Reflections on the first year as a MF owner
We’ve just passed the one year ownership mark, so I wanted to use this milestone occasion to update the BP community on our progress with the 18-unit package of condos that we purchased from a retiring landlord.
First, a little background. My wife and I have been REIs since we were newlyweds in the mid-90s, when we followed the advice often offered here in BP and bought a duplex, renting out the lower unit to a tenant. The tenant paid the mortgage for the 6 years we owned the house, and with appreciation we walked away with a $75k gain after all expenses; i.e., we'd been paid about $1,000/mo to live in the house. We next bought a SF house which we rented out when we went to work overseas, which wasn't as good a money earner, but did teach us that we want to manage our own properties at this stage rather than turn things over to a PM. When we repatriated to the USA my company began moving us around, so we sold the SFR and took a hiatus from landlording, although we never stopped looking. A few years ago during the Great Recession, when at last we'd settled down, in metro Detroit, we picked up an almost-new short sale condo in an upscale area that is renting well, and a just-rehabbed foreclosure SFR from a flipper.
Exactly one year ago my wife and I closed on our first multifamily property, and I thought I’d use the anniversary to recap and reflect on the ups and downs of owning apartments in a Class B/C neighborhood. We decided to move into multifamily for several reasons, primarily to accelerate the pace of portfolio building so we could complete the building stage by our early 50s, with the goal of paying off the properties and maximizing cash flow beginning in our early 60s (we’re in our mid-40s now). We also found we were depleting our savings putting 20% down per SF house, and the market recovery meant that savings from our jobs and rental property cash flow was taking longer than we liked to accumulate to the point we could move on the next, more expensive, SF house. Finally, much time was being spent on looking for SF property. Right or wrong, those reasons were our motivation for looking at MF property.
What we ended up buying was a package of 18 one-bedroom condos in a city nearby my workplace, from a landlord who had accumulated them in blocks over the past 20 years, paying $400k for the package. The previous owner had paid ~$600k to accumulate the units. The properties had been on the market for some time, and were not in the best shape, so the owner was offering land contract terms with the agreement of his mortgage holder, a local bank that finances many properties in the area.
The units were all fully occupied when we purchased them, although it turns out a number were new leases perhaps signed in haste to boost the occupancy rate. We received almost no records from the previous landlord, aside from copies of the leases, and what financials we did get were hand written, so his record-keeping was shambolic at best. The proverbial bag of keys at closing wasn’t proverbial, it was our reality.
A few days before closing one of the units went empty, so one of our first acts as new landlords was to scramble to find new tenants, which started one of our first ‘learning opportunities'. The unit was in so-so condition, with beige carpeting, beige walls, beige blinds, and beige kitchen floor tiles. The kitchen appliances were very tired, so we immediately changed them, but aside from that we rented the apartment as-is. We advertised on Craigslist and via a sign in the window, and got most of our inquiries from the window sign, which should have been a clue that the unit didn't have visual appeal. We ended up renting to a couple of guys, recent immigrants with poor English skills that we had to communicate with via a translator. They both signed on the lease, which we thought gave us better than average security, but their tenantship turned out to be a moderate disaster. While they didn't wreck the place, and paid their rent on time, they had no respect for the ‘quiet enjoyment' clause of the lease, and immediately began attracting complaints from the neighbors. The HOA started issuing fines that escalated on every complaint, and the neighbors placed my phone number on speed dial on their phone. It was with a sigh of relief that I granted the request of the tenants to be released from their lease when their jobs transferred to the far side of the metro area.
Two important lessons we gleaned from this mini-debacle are 1) nothing is more important than leasing to good quality tenants, and 2) having a property that shows well and is in a fact an up-to-date place that’s nice to rent is critical to attracting and retaining good tenants.
As this was happening we were also learning the ins and outs of the local eviction process as we evicted tenants from two units who were non-payers. The process is straightforward, and from start to end takes one to two months, depending on which of two legal paths are pursued.
After the first tenant turnover, where we acted in haste to put so-so tenants in a so-so unit, we changed our approach on the next turnover. In that case, once the eviction was complete, we stripped the damaged carpets, had the hardwood floors refinished, changed the blinds, changed the light fixtures and added ceiling fans, and had the unit repainted by a professional. We also changed the kitchen appliances. On subsequent units, we went further, changing the kitchen flooring, changing the kitchen counter top, changing cabinet knobs (a small thing, but very noticeable), and changing sinks, faucets, and toilet if needed. In short, we updated everything that the tenants see and touch.
I've been very involved in all the work in the units, but it would be impossible without the help of a number of good contractors. The local REIA I belong to, Wayne County REIA, has been a valuable source of leads and advice. The wood floor refinisher I connected with via an investor at the REIA has done all the floor work. The HVAC guy and plumber both work for other owners in the complex and were recommended by multiple owners. I have a handyman who does counter tops, floors, toilets, and myriad other jobs, and a semi-retired painter and his housecleaner wife are a great combination I call on when a unit goes empty, and can do drywall and counter top work too. That still leaves plenty for me to do, including ripping out carpet and tossing out tenant-left trash, buying all materials, changing light fixtures, changing blinds, installing fans, and a dozen other small tasks that it takes to get an apartment move-in ready.
Besides renovating the interior of apartments, we’ve also spent considerable sums on HVAC and windows. One unit needed a completely new furnace and A/C system, one needed new central A/C, and 4 needed relatively expensive through-the-wall A/C units (2 more of those, plus one central A/C, will be needed by late spring next year). We began much-needed window replacement with $6000 targeted at the worst most-cracked windows, but we still have to spend about $4-$5000 for a number of large single pane (in Michigan’s frigid winters!!) and cracked window replacements before December.
Due to evictions (4), turnover (4), and abandonment (1), we’ve now completely (or almost, as noted above) renovated 9 of the 18 units. With the renovations, the units show much better, and we’ve had no problem finding tenants. We’ve raised rents on the renovated units, every one of which was rented at $500/mo, or less, to $550.
We’ve changed the rental collection method from those of the previous landlord so that we don’t go door to door collecting cash or checks like he did. All new tenants after the first few were required to sign up for rent payment by direct debit from their checking account on the first of the month. Existing tenants have that option, as well as the option of depositing directly into one of our company’s bank accounts, or mailing a check or money order using pre-addressed envelopes. Most of the existing tenants have chosen the direct deposit route, so there is no question whether their funds arrived on time or not.
Our new leases contain late fee provisions, and we quickly trained the existing tenants that the late fees in their original leases meant what was written. We typically have about 1 late payer out of the 18 units, sometimes 2, and they always include late fees with their payment. I don’t think the original owner enforced his fees, and he accepted partial payments, while we do not.
To keep track of rent payment, to generate invoices, to manage work orders, and to enable ACH direct debiting, we signed up for Rentecdirect.com as soon as we closed on the property. In general the web-based software works well, and I feel it is very useful for running the rental business. That said, it does not yet sync with my bank, so I maintain separate accounting in Quicken, which serves as the basis for our tax reporting and for balancing our checkbook, so I’m spending extra time (that I don’t have) maintaining much of the same info in two databases.
For lost rent due to vacancy and non-payment, we assumed that we’d have the equivalent of 1 unit continuously empty, and despite all the renovations, we only slightly exceeded that over the first year. Because the units are all the same, and we’re finishing them to the same standard, we’ve been advertising them as soon as they go empty, before renovations even get underway, as we can truthfully post photos of our final end product. As a result, we have had tenants lined up to rent before the work is completed, and we now usually have to expedite our work to accommodate tenant move-in dates.
To make renovation easier, and also general management, we’ve changed door locks on all our units to Schlage keypad deadbolts, with passage handles for the lower latch. Since the outer doors to the buildings the apartments are in (4 units per outer door) have a common key, I now only need one key and my master code to access all the units. Tenants like the keypads, and changing locks on move-out is simply a matter of deleting the tenant’s code.
If you’re thinking of going down the same path, small multifamily ownership, the two biggest lessons learned during our first year of ownership have been:
- 1.Have plenty of reserves set aside. While we’d planned on renovating all our units, we didn’t expect we’d have 50% turnover in the first year. After the initial investment, we’ve spent an additional $25,000 out of pocket, primarily on the renovations, but also windows and the HVAC work. The business checking account runs uncomfortably low most of the time, and the upcoming window work and another renewal in mid-October mean building up the reserve cushion is going to be pushed back at least a few more months.
- 2.If you buy a turnaround story like we did, expect to spend a LOT of time on the apartments. Renovated single family and to-be-renovated multifamily are completely different kettles of fish. With our single family properties, we’re in our third year with no turnover, and we generally never hear from the tenants aside from receiving monthly checks in the mail. With apartments, not only do we hear about problems with the tenants’ own units, we hear about problems caused by their neighbors. With 18 units, something is always breaking or clogging, and even though I’m not doing the work most of the time, I’m still taking phone calls, ordering garbage disposals from Amazon, and sending work orders to the handymen. All in the evening after I get home from my hectic, busy day job. Renovations require major chunks of time, generally 2 full Saturdays of my time per unit, plus most evenings after work for ~2 weeks. About half my Saturdays over the past year were spent at the apartments, and uncounted evenings.
Cash flow has been non-existent, with all funds after fixed expenses plowed back into the apartments. With upgrades we have planned to the units, that situation will only marginally improve over the next several years.
Planned upgrades:
New windows - $2500 x 17 = $42,500
New HVAC & central air - $3000 x 9 = $27,000
Interior upgrades to remaining 9 units - $3000 x 9 = $27,000
TOTAL - $96,000
This sounds daunting, but over the remaining 4 years of our 5 year plan equates to $24,000/year, or $2,000/mo., which is quite manageable. Add in miscellaneous repairs of $800/mo, and the round numbers for next year, assuming we buy the two units being offered, look like:
Gross rent:
$11,000
Lost rent - $500
PITI + HOA fees - $6000
Upgrades - $2000
Maintenance/repairs - $800
HELOC - $1000
$700/mo cash flow
It doesn’t seem like much, just $700/mo cash flow for all the hours spent working on the apartment upgrades, showing the units to prospective tenants, dealing with tenant calls, invoicing, paying bills, and dealing with taxes, etc., etc. On an hourly rate I’m probably not receiving much more than I would at a fast food place if I worked similar hours, certainly far far less than I earn hourly in my day job. But… on the $75k we’ve invested so far, it is a 11% cash on cash return. And, there is equity capture going on (not considering any forced appreciation) to the tune of around $1500/mo.
What does the picture look like 5 years down the road, assuming things continue on the path that they're on now? Assuming only a few percent increase in rents, PITI + HOA remaining the same (any increase in fees will be passed on to tenants, as we are now a little below market rent and are becoming even more so as our units are upgraded), lost rent staying constant, and maintenance & repairs at $1000/mo, our cash flow nevertheless jumps to $3500/mo. Ongoing major issues should be minimal, as all units will have appliances < 5yrs old, new or newer HVAC, new windows, refinished floors, renewed kitchens, etc.
Looking further down the road, there are a total of 52 one-BR units at the complex. We’ve been approached by an investor and an owner-occupant to buy their single units, and as we own the other units in those buildings, we probably will do so. There are 52 one bedroom units at the complex, and I believe we could eventually acquire most of them if we wanted to. Whether we pursue that course of action, or use this first multifamily deal and management experience to build a resume that allows us to move on to bigger deals, is something we’ll decide down the road.
We listen to the BP podcasts every week, and read forum articles regularly, although I don't do much posting myself. With BP and our local REIA, it doesn't feel like we're walking alone on this venture. Thanks for reading!