When I was in my mid 20's I was looking at purchasing a really old (1930's) two story Victorian in rough shape for like $15,000 (a strategy I would never recommend). The tenant was paying like $600 per month, and she declared with great pride that, "I have lived in this home for 29 years and 11 months, next month will be 30 years, so I'm a very stable tenant!" My jaw practically hit the floor, and I had to brace myself, because I felt so badly for this elderly lady who was so proud of her stability.
"When did you decide to buy this home," I asked in my mind, and within my gray matter she replied, "I am not buying the home, I'm renting." My retort if I could have gotten it to roll off my lips would have been, "You are buying the house, you just are buying it for your landlord, and not for yourself!" For her it was too late, she was approaching a fixed and low income retirement. Her rents would continue to go up, and instead of having an asset, she had become someone else's asset.
I genuinely felt mortified that nobody had helped her understand the value of home ownership. However, it did hit me strongly that if I wanted someone else to buy me a property, there were plenty of people out there willing to do that! In fact, not only will they buy me the house (paying the mortgage) but they can pay for my retirement contribution, purchase me a new car, pay for my annual vacations, my medical insurance, my kids college tuition. All of that simply depends upon how many people are buying me houses and that I pick the right ones that cash flow at least $300-400 per month!
I prefer to help my tenants build their credit and buy the homes they live in after three to five years. This allows me to do a 1031 exchange and get into newer properties with better tax advantages (once I have used up most of the depreciation from the previous rental), and it allows me to never deal with deferred maintenance issues that increase my cost of ownership. By selling to the tenants through an exchange I can buy two new rental properties and possibly double my cash flow, while recapturing tax benefits!
By helping my tenants I have improved neighborhoods (my homes are the nicest in the area) stabilized them - home owners tend to stay longer and take better care of their homes, and helped improve the credit and lives of those I help. It's truly good for society, and I make a really nice profit that rolls into the new homes, while allowing the 12-25% cash on cash return to fund the things above. By the end of 5 years I hopefully have between 60-125% of my down payment back and a capital gains profit that is rolled into two new properties!
For those reasons I recommend two things:
- Help Tenants Buy Your Exchanged Properties: Make sure that you try to find the very best tenants, people willing to work on improving their credit, who want to own their own homes again. Try to get them to rent from you for 3-5 years while you help them build their credit and then buy your rental at retail value. Assuming you bought distressed or at a great value turn-key, you should be able to make a nice profit and always do so as a 1031 exchange so that you buy more properties and increase your cash flow and equity.
- Liquidate Through 1031 Exchange Every 5-7 Years: Owning for 30 years while the house increases in deferred maintenance, the neighborhood may go down in quality or desirability are not good ideas. That's the old way of doing things. Going to newer homes in better locations and letting someone else deal with an aging asset is a much better plan, especially as you reset your tax depreciation and learn to do cost segregation! This also allows you to carefully watch the market and sell before it corrects.
P.S. The above pictured properties is one of mine that I'm doing this with! We picked it up for $40,000, renovated it for $21,382 and it has an ARV (After Repair Value) of about $90,000. It rents for $900 per month and provides us a 25.63% Cash on Cash Return or 11.16% Cap Rate (usually only used in commercial realm, but we do commercial loans on packages of homes to avoid using our personal credit). We believe we have about $17,000 equity, and we could easily wholesale this deal, retail it, or hold it long term. However, in 5-7 years our $21k rehab should still look pretty good and we won't have to do major rehab again that would hurt our returns. Having multiple exit strategies makes your investing a lot safer and more liquid.
I think this is really awesome! I'm still a newbie, and just getting ready to purchase my first house, but this is something that I have considered doing. I want to own apartments but I also want to do something like this. take run down homes and make them great again, hold them for a while, and then sell them to tenants, possibly through owner-financing. I'm sure with time I could do both, it's a matter of figuring out which one I want to start with.
What do you do to help your tenants build their credit? How much turn-over do you typically have in a home before you end up selling it?
Have a great weekend, and thanks for sharing! :-)
Great strategy! Definitely something I'd like to do as I collect some SFR's. How do you initiate the transition from renting to buying for the tenant? Do you ask them if they'd be interested from the beginning or after they have rented from you for a period or time?
On the theme of helping the tenants build credit, fun fact: You as a landlord can, in fact, report on-time rent payments to the credit reporting agencies.