This is long, both due to the complexity of the deals and my own writing style. I do think it will be worth your while if you learn one thing though from it. Also, Scott Britton would probably not approve of the way I used leverage in this transaction. I would also like to thank everyone at CRE Online and Ed Garcia for their input when I needed it.
Jump back to March of this year. I had just left law school after deciding to return to the computer business. Five years ago I had ordered the staple beginner’s course (Carleton Sheets) and had taken Chapter 4 (building dynamic credit) to heart. Too much so, though because I had 13 credit cards with balances of ~$30,000.
However, I knew how important credit was so I made sure to never have a late payment. I knew that real estate investing was the only way to generate the cash flow I needed to rid myself of this ball and chain of consumer debt. On to the deals…
On the Realtors’ website (one of the big ones in St. Louis), I periodically do searches based on price and type of property. This time I found one that looked good from a numbers standpoint. It was a 4-family, with 2-bedroom units that were listed as being rented for $300 each. The price, however was only $20,000?
I called the realtor and found out that the building only has one unit rented and two of the units are boarded up. Before I even mentioned price, she said that the owner owns a lot of property and just wants to dump it and will take $10,000 cash.
My eyes lit up because even with one rented, that should cover the note. So I went off on my quest to find a lender to lend me the 10K. Most lenders will not lend such small amounts without charging a couple thousand in fees; that seemed outrageous to me.
So the idea I came up with was this: I told the broker to tell the seller that I could give him $1,000 now (which I did have) and the rest in 90 days at 20% interest. The seller accepted with no payments in the interim period. My plan was to refinance in that 90 days.
So we closed, and for ~$350 in closing costs I owned the property! Now, I spent the next two months fixing up the place with my new-found spare time while looking for a full-time computer position. It was in this time of fix-up that I found my second and third properties (again on their web page.)
This time it was two condos that were being offered as a package in a desirable part of the city (Central West End.) After calling the Realtor, I found out that it was a bank-owned foreclosure. The bank, however, would not separate the two but only sell as a package. This was scaring off much of the market.
The broker’s assessment of their value was $60K and $110K respectively. The asking price had just been reduced from $165K to $155K. I thought a deal could be had (since it had been on the market for five months and one was vacant), so I offered $122K.
We went back and forth, but ended up at $139,500, which I still thought was a good deal. My original plan was to flip the smaller of the two to make the down payment for the larger. So I set my sales prices in two contracts at $27,000 and $112,500. That way if I flipped the smaller for 60K, I could use the excess to put down on the larger. However as often happens in real estate investing, things do not work out exactly as you plan.
I could not find a retail buyer in time to do the simultaneous closing, so I started to look into creative ways to fund the purchase of both condos. I could rent the smaller condo for $725 and was planning on living in the larger.
I was then looking for a hard money loan on the smaller condo to pay the $27,000 purchase price with enough left over to put down 20% on the larger. My lender said that he could do loans of this type, but there would be very high fees and points as well as a 12% rate. However, this seemed like a good deal and paying the fees should be worth it.
About this same time I was starting on the refinance on the 4-family. Since I had no verifiable income, my mortgage broker said he can get my 70% cash out based on appraised value. My rehab was not complete and, actually, I had put it on hold because I had run out of cash (and credit). I did have one unit finished and rented out for $350 though, and my lender suggested that we get his appraiser to take a look at it.
Well, I met the appraiser and we went through the one completed unit and took pictures of the outside. The other three units were not looked at since the floor plan was the same. (While some may think I was misleading the appraiser by not showing them, I did state that I was not finished with the other three, but they would eventually look like the one we went through.)
I was hoping to get a value of somewhere around $50K-60K (which is what the comps suggested) and get $35K to pay off some bills and finish the rehab.
The next day, my lender calls me and tells me the appraisal came back at $94K! I know that this is somewhat of a “juiced” appraisal, but I am not trying to do anything illegal and the property will easily support such a loan when I am completed (rent of 3 x $400 + 1 x $350.)
After looking at the high fees on the other property loans, I have a moment of clarity lying in bed one night. Get the maximum loan amount on this refinance (70% * $94K = $65.8K), pay off the note $9K, use the rest ($54.8K) to put down what I have to on the condos to keep the rates and fees reasonable.
I left my refinance closing with a check for $53,888 which I promptly deposited. I ended up putting 15% on one condo and 20% on the other which ended up being ~$24K. This left me $30K to pay off those credit cards and the respective closing costs.
For tax reasons, I repriced the condos (which the seller allowed) as such. The appraisals on the two came back at $78K and $141K. I priced the smaller at $78K since it would be a rental (higher depreciation) and the larger at $61.5K since I would be living there and would write off $250K of gains when I sell down the road. This also lets me have a nice home equity line ($92K) to use for real estate investment.
The grand total works out as such:
Property with appraised values of $94K + $78K + $141K = $313K
Mortgages on these properties of $65.8K + $66.3K + $49.2K = $181.3K
Equity =$131.7K
Real cash out (after down payments & Closing Costs)=~$24K
Rental income (when rehab is done) of 3 x $400 + 1 x $350 + $725 = $2275
Mortgage payments of $541 + $525 + $427 = $1513
This leaves $762 per month to pay for expenses (condo fees, taxes, insurance, maintenance) etc., but this also includes me living for free. Not bad for a beginner with no real employment!