House 11

Our 11th purchase was a 4 bedroom and 2 bathroom house, which we were excited about. We only had one other 4 bedroom, and it only had 1.5 baths, so this was a new demographic we could meet. We again needed a mortgage, but we were tapped out (max of 10 mortgages allowed per Fannie Mae), so we went to our partner. I went through the process of establishing the partnership in the House 10 post.

The house had been listed for sale in July 2018, dropped the price in October 2018, and we went under contract on it on December 1, 2018. We went under contract at $129,000, which meant, according to the 1% Rule, we would look to rent it for at least $1290.

The house required a lot of cosmetic work (relative to our usual purchases) before we could rent it. The biggest hold up was the carpet replacement, but we had to do a lot of cleaning and painting also. We closed on February 4, 2019; got to work on the house on the 6th; and then had it rented on March 3, 2019. That’s a longer turnaround time than we’d like, but we thought the long-term benefits of a 4/2 house would be worth it. Plus, with our goal being $1290 based on the 1% Rule, we were happy that we rented it at $1300 and through March 31, 2020.

LOAN TERMS

We were given two options from the loan officer. Both options required 25% down. We could do a 15 year mortgage at 5.05% or a 30 year mortgage at 5.375%. The 15 year mortgage payment was $865, while the 30 year was $640. Since both options required 25% down and we aren’t concerned with our monthly cash flow (as in, we’re not living off of every dollar that comes out of these houses right now), we chose the 15 year. Escrow changes over the last few years have increased the mortgage to $941, unfortunately. However, we’ve been paying off this loan with pretty substantial chunks of money thrown at it. The loan started at $96,750, and the current balance is $21,350. We would have liked to have this paid off a few months ago, but we need to time our payments with our partner, who recently paid for a wedding, renovations to a new house, and a new tear-down property adjacent to his personal residence that he’s going to build a garage-type thing (city living = street parking for him).

We went under contract at $129,000, and the house appraised at $140,000, so that was a nice surprise. The current city assessment is at $148k, but it would likely sell for more than that.

PARTNERSHIP

Since the LLC was already under way when we purchased House 10, we needed to add this one to the LLC. We contacted our attorney. He processed all the paperwork, and we showed up just to sign everything in a quick meeting. At this time, we also requested an EIN be established for the LLC. To process adding this to an established LLC, it cost us $168 (which we paid half of since we’re split 50/50 with our partner).

PREPARING TO RENT

This house was probably the second most effort we had to put in to prepare it for renting. We had to replace quite a few blinds that were broken, do a deep clean of everything, install smoke alarms, paint, replace the carpet, and do some subfloor work.

We had to paint nearly every room (one room we even painted the ceiling the same color as the walls because the ceiling was in rough shape, and it wasn’t worth the time for precision of the edges).

The floor at the front door was rotted by termites. The guys had to cut out the floor and replace the wood before the new carpet could be ordered. We needed the house treated for termites at that point since there was an active infestation that we found. Depending on time and price, I’d rather replace carpeted areas with hard surface flooring for easier maintenance. Since we were already losing time with all the maintenance on this house to get it ready to rent and it was a small area, we just went the easy way out and put new carpet in. The carpet was only in the living room and hallway; all the bedrooms have hardwood flooring.

FIRST TENANTS

We were able to get a family in the house fairly quickly after we finished our work. We rented it at $1300. They signed it on March 3rd, and I had set the terms until March 31, 2020 (this comes into play later). The family had been renting with a roommate (and the husband’s boss!), and that guy had wanted to leave the house. In January 2020, the tenant said, “we signed the lease on March 3rd, so we want to be out at the end of February.” That’s not how leases work. The lease signed said until March 31, 2020. Some time between us telling him that he was in our lease until the end of March, not February, and the end of February actually coming, they decided they wanted to renew their lease. They signed a new lease with us on March 11 to cover 4/1/2020 through 3/31/2021.

In April 2020, the tenant received a job offer in Texas. He asked about a lease break, and we offered an option. All the communication was done via text message, so it was technically in writing, but there was never a “wrap up” text that identified all the agreed upon terms to allow for the lease break. I used this as a teaching opportunity for the 3 of us in the LLC that clearly documenting agreements in writing (preferably with signatures) is important.

The tenant offered to pay May rent without prompting, so we thought that was covered. The part that needed to be detailed was what was considered a “lease break” fee. We had agreed to 60 days worth of rent, and the security deposit couldn’t be used to pay that. Mr. ODA tried to contact the husband on multiple occasions to get rent paid at the beginning of May, but there was no response. I finally sent an email, detailing that they agreed to pay May’s rent, and that technically, they were on the hook for the entire year’s worth of the lease (quick aside: while that’s what the lease says, I think a caveat in the law actually means they’re not really liable for the whole amount because once the house is vacant for 7 days, it defaults back to our ownership, and then we have to show due diligence to re-rent it, leaving them liable for only the gap period). Well, as usual, the landlord gives us a guilt trip (their daughter was in the hospital in TX) instead of separating that from the concept of “pay your debts owed.” As a person, I feel for you on this; as a business owner, it’s not my responsibility to manage your finances and personal life.

The tenant called Mr. ODA and yelled at him. A few hours later, presumably with a more clear head, we received a fair response via text. He even apologized for yelling on the phone. He paid the last few hundreds that were owed, and we all moved on.

SECOND TENANTS

After our first tenants vacated the house, we had to get the house turned over. There was a good bit of work that needed to be done for just a year of someone living there. They had also left stuff behind that became our responsibility to get out of the house. We listed the house for rent. Our partner showed it to 3 younger people who would rent it together. They seemed great until we ran their background and credit check. They had evictions they didn’t disclose (claimed they didn’t know), so we shared the report with them and continued showing it.

We ended up showing it to a couple, and they liked it. After we accepted their application, we were able to get the lease signed on May 7, 2020. Since this was at the very beginning of the pandemic, we had to get creative. I signed this lease on a street corner (hadn’t realized that the place I had selected with outdoor seating was closed!), and they paid their first month’s rent, security deposit, and pet fee in cash that he handed to me in a sock (with a warning that told me this wasn’t the first time he handed someone cash like this haha). They’ve been great tenants, and they renewed their lease.

MAINTENANCE

The new carpeting when we first bought the house cost us $700. Between the termite treatments and other general pest control, we’ve spent $950.

Once the first tenant moved in, we learned of some other issues that weren’t apparent by us just working there and not living there. We had the plumber come out to fix several issues with the hot water that cost us $1450! Then we found out that the master bathroom shower wasn’t installed properly, and it was missing a p-trap; that cost us $325.

Our insurance carrier didn’t like that there wasn’t a handrail for the front steps of the property, so in March 2020, we had to have one installed at $190.

We had to replace the washing machine in April 2020 for about $500. As I’ve shared, we try to not include any ‘extra’ appliances because then maintenance and replacement are our responsibility. This was a fun one – we replaced it just to make the tenants happy and not deal with maintaining it, and then those tenants left right after that, and our new tenants brought their own appliances (so they just have two washers and two dryers in their kitchen).

We had an electrical issue with the master bathroom that cost us $150.

Luckily, I did the inspection over the summer, and nothing came of that initially. We did end up replacing a fan in the master bedroom because the light part of it stopped working with the switch. Since we don’t live near the house anymore, and our partner was in the middle of getting married, we went through Home Depot to have it installed, so all together (fan/light and install) it was about $175.

SUMMARY

This has been a good house. We didn’t realize that the house is located outside the city limits, so we needed to figure out trash pick up in the county (not included in the taxes). Other than a few maintenance hiccups, things have been smooth sailing. We’re happy with the tenants who are there, that they’re maintaining and cleaning the house, and we’re getting our desired rent amount (that they pay on time every month). The street is in a decently nice neighborhood with a lot of original owners, which helps it keep (and increase) its value.

Escrow Payments

A theme I stick to in this blog is that you need to watch your money. I’ve talked about ways that I’ve fought to get money back where it wasn’t billed correctly (e.g., medical bills), and today’s warning is about escrows.

An escrow account, in the sense that I want to talk about it, is tied to your mortgage. Your monthly payment includes an amount that goes into a separate account held by your mortgage company, and they manage paying out your taxes and insurance on your behalf.

The benefit of an escrow is that you don’t have to manage your insurance and tax payments. You don’t have to pay out a large sum of money once (or twice) a year because you’re paying towards this account every month that will manage that billing for you. The downside is that this escrow account requires you to maintain a balance, so it’s holding your money where your money isn’t working for you. Another downside is that your money movement is less transparent, and you just expect that the payments will be made accurately. The bank basically takes on the administrative burden of paying these bills on your behalf, in exchange for continually holding this money without paying you interest.

Each month your mortgage payment includes principal, interest, and escrow. For example, I have a mortgage payment that is $615.34. The P&I total will remain the same amount each month, but the principal portion of each payment will slowly increase while the interest slowly decreases. In my example, the total P&I is always $428.11, but the breakdown of what’s principal and what’s interest changes (e.g., October’s payment due included principal of $119.58 and interest of $308.53; November’s was $120.03 of principal and $308.08 of interest). The escrow amount each month for this mortgage is now $187.23; this number stays the same until there’s an escrow re-analysis.

An escrow analysis is conducted once per year to verify that the escrow account will have sufficient funds to pay out the bills received (typically taxes and insurance), while maintaining the required minimum balance. Sometimes the increase is known ahead of time because you can see that the estimates for the initial escrow contributions were off (or in our case, new construction uses estimates based on last year’s tax payment, which only included land value and not the final sale of the home, so we know there will be an escrow shortfall in our future). A shortfall may also occur when there’s been a drastic change in your property value assessment, causing taxes to increase more than an expected amount (like in 2021!), or when insurance costs change more than projected.

Below is an escrow analysis of one of our accounts. The highlighted row shows that when our taxes are paid, the balance will fall below the required minimum. The document says that the minimum “is determined by the Real Estate Settlement Procedures Act (RESPA), your mortgage contract, or state law. Your minimum balance may include up to 2 months cushion of escrow payments to cover increases in your taxes and insurance.” If you are projected to dip below the required minimum, they’ll offer you the opportunity to make a one-time contribution to the escrow account or your monthly payment will increase to cover that projected shortfall.

The increase is calculated in the image below. My payment to escrow at the time of this analysis was $126.18. They take my insurance and taxes owed, divide by 12, and come up with my monthly base escrow payment ($149.81). At the lowest point in my escrow balance (highlighted in yellow above), the account will be -149.43. The difference between this balance and the required balance of $299.62 is $449.05. Divide this number by 12 to get the $37.42 in the image below indicating the monthly shortage for the account.

The new escrow payment is added to my P&I payment (which stays the same), and this is my new monthly mortgage payment.

An escrow analysis showing that we’ll fall below the balance required inevitably means that my monthly cash flow will decrease (because we always opt for the change in monthly payment instead of a one-time contribution). As taxes and insurance increase, so does your requirement to fund your escrow account. While the reason for the escrow increase is to cover the taxes and insurance, which I would have to pay anyway, the escrow increase is higher because of the required minimums. One of our houses started with $766.96 as the monthly payment, and it is now $802.96 due to the escrow analysis. Another one started at $477.77, and it’s now at $537.60.

SO WHAT HAPPENED?

Honestly, the only way I’ve checked my escrow balances in the past is at the end of the year when I’m verifying the insurance and tax payments “make sense.” I’m not even verifying the details behind the numbers, just that it was similar to last year’s amount as I update my spreadsheet. Well this time, I logged in to update my spreadsheets with the new mortgage balances for the October Financial Update, and I saw my escrow account was negative by over $1000! That makes no sense because these accounts are reviewed annually through an escrow re-analysis to ensure you’re not projected to dip below their required minimum balance, and if it were to be negative, it would only be by a much smaller amount.

We had recently changed our insurance. Usually when we change insurance providers, we pay the current year on our credit card (to get those points!), and then all future billing goes to our escrow account. I don’t know why we didn’t do it this way for the most recent change, but I’m inclined to blame the fact that the process took months to get new insurance because this company hasn’t been responsive, so we just wanted it done and weren’t thinking. Since we didn’t get the new policy issued before our old policy was billed, both insurances were paid out by our escrow. Sure, that should have affected our escrow balances, but still not by $1000.

One house had a policy that cost $573.31 and the other had a policy that cost $750.06. The new policy includes both houses under one policy (this becomes annoying and it makes me uncomfortable for reasons I can’t seem to articulate to the agent) and costs $1,180.87. Each mortgage escrow paid out the original policy amounts since we didn’t execute the new policies timely. After these were paid out, the mortgage company received a bill for $1,180.87. For reasons I can’t quite figure out, the company paid $1042 from each of our escrow accounts, and then one escrow account paid $138.87 (which is the balance of 1180.87-1042). The $138.87 covers the policy fees; so someone realized that there was a separate line item for policy fees, but didn’t realize that the $1042 should have been split between two houses (even though they knew there were two houses because they took from both escrows).

I questioned the process with the new insurance company, but he didn’t take responsibility for it. He claimed that the mortgagee had to know to split it and they don’t manage any of that. I explained that I’ve had multiple houses insured by one company and have never been given one policy number for it. He acted surprised. My gut says this is wrong and isn’t going to work, both for future billing and the possibility of a need for a claim. We did receive a check in the mail for $903.13 (the difference of $1042-138.87), but we still have paid the $138.87 and want it reimbursed. I sent an email this morning explaining again that I’ve confirmed with my mortgage company that this insurance company was paid $1042+$1042+$138.87. He again responded that the $138.87 is the fees portion of the bill, and I again said that I know, but it’s been paid twice, and I’d like it back. So now I’ll stay on top of that $138.87 to make sure we get it back.

You need to fight for yourself. You need to know what companies are owed and know what you’ve paid. Then don’t back down to keep asking for an update. I recently discussed how I had to fight for medical bills (multiple times) for a year at a time to get the money reimbursed that I was owed. I even recently had to call on another medical bill that I paid before realizing it hadn’t been submitted to insurance (I would love to understand why this keeps being an issue that my medical bills aren’t submitted to my insurance before billing me). Then they submitted it to insurance and sat on my reimbursement until I called twice asking for the reimbursement (that both times they agreed I was owed and it was “in process.”). Manage your money. Especially because that $138 that I’m waiting for now could mean a big difference to a family in need or living paycheck to paycheck.

2021 Rental Terms and Lease Expirations

Spring is a time for lease renewals or preparing to re-rent a house.

Spring and Summer are times when people are most active in the real estate market. It’s the best time to be listing your house for sale and for rent, which may yield you a better sale/rent amount because of greater competition. This timeframe is likely most active because of the better weather for moving and the school year – if a family is looking to move, they’re more likely to do it when they don’t have to transfer their kids to a different school district mid-school-year. Personally, when I was in college, nearly all the rentals were available in May or June. I remember being frustrated that I couldn’t get an August lease and had to pay for the summer months even though I’d be back living at my parents’ house. Now that I’m older and have more experience, it all makes sense. Below, you can see the increase in applications processed by SmartMove (the way we process tenant applications) that occur during the summer months, which indicates the most active time in the market.

We have seen this reflected in our days-on-the-market and rent prices. When we can list a house in the Spring months, we’re able to get it rented with very few days vacant. Houses that we’ve closed on at the end of the Summer (when school starts) and in the Fall have taken us more time to find a tenant, and we’ve had to reduce our asking monthly rent amount.

For those houses that we had purchased in a less-opportune time of year, we’ve worked to get them back to a Spring-time market for renewal.

  • We purchased two in September 2019 that we weren’t able to get rented until November 1st that year; we offered those tenants an 18 month lease so that their lease expiration would become May 31st.
  • We did similar with a house that we purchased in August. After that first year, a prospective tenant tried negotiating the list price for rent, and we said we were willing to reduce the rent a bit for an 18 month lease; they agreed, and we got our rental on a Spring renewal.
  • We recently had a tenant break their lease (with our concurrence), so that house has a lease expiration of October 31st now. We intend to offer a 6 month lease term to that tenant when the time comes.

With that said, we have lots of activity at this time of year.

We have 9 houses in Virginia and 3 in Kentucky. These markets are so different for us. We do our best to work with our tenants to encourage them to continue renting with us. I wrote about this in detail in my Tenant Satisfaction post.

Here’s a break down of how we handled all the leases that are expiring at this time of year.

In Kentucky, one lease was set to expire at the end of April and another at the end of May. These two properties are under a property manager. She attempted to increase the rent for a new lease term, but the tenants pushed back. Landlords don’t have a lot of leverage in a pandemic. Since the property manager is the one who handled the communication, I don’ t know what the details were. We believe both these houses are rented for less than market value, so that’s unfortunate. But, we’re grateful that both tenants renewed their lease for a year, so we don’t have to work to turnover the houses. Within reason, we’d always rather rent for a few bucks under market value than to handle turnover and lost rent (vacancy) by trying to maximize monthly cash flow.

In Virginia, we have an array of situations. Richmond was quick to acknowledge the property value increases that have occurred over the last year or so. This means that they increased our assessments, which effectively increases our property taxes.

We have the first two properties that we bought in that market, which are next door to each other and both have long term tenants (one since we before we purchased it, and the other is the second tenant who moved in a year after we purchased). We inherited their rent at $1,050, and then we increased it to $1,100 two years ago. With the property assessment increases, it was time to raise their rent again for this July. I initiated a letter to each of them stating the rent will increase as of July 1, which gave two options: they could leave the property by June 30th in accordance with their lease, or they could sign on for another year at the increased rent rate. Both chose to stay in the property, and they signed another year at $1,150. This is still below market value for the houses, but we’re happy with the lack of maintenance needs in these houses over the last 5 years. We’re in the middle of replacing the flooring in one of the houses. That house has a family of 5 and a dog living in it, so it’s not surprising that it’s worn out faster than the identical one next door with one person in it.

We have a 2 bed, 1 bath house that rents at $795. She’s been in the house since July 2018, which means that her lease ends June 30th of this year. Based on the 1% Rule (i.e., we’re looking for the monthly rent to be 1% of the original purchase price) for this house, our rent goal is $635. Since we’ve exceeded that goal for the life of our ownership, and the house hasn’t cost us much in maintenance, we chose to not increase her rent if she wanted to renew for another year, which she did. She has also spent some of her own money to spruce up the house and make it her home, and we recognize the value to us that her efforts also bring.

Another house reached out to us and asked if we were willing to renew her lease for another year. She’s been there since we purchased the house in 2017, and we’ve never increased her rent. She usually pays rent early and doesn’t ask for anything. The 1% Rule puts us at $660, and we’ve been collecting $850. Since we’ve been lenient on rent increases, I thought it a good idea to re-evaluate her terms. I plugged all the numbers into Mr. ODA’s calculation sheet to see how we were doing since the taxes increased so much on this house. Our cash-on-cash return (which we aim to be at 8-10%) came back at 19.8%. A rent increase for the sake of increasing rent isn’t worth it for such a good tenant, so we agreed to renew her lease for another year at the same rent. She wrote back: “omg thanks so much for the good news!” Happy tenants = good tenants, remember?

As for the others that I haven’t mentioned:

  • Two of our houses were put under a two year lease last year, so they didn’t require any action from us this year.
  • We have another house in KY that has a lease ending 7/31 and is under a property manager. We’ll offer a renewal option for them (i.e., we’re not interested in asking them to leave), but we haven’t worked out those details yet. Since we’re very hands off for our KY houses, we don’t know the satisfaction level of those tenants to gauge. Historically, we’ve had trouble renting this unit, costing us long vacancy times, so if we can renew their lease for even the same rent, we’re happy. Plus, having a 7/31 end date starts pushing us closer to the Fall for any future year-long rental agreements.
  • One of the houses that we have with a partner has a difficult tenant. I mention the tenants almost every month in the financial updates because they don’t pay their rent on time, and getting information out of them is like pulling teeth. They’ve rented there long before we owned the property, and their rent has always been $1,300, which is well below market value. We plan on offering them a drastic rent increase and a new lease term (we’re still managing under the previous owner’s lease agreement) in July for their September 30th expiration term.

While we don’t have any houses to turn over, we’re going to get into each house this summer. Since so many of our houses don’t typically have turnover, we don’t get into them as often as we should to make sure things are running correctly (i.e., don’t want small issues to go unnoticed and cost us in the long run). Specifically, we need to make sure that the HVAC filters have all been changed and verify there aren’t any red flags. I plan to give the tenants at least a month’s notice before we enter, so that if there are any maintenance activities they should have been performing, they have time to get it situated. I’ll walk through with our typical move in/out inspection form and note any concerns or areas of interest. I also understand that by being visible, I’m opening myself up to being asked for things that a tenant may not necessarily ask for via email or text, but I’ll cross that bridge when I come to it. For now, we’re just grateful that we have no houses to turn over and no expected loss of rental income for the year thus far!

House 5: Bought and Sold

This was a mess. I learned my lesson to research each property individually and not to make any assumptions. I also learned my lesson to hold true to our standards and expectations for a renter. We owned this house for a year and a half, but we learned a lot about tenants and the selling process. Hey, every struggle is a learning opportunity for next time, right!?


Mr. ODA showed me House 6 first (5 and 6 closed at the same time, and on my numbering list, this one came second… so try to overlook this awkward numbering!). I researched the area and the house’s history in detail, and I decided that it was worth pursuing. Very shortly after that, he approached me about House 5. The house was in better condition than House 6 and was literally only half a mile away. I assumed it was in the same neighborhood. I was wrong, and that’s where things went downhill fast.

LOAN

This house was so cheap that we needed an exception approved to get a loan. The purchase price was $60,000, which means a loan with 20% down is $48,000. The cutoff for even approving a loan with our regular lender is typically $50,000. Since we were below that threshold, we were ‘penalized’ by the rate.

I covered the closing snafu in the House 6 post, which also highlights the decision-making on the loan terms. Since this house was below that $50k threshold, our options were: 5.125% with a $200 credit or 5% with no credit. The higher interest rate would cost us an additional $1300 in interest, which isn’t offset by the $200 credit, so we chose the 5% rate. Hindsight: If we had known we would sell it just 18 months later, the credit would’ve been the better choice!

We purchased the house in July 2017. We immediately started aggressively paying towards the mortgage since it was the lowest balance and the highest interest rate.

We rented the house for $775, which far exceeded the 1% Rule.

WORK ON THE HOUSE

We did a lot of work in the yard. Here’s what the house looked like at some point before we owned it. It’s cute!

While it was under contract, the house sat vacant, so there were a lot of overgrown bushes, flowerbeds were filled with debris and no remnants of flowers having lived there, the lawn hadn’t been cut in a long time, and the tree in the front left had been removed at some point, leaving behind a mound of a stump and mulch that also collected debris. It’s a shame, and I kind of wish we had brought this little 2 bed/1 bath house back to life like it was in this picture. But I digress. Although this picture shows that the previous owner took care of the property, and that’s what attracted us to the purchase.

The floors were in immaculate shape, and the kitchen was quaint, but in decent shape. We purchased a new refrigerator before we could list for a tenant.

The bathroom needed a lot of help, but we didn’t want to overhaul it. The medicine cabinet wasn’t working anymore and the glass was cracked, so we wanted to replace it with just a mirror that covered the old medicine cabinet hole. Interestingly, we found a stash of 100s of razors behind it! (Apparently this is a thing from times gone by. You finish your blade and then you shove it behind the medicine cabinet for it to reside in the wall for all eternity.) We had several plumbing issues in the house. The drain pipe for the tub had multiple kinks in it, which caused the water to drain slowly and be more easily clogged. This would have been a major overhaul to get new plumbing installed in a way that was more direct.

The electric in the house was in need of work. We fixed quite a few electric-related-things while we owned it, but re-wiring the house was a major expense that would’ve come due in a few years.

TENANT ACQUISITION

The house was in great condition, had a big lot, was in a located close to the downtown area, and was on several bus routes (I even had a bus driver stop and ask me what the rent was on the house while I was working out front). It seemed like a great investment. We had several showings to qualified individuals….. who then went home, researched the house, and saw that it was in the highest crime area on Trulia’s crime map.

After sitting on the market for 5 weeks, we lowered our standards. There’s a reason you have standards as a landlord – it’s because if you select the right tenant, you’re saving yourself time, money, and headaches in the future. Here’s the email from our property manager. There are multiple red flags, and yet we gave her a chance.

The prospective tenant provided us with an employment verification letter showing that she had just started a new job, her most recent pay stub corroborating the employment verification letter, and wrote a decent introduction in her application. Between it being 5 weeks with no tenant and it now being mid-August (with it harder to rent in the Fall), we overlooked her credit score of FOUR HUNDRED AND FORTY EIGHT (448) and SEVEN (7) accounts sent to collections. I don’t recommend you do this. Oops.


EVICTION

This is the fun part to recount. It’s detailed, but I think it’s interesting.

RENT COLLECTION

She moved in August 2017. By December 2017, we already had enough issues that she wasn’t going to be trusted going forward. We’re very flexible landlords, and we’re happy to work with you on any issues as long as they’re communicated up front and timely (meaning, if we have to continuously reach out to you for rent, you’re not in a position to ask for favors).

We had allowed PayPal to be used to pay rent, but every month there was an issue. She either sent it in a way that incurred fees (after being told that she would be responsible for such fees) or it was sent in a manner that caused PayPal to hold the funds and not immediately release them. After December’s rent was late, the late fee wasn’t paid in full, and there were fees taken out by PayPal, we cut her off from electronic payments. Our property manager informed her that going forward, all rent had to be received by her office (either by mail or drop off) before the 5th.

Speaking of flexibilities – we noticed that she needed to send us rent based on each pay check, versus having all the rent money at the beginning of the month. She was paying us a late fee every month. Her rent was $775, and her late fee was $77.50. That meant every month, we were collecting $852.50, which really wasn’t necessary. We offered a change to her lease terms – rent was due on the 1st and 15th. As compensation on our part, rent would be increased to $800, split into two $400 payments. However, if rent was late, the late fee was now 10% of the late payment ($40) or up to $80 if she was late on both installments. She agreed to this, as it saved her money each month and set her up for success by being able to set up a system with each of her paychecks. We didn’t like that our relationship with the tenant had come to us hounding her over money, so we thought this was the best path forward for both sides of the party. Here’s the addendum to her lease.

And yet this didn’t change anything!! The addendum was signed at the end of January 2018. She paid February’s 1st $400 late. Then she didn’t pay February’s 2nd $400, and we had to reach out to her several times before even getting a response… after she also didn’t pay March’s 1st $400.

Our property manager filed unlawful detainer (eviction) with the court, and that got the tenant’s attention. She then had to pay the balance due, as well as the court filing fee, before March 30th (court appearance date) to dismiss the court action. She showed up to court with the cash to pay and then everyone just went home. You can’t evict someone who has paid in full, even if the process of collecting rent was unnecessarily burdensome.

And then came April. There was another story about a medical emergency and a new job on the books. We had agreed to a new one-time schedule for April’s rent payment, and she missed those deadlines and was incommunicado. We sent her another default notice on April 25. Note that this medical emergency was for her “husband.” This is the first that she had implicated herself that someone may be living in the house other than her and her son. She paid her balance owed on May 4th.

On May 8, she was given another eviction warning notice for lack of May rent (the 1st $400) and gave no response to requests for information on when to expect rent. After continued lack of payment after that notice, she was served with another eviction notice. On May 17, she was given 30-days notice to vacate the premises by June 17, 2018 at 5:00 pm. But then she paid in full and on time. We then changed her lease terms to state she was on a month-to-month basis and she would be granted 30 days notice when we (or she) decided to terminate the lease agreement. It was signed on July 16.

Guess what? She didn’t pay September’s rent. At this time, we also addressed her husband.

She was married when she applied, but we didn’t know. Just now as I was looking back through our files to write this post, I saw that her pay stub she used for employment verification said that she was filing her taxes as married. I hadn’t seen that before. In all our visits to the house, there were always other people there. There was one man that seemed to be around 90% of the time. We overlooked it, but our lease did stipulate that anyone who stayed for more than 2 weeks was required to pass a background check and be on the lease. I strongly suspect that this individual was not going to pass a background check, which is why it was never disclosed to us that she was married and another adult was living there. Our property manager informed her that only she and her son were on the lease, and that if anyone else was living there, they had to be on the lease. She asked if we were referring to her mother-in-law visiting, our property manager said that it appeared to be her husband was living there, and then she ignored us.

We gave her our 30 days notice on October 5 to vacate, meaning she had to be out by November 5. Our property manager reached out to her on October 26 to see if she would be out earlier and set a time for key pick up. The tenant nonchalantly stated she wouldn’t be able to make it out by the 5th and she’ll be out by the 9th. Umm, excuse me, ma’am, but that’s not how this works. We held strong to the 5th and she lost it. Our property manager said that her lease is over on the 5th, and if she was not gone by then, the court fees would be her responsibility for us to get the court and local police department involved for her removal. She got angry and claimed that we didn’t handle the rental well at all, that we couldn’t charge her any court fees, and that she should charge us for not being able to use her tub because it was clogged (guess what on this one? The plumber removed things like a dental floss pick from the drain, immediately making it her fault (and at her cost) for said clog). She then said: “Lets just hope your (sic) as speedy with my deposit as you all were with terminating the lease.” I laughed out loud on this one just now. We should have terminated her lease an entire year before this discussion happened, but we kept working with her! Hysterical! Gosh, and to think this wasn’t our worst eviction process (more to come :)).

SELLING

A friend-of-a-friend was attempting to purchase a house in the same neighborhood as this house, and they ran into multiple issues causing them to walk away from other deals. Mr. ODA approached him with an opportunity to sell this house, which had similar specs to the one that they were pursuing. The buyer spoke to his wife and father about the deal and agreed to move forward. Of course, this deal was not easy.

The contract was ratified on October 31, 2018. We didn’t close until January 8, 2019. Our typical close time on our purchases is 4 weeks. We’ve done faster, and we may have done a bit longer if the time of month lined up better for our finances, but over 2 months was horrendous. Since our tenant was moving out on 11/5, and the closing was expected to be no later than November 30th, we didn’t pursue finding a tenant.

The appraisal was late being ordered, which was somehow allowable. Then it came in at the beginning of December at $65,000; our contract was for $68,000. We split the difference ($1000 from the buyer, $1000 from the seller, $1000 from the agent who was dual representing).

On December 18, our Realtor finally pushed back on the buyer’s side of the transaction to get things done. But it was Christmas time now. With so many offices closing for the end of the year, we weren’t able to get a closing date until the first week of January. The buyers were signing paperwork from Pennsylvania, which caused more delays because of having to send the paperwork back and forth for everyone’s signatures.

We sold in January 2019 for $67,000, after having purchased it for $60k just 18 months earlier. While this seems like a great deal, it’s not an automatic $7k in our pockets. You need to account for our closing costs from the purchase and sale (about $6,500), loss of rent for two months while trying to close the sale and the 6 weeks of no tenant when we purchased it, utility costs associated with vacant times, and costs to fix things around the house during our ownership. However, during that time, we had a tenant paying our mortgage (covering the loan interest and paying down the principal), and we were collecting more rent than projected because of her continued late payments.

1031 EXCHANGE

We made the decision not to pursue a 1031 exchange on this house. A 1031 continues to defer the depreciation to the next property, and it allows capital gains to be deferred. Based on current tax law, it can be done infinite times. However, there are extra lawyers and fees that come into play, so it becomes worth it when you have big dollars at stake, and that you have another property to purchase quite quickly after selling the first one.

The appreciation on the house was minimal given that it had only been 18 months since purchase, we had two sets of closing costs to add to the cost basis, and we hadn’t earmarked a place for that money to go upon selling. Plus, the cost of an intermediary would continue to eat into the “profit” versus tax paid, so we just went ahead and planned to pay capital gains taxes on it. Unfortunately, since we had depreciated the structure and the fridge over the prior 18 months, that paper money had to be brought back into the fold when calculating our taxes the following April. That’s several thousands of hidden money that is easy to forget about.

Depreciation is a great tax break when you own the property. The IRS assumes the value of your asset is being reduced by wear and tear and father time. This is true. It’s why if a landlord neglects the property and isn’t active with maintenance, renovations, and other replacements, the property will turn into a trash-heap in time. However, when you sell the property, you show the IRS that it in fact did not do that. If someone is willing to buy my property for more than I bought it for, then it obviously didn’t depreciate to a lesser value. I have to pay the IRS back for the depreciation assumptions that I was allowed to make over the time I owned it, plus pay the tax on the actual profits. Bummer, but logical.


In summary, we bought a cheap house and got a poor tenant. We had a TON of headaches with that tenant. We had to do a few house/yard projects over the ownership life of the property, but nothing worrisome and not already built into our numbers. Somehow, we made it work that eventually the tenant always paid up and then some (late fees). We made mistakes, we learned lessons. We figured out a set of streets to avoid for future purchases, learned how to sell an investment, and learned how to file taxes on an investment property sale. The story is fun to look back on. I’m glad we experienced what we did. But I don’t want to do it again.

Doing Your Own Taxes: Set Yourself Up for Success

I manage all the financials for my family. Mr. ODA makes the maneuvers, and I record them. Excel is where our organization lives and dies. Sure, I have a degree in Finance and Information Technology Management (i.e., Excel), but it doesn’t need to be complicated or difficult to make tax prep easy for you.

This level of organization allows us to do our own taxes. After the first year of purchasing rental properties, we thought we’d have to hire someone to do our taxes because it would be complicated. It’s not any different than filing your own personal taxes. The software systems available online walk you through the entire process. Each property’s income and expenses have to be entered separately, which is time consuming if you have several properties, but it isn’t difficult.

The most important thing to be ready for your taxes is to make it a whole year activity. If you record income and expenses as they occur, it’s less of a hurdle when the year is over. By recording the activity all year, it then becomes a verification process when the year is over, thereby reducing the possibility of missing something or recording something wrong.

At the beginning of each year, I create a projection of income and expenses, which helps Mr. ODA adjust his W2 tax bracket throughout the year so that we break as close to even or owe very little when it comes to tax filing. Let me dive into that aside quickly.

Go back to Mr. ODA’s tax posts:
TAXES! Part 1 – What are Marginal Tax Brackets?
TAXES! Part 2 – Is Your Bonus at Work “Really” taxed more?

Taxes Part 2 is what I’m particularly referring to, but you may need the lesson in Part 1 to know what that means. There are IRS penalties if you fail to pay your proper estimated tax (when you don’t pay enough taxes due for the year with your quarterly estimated tax payments, or through withholding, when required). Title 26 of the United States Code covers the penalties. Essentially, the IRS is saying, “You have to estimate your annual taxes owed, and you’re not allowed to only pay us taxes on April 15th every year, but you have to pay the taxes over the course of the year.” People get excited to receive a refund from their taxes, but really that’s just an interest-free loan you’ve given the government. Perhaps some people do need that forced savings, but wouldn’t it be nicer to have that extra money in your pocket throughout the year?

Back to the point…

I create a new workbook every year with each house having its own spreadsheet. Schedule E is going to require you to put your income and expenses, per property, not as a whole, so it’s important to have expenses assigned to a particular house. I set up each spreadsheet in an Excel workbook to identify all known costs for the coming year. Not all of these apply, but these are typically the categories of my known costs for each year: property management, HOA, utilities (City of Richmond bills the owner (not tenant) for sewer fees), property taxes, insurance, annual mortgage interest, cost basis depreciation, and prepaid points depreciation. There’s also a chance that you’re carrying appliance depreciation costs (meaning, the purchase of a washer, dryer, refrigerator, etc. aren’t recorded as an actual expense in the year purchased, but are required to be depreciated over its useful life).

As the year goes on, I record any mileage (record the actual miles along with the mileage cost) and maintenance costs. The IRS posts the standard mileage rate for each year here. If a roundtrip to a rental property is 40 miles, then the expense is calculated as 40 miles multiplied by the standard mileage rate, which is $0.56 for 2021. I’ve learned over the years that the software systems just request your miles and do the calculation for you (which is smart and safer on the calculation side), but we want to know what the calculation is going to be, so I enter it as $22.40 in my spreadsheet.

You’ll be expected to input the days your property was vacant, so record that once it’s known.

Each spreadsheet is linked to a master sheet at the beginning of the workbook that shows the net income and expenses for each property. The difference of these amounts are what Mr. ODA uses to adjust his W4 deductions.

I personally assign costs month by month so I can keep track of them, but it doesn’t even need to be that fancy. A running list of these expenses are enough.

The categories are based on what’s going to be requested through Schedule E.

Then in January/February of the following year, I go through my filing cabinet and my email to ensure I’ve captured all of the expenses that I have receipts for, and vice versa to ensure that if I’ve recorded an expense, I have a receipt for it. Having already captured the expenses throughout the year serves as ‘checks and balances’ and doesn’t make the task feel too overwhelming.