My first RE investment before the first rent check
My first post while riding the ripple of closing on my first investment property
Why?
I followed the path I was taught since grammar school: go to school, get a job, live below your means, save your money, retire. While also following my family method of arrive early, work hard, be dedicated, go the extra mile, get married, buy a house, have kids, do your best to be happy.
I have followed these regimes since I was 10, starting with cutting, splitting, and stacking wood, pet sitting, yard work, and many other forms of physical labor. Followed in highschool by skilled labor working with drywall, cement, auto mechanic, dirt related construction, and still other forms of physical labor. Moving on to college with skilled labor, machinist, dirt construction, and retail sales. Until I made it to the much talked about white collar desk job, at least one ruptured disk, and house payments.
More than 30 years later and 10 years of desk job… which turns out to be another form of skilled labor. I still have a mortgage, I am still concerned about having enough money for retirement, medical issues still cost more than insurance covers and steals time as well as having prevented children.
I want time to spend with family, time to be there for foster children, time to travel, reduced concerns about how to pay for living.
In this post I will have to gloss over how I arrived at the stage of wanting to invest in real estate. Short form: I had flirted with the idea of RE/investing while still in construction but became distracted by desk job and medical costs.
Where does the money come from?
Being a fan of education and fairly skilled at the art of Google I turned to the internet to educate myself. Flipping, rehabbing, and wholesaling were active forms of income not something I would have time for, but buy and hold resonated.
Through living below my means my whole life and maxing out my IRA for the last 20 years I had managed to accumulate a reasonable sum. However I am not 59 ½ and distributions needed to be approached cautiously. Fortunately when I opened my IRA account I did not want to believe I would make less money when I retired than I did currently so I made it a ROTH IRA with the anticipation that I would be in a much higher tax bracket at retirement (why do people buy into the concept of a lower tax bracket at retirement anyway?).
Some research indicated, because I had a ROTH IRA, I had already paid tax on the contributions. My ROTH IRA was over 5 years old which allows me to take up to all of my original contributions out without penalty or additional taxes (remember, with a ROTH I paid the taxes before investing).
https://www.law.cornell.edu/cfr/text/26/1.408A-6
Q-1. How are distributions from Roth IRAs taxed?
A-1. (a) The taxability of a distribution from a Roth IRA generally depends on whether or not the distribution is a qualified distribution. This A-1 provides rules for qualified distributions and certain other nontaxable distributions. A-4 of this section provides rules for the taxability of distributions that are not qualified distributions.
(b) A distribution from a Roth IRA is not includible in the owner's gross income if it is a qualified distribution or to the extent that it is a return of the owner's contributions to the Roth IRA (determined in accordance with A-8 of this section). A qualified distribution is one that is both—
(1) Made after a 5-taxable-year period (defined in A-2 of this section); and
Q-8. How is it determined whether an amount distributed from a Roth IRA is allocated to regular contributions, conversion contributions, or earnings?
A-8. (a) Any amount distributed from an individual's Roth IRA is treated as made in the following order (determined as of the end of a taxable year and exhausting each category before moving to the following category)—
(1) From regular contributions;
(2) From conversion contributions, on a first-in-first-out basis; and
(3) From earnings.
(b) To the extent a distribution is treated as made from a particular conversion contribution, it is treated as made first from the portion, if any, that was includible in gross income as a result of the conversion.
It helped a great deal, for the math, that I had made full contributions each year up to this point. While the maximum contribution amount changed each year it is easy to look up the historic contribution limits.
While researching where I could get money from, I had come across another concept using whole life insurance. While I generally agree with Neal Frankle’s perspective in the BP podcast 5 about the utility of term life insurance vs whole life insurance I am also willing to look a little further at whole life as a tax free ~5% interest bearing bank account. This concept deserves a much more in depth write up and can be looked up under names such as the 770 account, Income For life, Infinite Banking, etc (no I do not sell insurance, nor have I received or anticipate receiving any reimbursement for these statements). The point being to not view whole life insurance as insurance so much as a tax free ~5% interest bearing accumulation account with a bonus of life insurance - for an up front fee (in my case the fee is anticipated to be completely recovered after 6 years of accumulating interest – I hope all my investment properties do this well). I am sure there are many insurance agents salivating to sell you whole life insurance – do your due diligence and make sure they know what the heck they are doing before going down this road (like I hear about property investing, it is great when done right and miserable/expensive when done wrong).
I bring the 770 account up because it allowed me to lock in a base at 4% compounding annual-variable-rate on the funds I sourced from my IRA account and it allows me to make unquestioned loans on the cash balance (I had a significant lump sum which required a policy rider to keep the amount of insurance purchased at a minimum while making as much cash value available to me to borrow against. Note: at year 3 all the cash I put into the account will be immediately available to me as a policy loan).
Now I have identified the source of my funds, I have leveraged them for a hedge against disaster. It is time to shop for some income producing assets.
Where do I invest?
BiggerPockets is a fantastic and informative community. I was convinced low-time-invested deals in my local area would be few and far between… until the next housing crash. For example a quick search indicates a typical price in my neighborhood would be around 400k while it would rent for around 1900/month. The investment to make buying such a place cashflow-positive would be a poor return.
The term “turnkey real estate” sounded too good to be true. Someone else finds a deal, rehabs the deal, property manages the deal, and sells the house to me at a cashflow positive price? Why would anyone do that?
I did some homework on the turnkey operations identified through online research. I found several that seem on the up-and-up and chose the one I did because I was able to interview a current client of theirs who agrees, for the last 3 years they have delivered as advertised.
What kind of property do I invest in?
If I understand my market criteria this would be a B neighborhood. Prices are going up slowly, schools suck, and a great deal of blue collar industry to support.
How the deal went down
I signed up for their turnkey process to become an investor (December). I identified one of the available properties I was interested in and committed to buying it (February). I visited the place to see that they were actually doing the work, meet the team, and get a tour of completed units (March). The rehab of the place took a month longer (April) then anticipated due to the unusually cold weather delaying all exterior rehab components. I signed on to use the property management umbrella insurance policy, the recommended broker, and the ASHI certified inspector.
While nobody from the turnkey said so, it seemed like my inspector and the appraiser were a bit premature (March) due to the delays. As a result the fixit list included items easily addressed (missing lightbulbs) and major components that had not had the rehab replacement installed yet (Air conditioning unit). Also the area has a 90 day 3 mile comp requirement for appraisal and nothing similar had sold during the cold spell. So the appraisal came in 12+% lower than the initially agreed upon price (original numbers were cashflow positive ~250/month – assuming my newbie investing numbers are accurate and no typos in the BP calculator).
I am anticipating years/decades of working with this company and do not want any part of the turnkey operation harboring negative thoughts. The numbers show cashflow positive at the original price so anything less would be that much better. Being a first time investor I was not sure what would happen next.
It was easy for me to agree to splitting the appraisal difference 50/50.
Goodwill
The turnkey owner also offered seller financing at 0% and for me to name an end time for payoff… since the sum above the appraisal price would not be financed. While this would be easy to agree to from a financial aspect, this is where I had a little room to earn some positive thoughts back. I already had the downpayment/closing-costs cash ready for the original price. Additionally the closing costs should have gone down by the reduced interest on the reduced principal amount allowing for more room. The lack of comps in the area would not be helped by a lower closing price.
I chose a number as high as I could go (with the existing cash) for the new sale price and opted to divert the cashflow from the rent payments to cover the remaining difference.
The end result is what I believe to be a fair deal, the turnkey owner did not get the asking price and 0% financed some of the price, and the comps for the area will be slightly higher for the next 90 days. While my cashflow will not start for a while on this property, my cashflow will be a bit higher from this property when it does finally flow and my DTI will be slightly lower than it would have been (while it still matters).
The renter moves in tomorrow (from the day I am writing this). May the renter have a long, happy, prosperous, and quiet tenancy.