How We Bought our FIRST Investment Property

Rental Property #1 - Central PA 4-plex!

Rental Property #1 - Central PA 4-plex!

My wife and I purchased our first investment property in June of 2015.  Looking back on it, I was a complete newbie and didn't know what I was doing, but this property has been working out so far! I had read a few books but had barely scratched the surface on the wealth of information out there.  

To use a popular cliché, I didn't know what I didn't know! I still hadn't discovered Bigger Pockets or even the life-changing book, Rich Dad, Poor Dad! I also hadn't become the avid podcast listener that I am today.  I had never attended any local REIA (Real Estate Investor Association) meetups.  I hadn't met any mentors.  I didn't know the proper way to analyze a property and determine my estimated Cash-On-Cash Return.  I didn't understand lending, I didn't have the right buying criteria, I knew nothing about insurance, and the list goes on and on.

I also didn't know some of the amazing benefits available to real estate investors such as tax depreciation and leveraged appreciation.  I just knew deep down that it just seemed like a good idea!

I suppose the nice way to say it is that I was just "naively bold".

The Story

Investing in real estate had always interested me, but I became more serious about it after reading a few books and doing some back of the napkin math.  I began asking around to find a reliable real estate agent to represent me as a buyer.  Luckily I found one that was very patient with me as a newbie and someone who really didn't know what they wanted yet.  I told him that I was ONLY interested in multi-family (at the time, this was the case).  I looked on Zillow and for multi-family buildings, sent them to him, and he set up the showings.

I learned quickly that setting up showings for multi-family apartments are a PAIN.  Tenants need to have 24 hour advance notice, and many times there was miscommunication leading us to thinking that tenants were notified when in fact they were not.  This led to many awkward encounters with tenants and many times we weren't able to see a place because the tenants refused to let us in (or they were sleeping, or they were sick, or they had a ferocious dog, etc. etc.)

I also learned very quickly that it takes a lot of work and time to create "passive" income! Between finding the properties, coordinating with my agent, the listing agent, the owner and the tenants, researching sales and rent comps, it can be a long and tedious process just to FIND a deal.  This was one of the main reasons that I eventually decided to try turnkey investing a year later.

My initial buying criteria for my first property was exactly the opposite of what it should have been.  I was looking for properties that "I would be comfortable living in myself" which is a terrible way to vet potential investments.  This also probably caused me to pass up many opportunities, because let's face it, most of the 2-4 unit housing stock in Central Pennsylvania is 100 years old, small, ugly and weird!

The Deal

I finally found this deal in late April of 2015.  My agent texted me to let me know that a 4-plex was just listed in a small college town about 20 minutes from me.  The building was fully occupied, in a good shape, and performing, so my agent thought we should go look at it quickly (he was right).

The property was listed for $250,000 (I ended up getting it for $235,000), and each unit rented for about $550.  However, it was written in their lease that if they paid on time, they would get a $25 discount (I'm not crazy about this policy and have gotten rid of it once the tenants signed new leases.  I would rather charge a late fee for late payments.  However, existing leases remain in effect when the property is sold and the new owner is usually bound by the existing lease).  So, the total monthly rents ended up being around $2100.

This is not ideal - I did not know about the 1%/2% rule at the time, but this comes out to .89% ($2100 monthly rent/$235,000 purchase price).  Also, the 1% rule works more for single family investments because it only takes into account the gross rent.  For multi-families, many times the owner pays for some or all of the utilities, meaning you should really look for 1.2% or more on multi-family properties.  For this deal, the owner pays for water, sewer, and trash, which adds up to over $3,000 per year.

At the time, I liked this deal because I saw opportunity to split the utilities and bill them to the tenants (which I've found is harder/more expensive than it sounds) and also to raise the rents (I estimated they were under market by about $75-$100).  Although I did not understand how to calculate cash-on-cash return at the time, thankfully I was smart enough to create a proforma to determine if I could consistently cash flow!

My wife and I bought and financed the property in both our names.  We obtained a 30 year mortgage fixed at 4.25%, with a 25% down payment.

Below is an image of the exact spreadsheet that I used to evaluate the property.  Please note: this isn't necessarily wrong, but I definitely left some things out because I didn't know better!

My proforma on my first rental property (I do these a little differently now, but wanted to show you my first back-of-the-napkin math).

My proforma on my first rental property (I do these a little differently now, but wanted to show you my first back-of-the-napkin math).

So, at the time, this met my way-too-simple criteria of: a) does it cash flow positive? and b) would I be willing to live there? (reminder: my criteria has gotten much more sophisticated, and better, since then!)

I think that two things ended up making this an OK first deal:

  1. I was right about the units being under market rent. Currently, 3 are rented for $595, and one is rented for $625. Plus no more $25 incentive to pay on time. That brings total rents to $2410 per month (up from $2100), and that extra $310 is pure extra profit.

  2. During the inspection, multiple high-dollar maintenance issues were brought up, and I was able to negotiate a seller credit of about $17K for a new roof and other items. I ended up paying only about $10K for the roof and other items to fix. That extra $7K was kept in the bank as my first cash reserves!

Lessons Learned

Almost too many to list! But I'll make sure to hit the big ones:

  1. Be specific about your criteria. As I've stated multiple times, "would I be willing to live there?" is a terrible investing criteria! Start with specific characteristics and metrics, THEN find properties that meet those criteria.

  2. ONLY schedule showings on properties that meet your initial criteria before looking at them. Don't waste your time or your agent's time looking at properties that you'll never make an offer on anyways.

  3. Make your offers based on your criteria. Who cares what the list price is...make an offer that makes the numbers work for YOU.

  4. Learn to look for high dollar items that need to be fixed or replaced (think roofs, furnaces, water heaters). If you can get these replaced (or seller credit to replace) then this will limit your capital expenses in the future!

  5. When possible, find your team BEFORE you find the deal. This includes but is not limited to: mortgage broker, inspector, real estate agent, insurance agent and (most importantly) the property manager. I had to scramble to line up the property manager and I think this got us off to a rocky start.

So there you have it, the details from my first deal! If you have any questions or noticed any key details that I left out, please leave me a message in the comments!