer for two weeks. At the end of those two weeks, we were told they still didn’t know if they could move forward with our refinance. A week later, Mr. ODA followed up, and they had approved us to move forward. We were patient through the process, but it wasn’t until mid-May that we finally closed (in a parking lot, under a tent = pandemic closing #1!).
We rent this property for $1,280 and pay a property manager 10% of that. Minus the $674 mortgage and we’re still sitting quite pretty. While we reset the payoff clock by 3 years by starting a new 30 year mortgage, the extra money working for us in future years will far outweigh the costs of refinance.
In January 2021, we refinanced House 7 from 5.05% to 3.375%. Our monthly payment went from $664.31 to $559.34.
Our loan balance was $85,616, and the closing costs of $3,108 were rolled into the new mortgage. We also cashed out $2,000, so our new loan amount was $91k. The $2,000 was the most that could be cashed out during the refinance; we chose to take the cash out because we could make that money work elsewhere (e.g., pay down a mortgage with a higher interest rate). Even with the higher loan amount, the interest rate is so much lower that we’ll save over $15k in interest.
An appraisal was required as part of the refinance, which is how we learned that the house that we purchased for for $110,500, is now appraised at $168,000!
So, we rent it for $1,200 and self manage but only have to pay a $559 mortgage now? HELLO cash flow!
This closing was done at our kitchen table in KY through a VA-based loan officer. Mr. ODA initiated this loan in November, and we closed in January. A notary came to our house to go through all the paperwork, but it was all wrong. I enjoyed the “we never make mistakes” type of response from the Title company, and I pointed out that their paperwork did not match the lender’s paperwork that we had sitting at the table. Since the closing was at 6 pm, it was after hours for everyone and we couldn’t get an answer quickly, so we sent the notary home. We spoke with the loan officer an hour or so later and pointed how how each closing document had different numbers on it, and she went to work fixing it.
Theoretically, every investment property we own could’ve benefited from a refinance. And we would have with the “zero closing cost” company over time without their own pandemic policies getting in the way. If the loan amount was less than $100k, they would make you pay the closing costs AND would arbitrarily add 0.375% to the advertised rate. BUT, they wouldn’t let you pull equity out as cash to get the loan back up to $100k. So, that crushed our dreams a bit.
With options limited to “traditional” lenders’ pricing structures, we had to evaluate our future goals for the property and where the loan balances and rates already stood. Not to mention, there’s the time and complexity that comes with refinancing while hoping rates continue to stay low.
The lender we normally use has closing costs around $3k. This means that with the extra principal proportion and smaller monthly payment resulting from a refi, we need to balance against $3k to determine how long it will take to break even. Properties with small balances and properties with decent rates (mid 4%) would take longer to break even. Since we pay down our mortgages relatively systematically to achieve greater portfolio cash flow, some of our 30 year loans won’t be around for 30 years. And what if we wanted to sell the property to ‘1031’ to a different one? Our portfolio also has 15 and 20 year loans with great rates that wouldn’t be beneficial for us to pay to lower that rate.
There are a lot of moving parts when deciding whether or not to refi, and its very rarely free, especially with rental properties. But if the numbers work, it should be a no-brainer to pull the trigger and make it happen. Your future self will thank you!
Mr. ODA has regular emails come in with new listings in the areas we’re interested in. While some of our houses are 2 bedroom, we find it easier to rent 3 bedroom houses. We also are looking to the possibility of resale, which is better for the 3 and 4 bedroom houses.
First, we look at the condition of the property. We’re interested in properties that can be immediately rented, meaning we’re not looking for remodel projects. Most of our properties purchased required no work to prepare it for a renter, and they are typically recently updated. When I say these houses were recently updated, they weren’t top-of-the-line finishes. Here’s an example of one we purchase 4 years ago, and the pink knobs are still there!
There are a few properties that took slightly more work. We purchased one property that required a whole-house paint job (including trim work) that took a week doing it myself. We also attempted to rent another property with old carpet on the main floor. The potential renter asked if we’d be willing replace it or refinish the floors; we ended up taking a week to refinish the floors, which has paid off in the long run.
Typically, we’re going to replace appliances, paint, and scrub the place down to prepare it for renting. We’re not looking to overhaul the building or do massive capital improvements for that first renter. However, I’ll note that it doesn’t mean we don’t eventually do that. Just this past year, we had several roof replacements/repairs, plumbing replacements, and HVAC repairs.
We want the house to be in good condition to keep a renter there (we’ve actually had very low turnover), make it easy to re-rent it when there is a vacancy, and to make it attractive for any future sale. We’ve noticed that homes that were typically owned instead of rented are in better condition than if it was managed by a landlord. We seem to struggle wanting to move forward with houses that are currently rented because of all the deferred maintenance.
We have been under contract on multiple houses that we walked away from after the home inspection (e.g., knob-and-tube wiring, vertical clearance requirements on stairs, remnants of a previous fire found, poor patch work). Don’t feel like you’re in too deep if the inspection comes back to show a lot of improvements are necessary. It’s a hard mentality to talk yourself (and your partner) through because you’ve spent time looking at the house, reviewing rental comps, possibly reviewing current lease agreements, and spent the money and time for the home inspection. But keep in mind that it’s not worth purchasing the house and spending more than you’d like to keep the house standing and rentable.
Then, in broad strokes, we’re watching the 1% Rule. This means the monthly rent should be 1% of the purchase price (e.g., a purchase of $100,000 house should yield $1,000 per month in rent). Review current rent prices in the immediate vicinity. We’ve purchased houses in areas that have several rental properties, so it’s been fairly easy to identify a rate based on the number of bedrooms and bathrooms, as well as the amenities we can offer (e.g., appliances, lease term, parking availability). In future posts, I’ll provide the details of each of our purchases.
Here’s a break-down of our current properties related to the 1% Rule.
You can see that we didn’t hit the 1% on 5 of them. The first had a tenant when we purchased it 4 years ago; we’ve risen the rent once and plan to raise it to $1200 at the renewal term in July (so raised the rent $50 every two years). The bottom two were in a market that we were unfamiliar with, and even though we thought we would yield $990 easily for rent (yes, is still below 1%), the houses were in excellent condition, so we looked to the future value in the decision making. Unfortunately, we didn’t close on these until September, which is difficult to find renters. We didn’t have many showings at ~$1,000 rent. We ended up lowering the rental price by offering an 18-month lease so that the future rental timeframe was in the spring, and we offered the rest of October as free.
Mr. ODA developed a spreadsheet to calculate all the costs associated with owning the house, which helps determine whether the house fits our portfolio goals, especially if it doesn’t exactly meet the 1% Rule. This spreadsheet makes assumptions for routine maintenance costs, capital improvement costs, vacancy assumptions, insurance, mortgage interest, etc. Calculate the monthly rent less than the monthly cost of each of these assumptions to arrive at the monthly cash flow. Annualize the monthly cash flow, and then divide it by the down payment and closing costs to arrive at a ‘cash-on-cash’ return, which we’re looking to be at least 8-10%.
Next, we examine the neighborhood. We have thresholds for prospective tenants, which typically yields to a middle-of-the-road neighborhood. We’re not looking for a perfect, upscale neighborhood to own a rental because these types of homes rarely meet the 1% Rule. I utilize Trulia to examine the crime rates of the area. We want to offer homes that are in reasonable city locations.
I had fully vetted one house and determined it was worth our purchase. A similar house, with an upgraded kitchen, was for sale a couple of blocks away. I assumed it was the same neighborhood and didn’t do my due diligence. The house showed very well online, and we had several showings from qualified individuals, but then they’d check the house details, only to find out that it was in a high crime zone. We ended up having to lower our credit score threshold to find a renter (compensating with additional security deposit), then had difficulties for over a year collecting her rent, which really should have been expected. We have since sold off that property.
If all these steps, including the cash-on-cash evaluation, should take about an hour. If we get this far, we go see the house. If the house is in the condition we expect it to be based on the pictures, we make an offer. Our Realtor will write up that offer the same day. Recently, many houses have been in a multiple-offer scenario. This is another trap to not get sucked into. After so much time vetting the house, it’s easy to be attached, especially if you find very favorable data (e.g., you can get rent higher than 1%). It’s not worth owning the house if you have to purchase it at a higher price than you’re comfortable at; it must be a business decision, purely based on the financials.
Keep an eye on listings daily or weekly to keep a pulse on the neighborhoods you’re interested in, evaluate the property condition, consider the 1% Rule and evaluate the detailed financial cash flow, don’t skip the home inspection nor should you ignore the results of it, and keep it a business (not emotional) decision.
One Dollar Allowance 