The Springfield Deal - A DFW Case Study

Below is a case study of a real estate investment I did back in 2011. The deal generated a 32% annual return on my investment, profited over $33 thousand dollars, and created over $250 per month in passive income.

3 bed 2 bath, 2 car garage, 1,795 SqFt

In Texas, the typical house you want to invest in has 3 bedrooms, 2 bathrooms with a 2 car garage. It will range from 1,500 sqft to 2,500 sqft. It will have an after repair value from $125k to $175k. Of course, that will differ if you live in Los Angeles.

I also look for a house in an area that I am familiar with. I think most people are this way. Knowing the area creates a certain level of comfort. Honestly, this is more of a placebo than it is a true investing strategy. The truth is, there are great deals all over the place, and you may perceive a house to be in a bad area, but in reality its just as safe as the area you grew up in. Invest in locations you are familiar with, but do not paralyze yourself just because you don't know the area that well. Housing prices are what they are for a reason. The price of the house is a good indicator of the quality of the neighborhood. If the neighborhood were dangerous, then housing values would drop due to lack of sales.

The age of the house is a factor, but not a deal breaker. Obviously, the older the house the more likely there is to be something chronically wrong with it. Chronic problem are generally not cheap. My 2nd real estate deal involved a house that was built in the 1930s. I was suprised with a $5k electrical upgrade after a few weeks of owning the house.

Pools....No Thanks! I'm really not interested in a pool. Its a danger for young children which creates a liability for you. It takes a lot of work from the tenant to keep it in good shape. A tenant is less likely to take care of it. Then at the end of the deal you have to spend a lot of your profits fixing it and making it presentable to a prospective buyer. It also limits your renting and selling market. People that don't want a pool are not going to look at your house. There are plenty of deals out there. It would have to be a Grand Slam Deal for me to even consider it.

Purchased in June 2011 - $60,000

I purchased Springfield Drive in June 2011 for $60k. It was listed for about $65k from what I remember. It was a bank owned foreclosure. I low balled them on my first offer, and they came back with the $60k rebuttal. I tried to go lower than $60k again, and they refused. I was very nervous about the deal. One of the guidelines of property locating is to look for a house that has been on the market for less than 10 days. If it lasts longer than that, than there is something wrong with it or it is just not cheap enough to be a good deal. Well this house had been on the market for over 200 days. All the numbers made sense, but the days on market was way off. This made me very nervous. I decided to trust my gut and go for it.

I paid a $100 option to be able to cancel the contract for whatever reason within 10 days of the contract agreement date. This means I had 10 days to find everything that is wrong with the house, how much it would take to insure it, get my financing approved, and have a contractor come and bid on the repairs. It seemed like a ton of work. In reality it took less than 10 hours of my time to get answers to all of these questions. And the answers help prove that this was a deal worth investing in. So I pulled the trigger.

Used a Hard Money Loan to Fund it - $5,500

I used a hard money loan to fund the purchase and rehabilitation of the property. A hard money loan gives someone the ability to purchase and rehab a property with little cash. Ideal for young investors. Of course, you pay a price for this luxury, and its not cheap. This loan cost me $5,500 to close and 14% interest for 6 months. This ended up being about $6k in interest payments. OUCH! I factored all of this into the deal and the numbers still made sense.

Rehabilitated the House - $24,945

Part of the due diligence phase is getting a real fixed price bid. I did some research and used the better business bureau website to focus in on a couple of contractors. I had them come out to the house after the purchase contract was in place, and the inspection was complete. The winning contract bid $19k to do everything I needed. And it needed alot.

We replaced the floors in the entire house. Carpet in all the bedrooms, vynal in the living room that looks exactly like hardwood floors, new tile in the bathrooms and kitchen. New budget friendly countertops in the kitchen. We painted the entire house, fixed the fence, put blinds up, replaced the water heater, and purchased a new condenser for the A/C system. We also had another little surpise during the inspection.

The foundation had settled and had to be repaired. Oh boy!

I knew nothing about foundation repairs, except for rumors I had heard. For example, we had a neighbor when I was a teenager that had to have their foundation repaired, and I can remember my father and others in the neighborhood acting like it was a death sentence for the house. "Just bulldoze it and build another house" is what my perception was.

I brought in a contractor to quote the repair, and was pleasantly surprised with the cost. $4.5k was the result. Certainly, not bulldozer worthy!

Most of the time our fears are way overblown. If you take some time to do research and ask questions, you will find that its not as bad as you perceive.

Found a Tenant - $1,095

I exclusively use Postlets.com to make digital flyers and automatically post them to Zillow, Trulia, and to Craigslist. I found my tenants within two weeks, and they moved in a couple of days after the rehab finished.

One of the biggest and most ridiculous fears with first time investors, is that they think no one rents single family homes. I'm here to tell you, you will find a tenant if your property is priced correctly within a week. There is no question about it. I listed this property $1,000 cheaper per month than the market value, and had 6 or 7 tenants to choose from. Getting a bad tenant can ruin a deal. You want to list the best property in your area for the best price.

Refinanced to a Conventional Mortgage - $3,595

Once the rehab was complete and I had a tenant. I was ready to refinance to a conventional mortgage to get the weight of the hard money loan off my profits.

The bank hired their appraiser, and it appraised for $99k! That was $21k less than the after hard money loan appraiser! This is a huge problem. This means I am going to have to bring an additional $21k in cash to close on the refi. My initial knee jerk reaction was to panic. I emailed everyone from the lender to the appraiser to figure out how this could have happened. They quickly calmed me down, and explained to me that this does happen sometimes. Appraisals are subjective. Appraisers do their best to make it as repeatable as possible, but its still subjective at the end of the day. The lender hired another appraiser to re-evaluate the property, and it appraised for $116k the second time. I was so happy, but also shocked that the value could swing that much just based on the opinion and training of the appraiser.

This is one of the biggest risks in this type of financing strategy. You need to plan for it. In all my deals now, I plan for the refi conventional mortgage appraisal to be 95% of what the after repaired value appraisal is. This helps me understand how much cash I may actually need to complete the deal. To ignore this risk, could be the difference in you having a profitable real estate investment, or being foreclosed on for not being able to pay-off your hard money lender.

Second appraisal:

The End Game

The end game for this house is to sell it to stay on my 30% ROI curve. The longer I rent it, the lower my annual ROI is. This is because the the value I created from the rehab does not change over time. So the ROI is set, and the longer I hold the property, the less the annual ROI is for the rehab portion of the deal. My tenants move out on May 31, and it will go on the market the next day. My realtor recommends I sell the house for $139k. Assuming I get 90% of the list price (again, very uncommon to be able to purchase a property for less than 90% of the list price), I will sell for $129,024

The Math

So lets put all the numbers together, and see how I will make-out if I sell the property for $129k. Below is a snapshot of the calculator I use to analyze my deals.

So what does this spreadsheet tell me about the deal.

1. 1) It required that I have $26,461 of cash money in the bank to do the deal.
2. 2) I will profit $33,731 after 4 years.
3. 3) My annual return on my investment will be 32%. That is more than 2.5 times what the stock market can offer.
4. 4) I received on average $281 per month in cash flow.