Discussing My First Deal
Hello everyone,
My name is Derek Sharrard and I am from Bay City, Michigan. I recently just closed on my first Investment Property (Buy and Hold) and wanted to discuss it with other people who are starting out. Hopefully you can learn from my mistakes and make some of your own to further your knowledge in Real Estate Investing.
I have attached the link from my original post, "Screening My First Deal". I encourage everyone to read it really quick to give you the basic background information on the property that I purchased. Some things have changed from the original numbers and I will go over the changes in this post.
https://www.biggerpockets.com/forums/311/topics/52...
The original price for this 3 Unit Multi-Family was $54,900. I found this property through my real estate agent, it was owned by another real estate agent in the same company. The property wasn't on the market yet and I was the first and only one to go through it. I offered the seller $54,900 which was what she was asking, which may seem crazy to most, but when the numbers work for you that is all that matters.
Included in the offer was 6% Seller Concessions, this is an important step to go over because if you don't have a lot of money for closing, this can help you greatly. In Michigan, the Seller is allowed to give up to 6% in concessions to the buyer. This means that the Seller will pay 6% of the Purchase Price of the home towards the Buyers closing costs. This means that I was buying the property for $54,900, but the seller was going to give me $3,294 towards my closing cost. Closing costs can mean many different things depending on the terms set by the bank or mortgage broker. In my case, my closing costs included my down payment, the mortgage closing costs, and my escrow costs. This was a huge help because I didn't have a lot of money going into this deal, I had just enough to get me into the property, but now I was going to have over $3,000 in reserves. I always recommend investors set aside some money for each property just in case of a worst case scenario.
I know many people who are starting out talk about different strategies to get their foot in the door and if you have listened to the Podcasts, you should know by now what Brandon Turner preaches. House Hacking. Living in a Multi-Family house and renting out the other units or apartments to pay the Mortgage, Taxes, Insurance, and all your other bills. Essentially, you are living for free and still paying off your mortgage with other people’s money. This now brings us to different loan options.
In Michigan, if you are planning on buying an owner/occupied Multi-Family home it is still seen as an investment property and you still need 25% down payment on the house, at least that is what 5 different banks told me. So I had to come up with different ideas, such as Seller Financing or FHA Loan. People get scared of going outside the norm of Conventional Mortgages, but being flexible with your financing options is what can make you a great investor. Now for the dreaded FHA Loan, it was one of the easiest processes I have ever been through. The only difference is that FHA requires the property to meet a certain standard to have their loan cover the house. This was good for me because if there were any major issues the Inspector and Appraiser would pick up on them and require the seller to fix them before they would sign off for the property to be financed through FHA. The only problem is if you have a seller that isn't willing to go the extra mile and fix things on the house to meet those standards then your deal is dead. Fortunately for me, the seller agreed to get the property to meet FHA standards and help up their end of the bargain because there was a list of things for them to fix. For instance, the basement was leaking water from one wall and the seller had to put up gutters with downspouts leading far enough away from the house. This took care of the problem and the inspector was happy with the work that was done. If you are starting out, FHA is a great way to get your Buy and Hold portfolio started and give yourself a place to live for free.
So before all the work was done to fix up the home, the first step that was needed was the Appraisal. The Appraisal process is there to help banks and mortgage broker’s double check to make sure they are not loaning out more money than what the property is worth. The Buyer pays for the Appraisal normally because they are the ones who need they financing. So the Appraisal came back and it came back low, like really low. My Purchase Agreement was for $54,900 with 6% Seller Concessions and the Appraisal came back at $48,000. That is $6,900 cheaper than what I offered. From here there are a couple options for a low Appraisal, either the Seller can lower their price to the Appraised amount and the deal will continue or they can ask you to personally bring extra cash to the table in order to close. So I called the Seller and explained to her that I didn't have any additional funds to purchase this home with and that if she was not able to lower the price to the Appraised Value then we would have to go our separate ways. The Seller thought about it and dropped the price to $48,000 and even kept my Seller Concessions! The Appraisal saved me $6,900 on this house. Now looking back, I shouldn't have offered that much in the first place, but I would have never offered as low as $48,000. This shows the importance and power that an Appraisal has over the Seller and how you can make it work in your favor. The Appraisal saved me and it is a mistake I won't make again. If you are getting financing from a bank or mortgage broker they will require you to get an Appraisal, but if you are funding it with private money it still may be a good idea to get an Appraisal done to give you a reality check of where the market really is.
As investors, you need to have a benchmark to tell you when something is a good deal or not. One of these benchmarks for Buy and Hold Investments is the 2% Rule. The 2% rule states that if you are earning 2% or more of the Purchase Price of the property per month then it is a good deal. For instance, I was going to purchase this property for $54,900 and it was bringing in Monthly Gross Revenues of $1,475, this means if you take Monthly Gross Revenues/Purchase Price ($1,475/$54,900) = 2.69%. This means at the original price that I was willing to pay for this property I would make 2.69% of the Purchase Price every month which meets the 2% Rule. Now I purchased this house for $48,000 and I can actually increase the rent on two of the Units, but putting that aside, $1,475/$48,000 = 3.07%.
Listening to the podcasts, I have heard people talk about properties meeting 3% and 4%, but I never thought I would see one, especially my first deal. Now the 2% Rule isn't the only benchmark you should be using. You should find out what the Capitalization Rate is in your area and try to meet that as well, but the 2% rule is pretty good to screen deals quickly.
Finally, I'm going to list my expenses and show you how to House Hack with Multi-Family homes. Amounts shown are Monthly.
Mortgage = $245.85
Taxes = $160.17
Insurance = $75.82
Water = $200.00
Total = $681.84
Fixed Expenses that I know I have to pay every month total to $681.84. If this is all I had to pay for the month I would Net $793.16/month when I move out that is. I will be living in one of the units, the one paying $425.00, so that Net number would be after I move out in a year. When looking at deals though and when determining if it is a good investment, you should look at all the units even if you are living there.
Now every new investor is seeing this and thinking it is amazing to make an extra $800.00 a month, but that isn’t how it really is. There are other Expenses that might not be Fixed, but you need to account for every month in case something happens. Maintenance is a huge expense to keep in mind, Vacancy in case one of your tenants moves out and stops paying, and of course Capital Expenditures to plan for bigger projects in the future such as roofs and siding. A good rule is to plan 10% of your Gross Rent for each of these categories and if your numbers still work out to $100.00/door then you are doing pretty good. So these expenses would look like this per month.
Maintenance = $147.50
Vacancy = $147.50
Capital Expenditures = $147.50
Total = $442.50
Adding Fixed Expenses and 10% in each of these categories creates a total of $1,124.34. Monthly Gross Revenue of $1,475.00 - Monthly Expenses of $1,124.34 = Monthly Net Income of $350.66. As I said befor I will be living in the unit paying $425.00/month so this actually would put me in the negative at this point, but all my fixed expenses are covered while House Hacking and that is what really matters.
Finally, the last thing you need to include even if you don't plan on using someone is the Management Fee. If you plan on managing your properties at the beginning that is fine, but you never know what the future holds and might not want to when your portfolio grows large enough. So figure it in now and make sure you will still make some money with it in there. Many investors have different views on these things, but my thought is to be as conservative as possible and then be pleasantly surprised when my properties beat my expectations. Another good rule for the Management Fee is 10% of Monthly Gross Rent. It is as follows.
Management Fee = $147.50
This brings down your Monthly Net Income to $203.16. Many people say that if you break even at this point you are doing great with your investment, but in reality you can do better than break even. The deals are out there, you just have to go and find them!
I know that this was a ton of information for one post, but hopefully you learned something that will help you with your current deal or future deals to come. If you have any questions, don't be afraid to reply or comment and I will try to help anyway that I can!
-Derek Sharrard