Making Money In Real Estate

If you’ve been reading my site for awhile, then by now you’re probably aware of my passion for diversifying income and having a diverse asset allocation.  By this, I’m talking about investments beyond traditional stocks and bonds – into things like Private Equity funds, peer-to-peer lending, and real estate.

A well diversified portfolio of stocks and bonds are a great foundation, but a portfolio that solely relies on this strategy has a few flaws:

  1. In the short term, the stock market tends to rise and fall together – despite diversifying across many equity types.  2012 has been a great example of this.  Sure, my portfolio is up nearly 20% this year, but so are all diversified stock portfolios.  And next year, if the market is down 20% – mine will be down too.  Investing in dividend growth (DG) stocks is a good hedge against this, since the dividend is less likely to be cut despite drops in capital value, but if you need to (or want to) sell a stock at that time, you’ll potentially end up taking a significant loss.
  2. Dividends are great, but when the S&P only pays out 2% on average, the income just isn’t that great.  Even more high-yielding DG stocks are only in the 3-5% range.

I’m not proposing that DG stocks aren’t a good investment (they still make up the heavy majority of my overall diversified portfolio), but I do think they can be supplemented with some larger income generating methods.

Part 1 – My First Rental Property

A few weeks ago, I finally made decided to actively pursue a rental property.  I created a plan to pay cash on a distressed home, fix it up, and rent it out for a high return.

At first, I had visions of doing what I’d read about by MMM and Lacking Ambition – finding a fixer-upper, do most of the work myself, and subsequently build in an immediate large amount of equity in the process.  Then I’d rent out the house at a competitive rate and turn a high profit.

Unfortunately, after about a month of research and consulting with my real estate agent who specialized in foreclosures, I learned that the local market for this type of investing was overly saturated and prices were being driven up by too many fix-n-flippers looking to make a quick buck.  We tried anyways, but his prediction proved to be true.  The only areas open to fix-n-rent are in the lower scale areas of town.  Although I have no fundamental issue with this, the fact is that when you rent a house for $700-800/month you often end up with tenants that can barely making ends meet.  I had no desire to get into the business of evictions…

I explored every price range from $50K-$200K for a property.  I searched every property type from single-family houses, to condo’s, to town houses.  And I walked through houses ranging in age from from 50-year old beaters to 5-year old ready-to-move-in homes.  And after a few weeks, I found the deal I was looking for.

It was a foreclosed single-family residential (SFR) just a few miles from my house. It was in my home’s school district, and was a house and neighborhood I would happily move into myself. The HUD listing price had just dropped from $180K to $162K that day, and so I pounced on it.  I figured the cost to fix it up would be ~10K if I did the work myself, but that the after repair value (ARV) would be at least $200K, and the rental comps showed I could easily charge $1350/month.

I offered $163K the day the price dropped, giving an extra thousand on top of the listing price to ensure I got the property.  The next morning my agent called…  I had been outbid.

Damn.

A few days later, my agent called with another house on the east side of town. It was a newer house built in 2007, and was in great condition.  It had recently sold for $190K twice in the past 3 months, but both times the buyer’s financing fell through.  HUD had grown weary of this, so they dropped the price to $172K.

I drove out there that day to view the property, and discovered it was a 4-bedroom, 2.5 bath home in new condition having only been built in 2007 (and sold for $235k).  Again, it was a house I’d happily live in it myself.  Doing a rental comparison of the area, I found I should be able to easily rent the house for $1300/month, and potentially for $1400/month.  The only downside (sort of) was that I wouldn’t get to improve my carpentry skills by fixing anything up, since it was already in near-perfect condition.

Well, that’s not true. There was a second downside: the neighborhood was a heavily controlled HOA area, and the HOA fees came out to be $90/month! Since this would eat into my profit, I decided to take a chance and offer only $162K. My realtor warned that this low-ball bid would potentially cost me the house, but that he’d write it up that night and submit it.

The sales comps on the house showed that the house was worth $195K-$210K as is, so I would be banking an immediate $30-$50K in equity if my price was accepted.

The next morning my realtor and I traded some text messages:

 

10:21AM (agent):  I’ve been on the phone with HUD all morning.  They aren’t happy, but I think we might get it.

10:24AM (me):  Awesome.  That’s why you make the big bucks.  Make it happen.

11:01AM (agent): I’m good but I didn’t think I was this good.  You’re under contract.  I need $1000 earnest money and your signature on the contract by this afternoon so I can overnight it to them today.

 

This is one moment that I wished I had a car instead of a bike!   I now had 29 minutes to ride to the bank, get a cashiers check, find a place to hold an 11:30 conference call for work, and be home by noon to watch my daughter.  So I hopped on my bike, rode like mad to the Wells Fargo, and got the cashiers check.  I then scurried over to a Starbucks to get online for my conference call, held the meeting from their outdoor patio, ended it a few minutes early, and raced home just before noon.

My exciting and busy life as a real estate mogul had commenced!

Part 2 – Private Money Lending

During my search for a rental house, and in my past real estate experiments, I’ve learned 2 few things.

  1. Success is all about connections
  2. Most real estate investors are willing to work hard, but few have the money to scale their business

While driving between houses in my real estate agents Hummer (yes, BNL in a Hummer burning gas at 10mpg), and as he discussed his recent trip to Boston where he and friends rented Ferrari’s and other high-end European cars I’ve never even heard of, I managed to turn the conversation back to real estate investing.  I learned that my agent was also a fix-and-flipper on the side.  Intrigued, I asked how he funded his deals.  Considering he makes over $300K/year in real estate, surely he must pay cash, right?

Sort of.  Much like others in this field, he uses other people’s cash instead of his own.  And he borrows the money from a number of hard money lenders at 2-4 points, and 12-15% interest rate.  I half jokingly laughed and replied that I would gladly beat those terms.

Quick explanation: For those not familiar , “points” basically means that he pays me a percentage of the loan up front.  This helps pay for processing fees, and lost money from having my money inactive between investments.  For example, 2 points on a $100,000 means he pays me $2000 up front.

A few hours later, after a long day of looking at houses, he brought the loan idea back up.  He told me about a deal he has lined up to buy a house for $72K, which needed $20K in work – but that he thought he could sell for $120K within 3 months.  He offered me a 12% interest rate.  I counter offered him with 2 points plus 12% interest – still better than any deal he can get from the big time hard-money lenders in the area.  We had a deal.

And with that, my new career in hard money lending had also begun.

On this particular deal, if he does sell it in 3 months I’d be looking at lending out $92K for a 3 month return of $4600.  That’s a 5% return in 3 months, or roughly a 20% annualized return.  Thinking overly optimistically, if I could repeat this deal 4 times per year, I could nearly pay my family’s entire annual expenses off this $92K.

Of course, there are risks.  But since the money is backed by a first lien on the house, and since I’m only funding 76% ARV, if he did foreclose I’d be buying the house at an extreme discount.

Let me know if the hard money business is interesting to you guys – I’ve been researching it a lot the past few weeks, and would be glad to write a post about the associated risks and risk mitigation that I’ve been learning about.  I’ll also be meeting with an attorney before I sign the contract – so I could use that time (and my money) to ask any questions you all have on it…

Putting It All Together

Once both of these deals close later this month, I’ve made a plan to combine my rental business with my private money lending business.  Here’s how it works:

First, since I’ll be paying cash for the rental property, I can then open a no-fee HELOC on the rental property.  A quick investigation shows I can get that opened at about 4% interest with a 50% loan-to-value. I may be able to do even better once I shop around more. But the beauty of the HELOC is that you only pay the interest when the money is actually loaned out.  As soon as you pay all or a portion of it back, the interest payments are immediately reduced.

With the HELOC opened, I’ll use that to fund any future hard money loans.  The spread between the 4% rate I’ll pay and the 12% I’ll charge will spread of 8%, plus I’ll continue to get 2 points at the beginning of each loan.

I’d like to target 2 hard money loans per year, averaging $100K in value and 4 months in duration.  Of course, I realize some of that is out of my control.

If this can be done, I should be able to turn this single property into a cash flowing machine that can pay nearly all of my family’s annual expenses.

  • $10,800 in annual rental profit (after taxes, insurance, HOA fees, and assuming some vacancy time and some repair)
  • $9300 in annual hard money income (after paying HELOC interest, assuming 2 deals per year as described above)

Although this may be somewhat optimistic, this would effectively be creating a 12.5% ROI of my $160K investment, all while being backed by hard assets (the rental house I’ll own, and the house with a deed of trust for the hard money loan).


34 Responses to Making Money In Real Estate

  1. chrissy_o says:

    12% + 2pts is super cheap compared to most other areas right now. I’m about to help fund a deal for 15% +1pt, as well as additional back end quarter point for every week the project goes on beyond 3 months. Most lenders try to stay below 65% LTV, too, and in most areas are even negotiating a split of the profits through a SAM (shared appreciation mortgage) – especially if the real estate investor isn’t coming in with much of their own money. Unfortunately the market in Colorado is heavily dominated by a broker that is taking on riskier than usual loans and driving down rates. There’s a big network of private lenders across the country who share knowledge, deals, etc, and have some pretty awesome literature and teachings on the subject.

    • Chrissy – Good to hear from you again!

      I’m very happy with 2pts + 12% for my first deal, but I agree that 75% LTV is high for the returns and 65% would be safer in the future. I planned on getting a little more strict once I’ve established myself in the HML biz.

      I’d love to hear more about the HML network you mentioned. I’ve found the HML community to be surprisingly quiet and cut-throat locally…

      So are you in CO now, or still in the UK?

  2. Matthew says:

    You have enough money to pay $162k cash for an investment property and you don’t have a car?!

    Or did I say that wrong?

    You have enough money to pay $162k cash for an investment property BECAUSE you don’t have a car.

    You are killing it man! I’m glad I found your blog somewhat recently. Your writings and strategies are proving to be a valuable resource and stuff that I can reference as I move forward into creating passive income.

    Like the new theme, by the way.

  3. Joe says:

    I think you’re doing great on your real estate career. I’m sure you’ll keep growing in this area and make more money in the years to come.
    Why don’t you get a mortgage for the foreclosure? The interest rate is low right now and that would free up your money for another deal.
    Or are you planning to take money out once the deal is done.

    • My plan is to open a HELOC, probably on my own residence, and maybe eventually on the rental house. The nice thing about the HELOC is you only pay interest when the money is lent out, so for the hard money lending (HML) I can move it in and out and only pay the interest while that money is earning higher interest on the HML. A mortgage would mean I’m paying a penalty when the money isn’t actively invested in an HML.

      The mortgage would make sense if I wanted to buy a second rental – and some day I might – but for now I’m settling in with one.

  4. FI Fighter says:

    Congrats on the new property! I just secured one earlier this year and just recently got into contract for a second one. It’s definitely more work than investing in say stocks, but also really rewarding.

    You should be able to lock in pretty good cash flow at those rental rates.

    Best wishes.

  5. Glenn says:

    Great informative article. I am very interested in hearing what more you learn on the hard lending idea.

    I’ve recently moved from NYC to Arkansas to live the frugal, BNL, Mustachian life. It’s all still very new to me, but after retiring from a long career trading complex products on Wall Street, I feel I can learn these kinds of things pretty quickly. And it’s fun too.

    I recently began with the Lending Club and am loving the results so far.

    Next is real estate for me. I intend to get started in earnest in January. Right now I’m doing research and learning. I’ll surely be doing a SFR type thing, but am interested too in the hard money lending.

    One small hurdle is that I have no contacts or connections down here, so I’m reaching out to people cold. But I’m optimistic.

    Keep us informed.

    • Glenn – Have you checked out local REIC’s? Most places have them, and they are really helpful for networking. Once you get in the loop with a few others, you can very easily start growing that network. I’m super introverted, but once I made one connection, it was easy to just ask that person for references (other investors, RE attorneys, brokers, agents, etc).

      Also, have you checked out biggerpockets.com? That’s actually how I met my very first contact in the business.

  6. FIVEOH says:

    Do you mind breaking down the numbers on the rental? Whats your ROI on just the rental profit?

    • Here are the numbers:

      Purchase price: $162K

      Monthly rent: $1300
      Monthly HOA+taxes+insurance: ($250)
      Monthly reserve for vacancy and repair: ($150)

      This works out to an annual income of $10,800, and an annualized ROI of 6.7%. It’s not the greatest return, but it’s an average cap rate for a SFR in my town.

      There’s also another option I may pursue, which is to do a lease to own deal. Basically, lease it out for $1400/month, with an option to buy at $200K after 2 years. This is the price the house is appraised for today, so it’s very possible I could ask for more.

      In the lease to own option, I’d have $12K/year in income for 2 years, plus a $38K capital gain when it sells. That works out to about a 15% annualized return. It also adds the benefit of having a tenant that is more likely to treat the house as their own, so even if they choose not to buy in the end, it should come back to me in very good condition.

      • fiveoh says:

        Thanks for the breakdown! That’s about the same as I’ve found when I ran the numbers for houses around here. I never thought about doing a lease to own… thanks for pointing that out!

      • If you do look into lease to owns, just make sure to check out your local and state laws around this practice. Some states have put heavy restrictions on it. I’ve heard it’s totally illegal in some states, while others have maximum down payments, etc.

        I’m not an expert on it, but if you go to a local REIC meeting or even ask around on biggerpockets.com, you should be able to get an answer.

  7. Yabusame says:

    Great to see you posting afain BNL. Love to know more about the HML and rental business. Of course, I’m in the UK so I don’t know how relevant it would truly be…

  8. Michael says:

    Hi BNL, great to see you posting again!

    I am currently in mid 20’s and am thinking about moving out of NYC in early 30’s and live on income generated from my investments. Just wondering if you have thought about owning a small franchise (e.g., subway), in addition to all other investments?

    • I looked into it many years ago, but what I found was that the entry price was huge for any major franchise (like Subway). Even if I had the money, I’d never be willing to drop that kind of money on a business I didn’t understand.

      There are also some smaller/cheaper franchises out there – I think you can view most of them in any Entrepreneur magazine.

  9. Shawn says:

    Happy to hear that real estate investing is going well. Hard money lending sounds even better.
    “Playing bank is what it’s all about.” says my multi million dollar commercial developer friend. Much like you, having the available capital to deal with up front puts him in a great position at the start of any deal. For you, it got you a front row seat to a HML deal to a fellow that probably spends 301k per year. For my friend, it allows shopping of loans and services in various stages of his construction and development. At any time, he can front the money to a developing deal, closing out unreasonable bankers or other investors. He is a big talker and tells me a lot of stories of his business deals. One of his other statements is “Cash is king.” No doubt.
    He ends up brokering deals for one of the mainstream customers that he continually develops and builds for. He sell these freestanding business locations to individual investors normally at a 7% cap rate so I think your own rental percentage aspirations sound pretty good. He sells these business locations usually with a ten year lease in place for about 6-7 times the cost of your single family house. When a investors buys this location he has little to no control of the property or business until lease end. You are buying something that you have total control over. As you can see, I am anxious to get some similar properties in my own diversified, dividend producing portfolio.
    Thanks for sharing your adventures.

  10. Econowiser says:

    I would so love to invest in a rental property but my husband is afraid to take the jump…

  11. Nephi says:

    Thanks for the post. I’m very interested in all the alternative income sources you find. Currently I’m looking into tax lien certificates. Do you have any experience with those?

    • Looked into it, but I’ve never taken the plunge. I can;t find any good books/articles on it that give me the confidence that it’s worth it. So either that means it’s a major niche to take advantage of, or it’s a trap.. :)

      I suspect the former, so if I ever get around to finding some good deals, I’ll write about it here.

  12. This blog is too good!!! It definitely provides great knowledge over real state, even I am new to the field of real state and got enormous knowledge about it on this blog!!!

  13. Matt says:

    This is an interesting concept, I’d never thought of getting into HML as an option (always thought it required having a couple of Heavies with you for payments!

    But why are you paying cash for your rental, then loaning cash again to a HML rather than buying the rental with a loan and controlling the external risk on the default better?

    Is it because the deed of trust on the HML home is stacked in your favor in the event of him defaulting?

    Interesting stuff!

    • I’m paying cash on the rental becaue I can take out a HELOC if/when I get another HML set up. For now, I’m limiting my exposure on HML’s, so I can avoid the 4% interest on a mortgage, but take the 8% spread if a HML lines up.

      If I had 10 HMLs running simultaneously, this strategy wouldn’t make sense, since I’d be working with many investors. But as a small time lender with limited contacts, I felt it’s better to pay cash on my investments, and find ways to borrow only when it’s beneficial.

    • By the way, the HML is “stacked in my favor” but that had nothing to do with my strategy. I wouldn’t recommend an HML if the HML contract wasn’t stacked in the lender’s favor, no matter the outside circumstances.

  14. Glen Gordon says:

    I found many ways to make money using real estate from http://moneymakingprograms.ca/programs-2/real-estate/

    Best decision I ever made as I am now happier then I have ever been and only working a few hours a day.

  15. I would like to add a bit onto it.. Small multifamily properties (2-4 units) such as Duplex/Triplex/Quads one of the most convenient investment routes. These property types combine the financing and easy purchasing benefits of a single-family home with the cashflow benefits and less competition found in larger investments. Best of all, these properties can serve as both a solid investment as well as a personal residence for the smart investor. So I always suggest people that I know to go for it..
    Nevertheless a must read….!!

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  17. Its a nice post. At first I want to say thank you for sharing with us this kind of tremendous posting. Its my personal opinion that, Buying is much more effective than rent because then we have the freedom to do anything for next.

  18. Real estate is always risky especially when you’re entering a saturated market. The thought has crossed my mind however my the risk is too great as every tom, dick and harry in London is trying to get their hands on bankrupted properties to flip quickly. I always say that when a market is saturated it’s time to get out. Great post, thanks for sharing.

  19. Tag.a says:

    This post contains good information regarding real estate. Investing money in real estate is really good but little bit risk is also there. It’s my personal opinion that investing in real estate is really good. Thanks for sharing such an informative post. After reading your blog I got an idea to invest money in real estate……

  20. Really good and important information in your post. Really interesting to see how is your plan. Making money in real state is more difficult than years ago , but it is still be a good and fast way for making money.

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  22. Awesome work,nice information you share with us and i know it’s not that much easy to earn money in real estate, some these work realy difficult. Keep posting!

  23. Mark says:

    Very informative blog for making money in real estate and by reading this blog I knew that how to make money from real estate industry which will be great for me because as a real estate marketer I always look forward to get this sort of information and hope that this blog will help me a lot for getting success for sure. Thanks a lot:)

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