Sunday, July 30, 2017

Selling a Rental We've Never Seen

We're finally back from our trip to northern Europe: three and a half weeks of travel hacked goodness spent with our good friends from Phoenix. We'll have some posts and plenty of pictures to share from the trip in the coming weeks.

But we first wanted to tell you about the sale of one of our rentals, that we managed to accomplish mostly via email and digital signatures, from a smartphone.

Let's start at the beginning. How did we come to even own this house?

In the heady days of 2013, we had foolishly paid off the 15 year, 4.25% mortgage on our primary residence, a mere three years and change after buying it in 2010. This isn't as impressive as it might seem: we bought when the Phoenix metro area was in the toilet, and the initial mortgage was only $104,000 or so. 

Still, after the euphoria of being totally debt free wore off, we realized we had a lot more money coming in every month. We were maxing out our 401ks and IRAs at that point, and looking for another area to invest. Rental real estate sounded like a good option. What could go wrong?

Unfortunately, by 2014 our local market had recovered and the homes in decent areas weren't profitable investments. Forget about the 1% rule. Even when we factored in that we would not have to use a property manager, the houses wouldn't cashflow.

So we started looking into turnkey rentals: out of state opportunities where a company would buy a super cheap house that needed a ton of work, rehab it, sell it to us, and then even serve as the property manager afterwards. This last bit was important to us. We figured an ongoing relationship would make the company less likely to screw us over, especially since we were interested in buying several properties.

So after a series of phone calls, looking at potential properties online, negotiating purchase price and rehab options, we finally settled on a single family home: a really adorable brick ranch, with a detached two car garage, in what seemed like a pretty good part of town. We bought it for just over $90k and it was pulling in $1,125.00 a month in rent, just a couple weeks after we closed on the home. 

Everything was going so well in the first few months that we thought, hey, why not buy another? We had enough cash sitting around for another 20% down payment, as the houses were so cheap. So we did, again, sight unseen. This one rented for $1,000 a month, for a purchase price of $80k.

Anyone we bothered to share this news with thought we were crazy. How could we buy a house, shit, two houses we had never even seen? Weren't we worried?

Well, yeah. We had our share of worried nights. But we calmed ourselves by knowing that various inspectors, appraisers, title companies, and government agencies were there providing a certain level of governance. The properties existed, within the boundaries of property lines validated by local governments, were inspected, yada yada. We used sites like city-data to get an idea of the neighborhood's make up: how many renters and buyers, income, age distribution, education attainment, unemployment and crime rates, stuff like that.

We could have flown out a few times to see all this in person, but that also would wipe out a big chunk of the first year profits. And hey, we are doing this to make profit.


So we went forward. Before we knew it, we had two cute little brick ranch houses, covering the mortgages and property management costs, building up reserves for future repairs and vacancy, and throwing off a few hundred dollars in profit after all that.

Still, things were bound to change. The tenant on one of the houses got a job offer in Texas into the second year of her lease, in 2016. (And earning more in salary than her weird, blogger landlord, so good for her!) Luckily, she was happy to pay for the rent while the house was vacant and new tenants were found, so we only had to cover the utilities during the vacancy.

A new tenant applicant had a decent salary and passed all the checks from the property management company, so we went forward with a new lease. Everything was going fine until the rent suddenly stopped coming in. The tenant wasn't returning calls from the property manager, either. Eventually we found out that the tenant had been arrested.

I don't think it's prudent to go into the details of all that in this blog post. The tenants could be innocent, for all we know. Regardless, we needed the rent to be paid, and it wasn't. They weren't responding to calls or to letters left taped to the front door. The property manager would show up at random times, but no luck.

Eventually we went forward with the eviction process, which I learned can be a long, costly, pain-in-the-ass. The whole thing was delayed further by the holidays, but eventually we regained possession of the home. When we got inside, it was trashed. Garbage everywhere. Furniture and belongings left behind. Holes in the drywall, apropos of nothing. Who knows where the tenants went.

At this point, we had a decision. We'd been paying the mortgage and legal fees for months, just trying to get our house back. We could pay a few thousand in repairs to get it ready to rent again, or decide to cut bait, and sell. Given all the headaches with the property, we decided to sell.

Selling presented an additional choice. We could do a minimal repair to get it roughly back to the condition it was, try to sell for about what we sold it for (our agent estimated $75 to $80k), and thereby lock in a medium sized loss after realtor and transaction fees. Or, we could try to flip it: put roughly $20k into the house to redo the kitchen, floors, painting, etc. and aim for a $110k to $120k sale price, and make a small profit. Still, we could lose even more if our estimates were off.

We opted for the latter, despite the risk. Months of renovations later, we listed. A week before leaving for a three and a half week vacation to Europe that we'd planned for a year, we got an offer a thousand over our asking price.

Thanks to the wonders of modern telecom, we were able to handle everything from signing the purchase agreement to handling inspection items via digital signatures on a mobile phone. As an aside, I can't say enough about Google Voice and Google Hangouts. For $10 a month through Airvoice, I can call and text all I want, even abroad, through VOIP technology and wifi, and can use the less awesome mobile network when I need to.

The day after we got back from Glasgow and a seven hour layover spent in the Newark United Lounge, we signed the final papers with a mobile notary on our dining room table, and had our funds wired the next day.

For you fellow number nerds, here's a short summary of our end to end ownership of the house. The purchase and sales prices have been rounded/changed slightly to keep a bit of anonymity for ourselves and the new buyer, but the delta (i.e. - profits, losses, rents, costs, etc. are all accurate).

Initial Figures:
  • Purchase for $80,000 in fall 2014
  • $16,000 down payment
  • $4,000 transaction costs (loan, inspection, appraisal, etc.)
  • $1,000 per month rent
  • $80/month property management fee
  • $563 monthly payment (PITI)
  • $357 monthly cashflow when rented, prior to any repairs/vacancy
End of 2014 figures (partial year):
  • $3,600 in rent collected
  • $2,030 in mortgage payments (PITI)
  • $240 in property management fees
  • $575 in repairs & other costs
  • Net profit of $755
End of 2015 figures:
  • $12,000 in rent collected
  • $ 6,800 in mortgage payments (PITI)
  • $960 in property management fees
  • $700 in repairs & other costs
  • Net profit of $3,540
End of 2016 figures:
  • $8,900 in rent collected (tenant stopped paying in fall)
  • $6,800 in mortgage payments (PITI)
  • $1,262 in property management fees + placement fee for new tenant
  • $1,300 in repairs & other costs
  • Net loss of $462
Partial Year 2017 figures:
  • $0 in rent collected (tenant stopped paying in fall 2016)
  • $3,400 in mortgage payments (PITI)
  • $1,400 in court & legal fees 
  • $2,500 in repairs, utilities, & other costs
  • $20,000 for renovation/flip
  • $3,000 credit to seller and $1500 in post-inspection repairs/concessions
  • Sold for $124,000: $49,000 back to us after paying off mortgage, some title fees, notary, etc.
It's times like these that I wish I majored in something other than English, because it's hard for me to analyze the figures above. Looking just at the income, the vacancy in 2016 and 2017 killed us: that period wiped out all the profits from the prior years, netting us a $3,467 loss after paying the mortgage during the lengthy process to take possession of the home, and during the repairs for the flip.

We got lucky that we were able to sell the property for enough to cover the cost of the $20,000 flip and to eek out a tiny profit after paying ourselves back the costs for the flip and our own down payment. For now, it seems like we netted about $9k in profit overall, when accounting for the loss we got from just renting the house.

But we'll owe taxes on the gain, and we'll also owe for the depreciation we took over the past three years. I suppose I could say the depreciation is a bit of a wash: the same deductions from deprecation in 2014 to 2016 are just going to be added to our income next spring. Maybe if I majored in accounting I could make better sense of all this.

Anyway, maybe one of you savvy readers can point out if and where we went wrong with the analysis. 

I'm honestly just happy that we just have this chapter of our investing lives behind us, without losing any real money in the process. We thought we would enjoy being landlords, but the more houses we own, the more we like index funds. 

We're going to invest the funds we got from the sale into our brokerage account today, and I'm going to feel a little gratitude for how mutual funds can be bought or sold with a click, any day you want, without debt, or repairs, or court fees. 


*Photo is from PHOTO/arts Magazine at Flickr Creative Commons.

22 comments:

  1. Thanks for sharing your experience and sorry that it went the way it did. I've been reading and listening to a lot of blogs/podcasts about real estate and I find them overly optimistic at times. BP is an exception in that they really do talk about RE "without the hype." I've been hoping to use RE investing to turbo charge my FIRE date but experiences like this makes me a little cautious. From the price point, it would seem the property was in a decent neighborhood. When things like this happen, I sometimes chalk it up to investors going after cashflow in C/D neighborhoods but this doesn't seem to be the case. Would you say the PM did a decent job screening based on credit score/income or was it just bad luck? Are you keeping your other rental?

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    1. Thanks, Andrew. It's good to be able to write a bit about this stuff, now that we're free of the property.

      I don't want to go too deep into the details, but from my perspective there wasn't any real way for the property manager to anticipate this would have happened from background, employment, and prior rental checks. We reviewed all of that stuff with the property manager and this one seems truly to have come out of left field.

      I'd say this was a pretty solid B neighborhood. The $1,000 rent is higher than a lot of areas of the city...but of course I've never been there. :) But check out that city-data site. It is almost creepy how much you can get on a specific hood (use the map feature to really zoom in on individual blocks or parts of a neighborhood, and get the data for just that area). I can help here if you want.

      For now, we're keeping the other rental but we'll have another similar decision when the current tenants leave. I'd like to sell, but Mrs. Done by Forty likes property a lot and, to be fair, that income/diversification provides quite a lot of safety to our FIRE plans.

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  2. Oh man, it sounds like a ton of headache for not much profit. At least you learn some lessons from this investment. Getting the right tenant seems like such a crap shoot. We've been really lucky so far and I hope it continue for a few more years.
    The renovation should figure in when you calculate taxes, right? Less profit.

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    1. You're absolutely right. The costs for the flip, court and legal fees, etc. should all reduce the profit. I hesitate to try to estimate what all that will come out to once we have to pay back the depreciation: I'll probably write up a new post next spring when we do our taxes.

      I agree that sometimes you can't really tell about a tenant. I wish I could be more forthcoming with the details on what happened here but it's not prudent. Still, I am not blaming the property management here: they couldn't have anticipated what happened.

      I'm actually not down on rental real estate as a strategy: it's just not right for us, I think. But for those who have the stomach for it, I think the cashflow and tax advantages are pretty friggin awesome.

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  3. What happened to you is one of the big reasons we never wanted to get into long distance land-lording, especially if we don't know the area beforehand. There just seems like way more potential issues, even if the one that finally did you in was one you couldn't have anticipated persay.

    For us, the security of knowing that the tenants know Mr PoP stops by regularly - at least a couple times a month - is worth it. We've had a slob, but never anyone who truly destroyed the place.

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    1. I definitely can see the advantages of being there in person. I'm not sure I'd have been able to avoid this particular situation or not, but there are lot of other benefits from owning locally. As you noted, being able to stop by (and for the tenant to know you stop by) is pretty sweet.

      For us, we wouldn't buy out of state again. I don't really even know if we'd buy locally.

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  4. First, I apologize you had to spend such a long amount of time at Newark. Ick. Although I think United has one of the nicer areas.

    Second, I'm with you on being more of a word-person than a numbers-person, so I can't offer much analysis. I know a few people who don't mind buying real estate sight unseen, but I'm a control freak and wouldn't be 100% comfortable with it. At the end of the day, you made the best decision for your lifestyle - you didn't want to deal with the hassle, and it seems like the loss wasn't as bad as it could have been. It's a good lesson to learn and share with others.

    I've thought about RE investing many times, but the area I'm in isn't the best, and even with intensely screening applicants, I'm not sure who I'd end up with. I place a high value on peace of mind!

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    1. Erin! So great to hear from you (and to see that you're writing again). Welcome back to the blogroll, too. :)

      The United lounge was actually really nice, but it was still a pretty rough day of travel, even with free booze and food. :)

      For what it's worth, I don't want to the message to be that real estate is a bad investment, even this out of state approach. It just wasn't good for us, and I think the stories of when things don't go well often don't make it into blog posts.

      Still, I can pretty confidently say it's not easy to have peace of mind when things aren't going well with a property.

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  5. And.... there you have it, the reason I've always been terrified of investing in real estate. Virtually everyone I know who's tried it has similar horror stories, not all ending as well as yours did. So I guess we just have to hope that the stock market remains stable and doesn't take any major nose dives (been there, done that). Still, I guess these are good problems to have all things considered.

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    1. I hear you, and I don't know if I fully appreciate how lucky we were that this ill conceived flip worked out. Can you imagine if we had to sell for like $80k after the flip.

      Very different blog post after that.

      While the next correction in the stock market will surely have its own challenges, I can hopefully appreciate the fact that if I really need to sell (e.g. - to rebalance) it takes very little to accomplish. And no debt. No need to get it ready to find a buyer...

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  6. I'm sorry things turned out the way they did. To be fair, I think that could have happened even if you had seen the house before you bought. Congrats on the sale, though! I'm not too much help with the calculations, but at least it didn't end with you in the hole?

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    1. Yes, it could have turned out so much worse. We're at least in the black on this one, it seems. I'll follow up at tax time.

      I get the feeling things might have been slightly better if I were there in person, but I doubt I'd have been able to anticipate this situation and avoid it. Maybe I could have helped do some of the repairs myself though.

      All in all, just happy to have it in the rear view mirror.

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  7. Wow... thanks for sharing!
    I toyed with the idea of getting a buy-to-let (that's what we call landlording over here) years ago when I first got into the whole FI thing but didn't like the idea of doing it with a property that was far away, and couldn't afford an extra property anywhere near us in the South East, near London.

    Having read and heard many stories like this over the years since I'm pretty glad I never got into it to be honest!

    I invest in a property crowd fund which gives pretty good returns for zero work or stress, and you can put eggs in different baskets as well. It's called The House Crowd but there are a few others over here... I'm sure there must be similar companies doing this in the US? If not there is always REITs if you want property exposure without the headaches, maybe float that idea to Mrs DbF when the lease runs out for your remaining tenants?

    Cheers :)

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    1. I hear you: I think selling was the right thing for us. But I wouldn't go so far as to say rental properties are a bad idea overall: for many, I think it's just the right sort of investment.

      For me, I'm going to stick with Bernstein's Simpleton's portfolio and just call it a day, but I know that others really like REITs. A much, much more diversified approach to RE.

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  8. I'm so glad your flip worked out in your favor. One of the main reasons I rented out my first house was because it was 2007 and it was worth $50k less than I paid for it in 2004. The tenants are moving out at the end of the month and I am tempted to sell but... when it's good, I love getting that rent in my bank account (too bad I'm spending it all). Hopefully, the house won't be vacant too long. One month is all I can handle.

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    1. Yeah, when rentals are good, they're really good. But vacancy is a killer. For us, one month was the absolute quickest we could get a property turned around (getting in to the property, scheduling time with contractors, then finding a tenant, doing the checks, and then they need some time to transition into the house). But with a quicker system, I can see how having just one month vacant would be awesome.

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  9. This story is one of the reasons why I haven't pulled the trigger on buying another piece of property yet. However, I am really glad it turned out ok for the two of you. I am sure the next property you buy will be better. And you still are on track to FIRE.

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    1. Yeah, I didn't highlight that enough: we're still on track for FI by 40, which is awesome.

      I doubt we'll buy more investment properties though. We might keep our last rental for a while, for at least as long as it's sending us checks. But once the tenant moves out, we'll have a similar decision.

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  10. Whenever I hear news reports from my former home, Vancouver, about the shortage of rental housing while at the same time bemoaning the price of what is available I think about how unrealistic the complaints are. First of all, being a landlord is not a charity operation. Secondly, you are right about index funds--same gain, no pain. Rental income (in Canada) is added to your other income; no benefit there from providing much needed accommodation. And, of course, your capital gain is taxed. Now the municipal government intends to fine owners 1% if their property isn't either lived in by them at least 6 months of the year or rented. And if they are not able to rent it to suitable tenants who can pay a fair price, they are supposed to keep reducing the rent until they are able to.

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    1. I am an avid reader of Garth Turner's GreaterFool.com, and can't even imagine being a landlord there.

      In some locales, the rent vs. buy debate is pretty cut and dried. In others, there's an argument to own. But yeah, in Vancouver right now, I'd rent...for sure.

      I don't know how I feel about the government's attempts to cool down the markets up there. I can see what they're trying to do: to create a soft landing and hopefully get more affordable homes available to their citizens. But the way they're going about it...

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  11. Glad you escaped with a profit! I had never thought about mybtenants being arrested before and not paying rent.

    Your gross rental yield is amazing. But the absolute dollar amount is the problem - too low to make a meaningful difference. Hence why buying a reit or Crowdfunding is preferred.

    The big money comes from the expensive markets in terms of capital appreciation. But the risks are magnified of course.

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    1. Yeah, the initial plan was to purchase 8 or 10 of these small single family homes, so as to make the money have a meaningful difference, as you put it. (Or, at least it would have made a difference to us, as we are fairly frugal.)

      But going after capital appreciation in expensive markets has never been on our radar. Good to ride a rising tide if you can!

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