This is the anatomy of a rental property. Specifically our very first rental property 🙂
If you’ve ever considered getting into real estate investing, read on to see how we did it, how much money we’ve made, and our mistakes along the way.
In a previous article, I discussed how we got started in real estate investing. I talked about our mindset, why we decided to pursue real estate, and the series of events that led up to our first rental property. If you haven’t read it, I’d encourage you to start there first.
Our First Rental Property – The Duplex
Our very first rental property was a full duplex, built in the 1960’s. Both sides were 2 bedroom, 2 bath and 1350 square feet each. It was in a transitional area – good schools and I’d grade the neighborhood itself as a B-, but on the other side of the road from this neighborhood were some low income apartments.
How We Found the Property
We bought it in early 2013. It was a foreclosure listed on the MLS (multiple listing service). The real estate market was just starting to heat up in our area in the 2012 – 2013 time range. It was listed at $120,000 and we came in over asking price knowing it was underpriced.
At the time, my wife did not have her real estate license, so we were using a realtor to help us find an investment property. We had been looking for a few months, and had made a few offers but nothing had come through. When I saw this property, I knew we had to jump on it. Duplexes are fairly rare in our area, and even more rare that they would cash flow.
There were several other offers, some all cash. We got a little lucky that we were dealing with a bank that only cared about the overall number. We offered $130,000 and I think barely beat out the other offers.
Good deals can be a little harder to find these days, but there are some great new platforms out there like Roofstock that focus specifically on providing cash flowing rental properties nationwide.
While I haven’t bought anything through Roofstock yet, I have an account and keep tabs on the market. If you’re looking for an easy way to find a rental property, I’d recommend checking them out!
Why We Bought It
I think it’s always important to have a good reason for every property you purchase. Otherwise it is easy to get sucked into buying something just because you are anxious to get started, or you want a project, or you just don’t want to miss out.
For us, we had set our criteria beforehand, and the property met them:
- 10% cash on cash return
- monthly rent at least $1000 per month (a proxy for avoiding bad neighborhoods)
- at least $200 per door cash flow after expenses
This was actually a great starter property for us, though we didn’t know it at the time. One side of the duplex was already rented out and the tenants wanted to stay. They were paying way under-market rent at $800 per month, and we agreed to keep their rent under-market but bump it up to $900. Their side was in overall good condition, but pretty much everything was original (kitchen, bathrooms, etc.)
The other side of the duplex was a disaster and needed a complete overhaul. But with one tenant in place, they would basically cover the mortgage while we fixed up the other side.
When we ran the numbers, we knew it was a good deal and easily met the 1% rule. Even with one side rented out at $900, we thought we could rent the other side out at $1100 once we fixed it up, bringing in a total of $2000 per month.
The Numbers (on Paper)
I talked a little about the numbers already, but here they are in detail. We ended up closing for $128,600 with an additional $5,000 in concessions from the seller. Upon inspection we found out it needed foundation work (or so we thought at the time) and negotiated the concessions based on that and a few other things.
We put 20% down and took out a loan for $102,880 at 3.75% interest. I wish we could still get those terms today! Including insurance and taxes, our monthly mortgage payment was right around $900.
We were getting $900 in rent from one side and based on comps in the area thought we could get $1,100 for the other side once we fixed it up. We got some contractor bids and thought it would cost about $30,000 to fix up the vacant side.
With taxes and insurance included in the mortgage payment, we also wanted to figure in our expenses for vacancy, maintenance, and capital expenses. We decided to self-manage so were able to avoid that expense. I honestly don’t remember exactly what numbers we used in our calculations, but we usually assume a 1 month vacancy per year (about 8% of rents) and maintenance/capex expense of 15% of rents. So if we could get $2000 in rent, after expenses we were hoping to cash flow $640 per month ($2000 – $900 mortgage – $160 vacancy – $300 maintenance/capex).
With a downpayment plus closing costs around $30,000 and another $30,000 to fix up one unit, we would be all in for $60,000 and generate $7,680 of cash flow per year, almost a 13% cash on cash return! And in addition to that we’d get the reduction in the mortgage balance as the tenants slowly paid down our principal, as well as any appreciation.
RELATED: How to Invest in Real Estate with No Money (The Truth)
The Real Numbers (Cold, Harsh Reality)
In reality, we were brand new to real estate investing and didn’t know what we didn’t know. And we also made some costly mistakes at the beginning. We went into it knowing we’d make some mistakes and would have to learn as we go. (Or at least I did, I think my wife was a little more shocked at my initial incompetence…) Most of our mistakes were minor and were good learning opportunities of what to do better next time. Unfortunately, there was one big mistake that cost us quite a bit that I wish we did not have to learn the hard way.
Mistake #1 – Underestimating the Amount of Deferred Maintenance
We knew that the house hadn’t been kept up too well, and that a lot of the major systems were older (HVAC, water heater, roof, etc.). But they were in working condition so I figured they still had some life in them, so we decided not to replace them up front.
Shortly after our first tenant moved in, the water heater started leaking and we had to have it replaced quickly. Having to do anything as an emergency repair will cost you, and it cost us almost twice as much as we should have paid to get the water heater replaced. Shortly after that, we decided to go ahead and replace the water heater on the other side before it was an emergency, which cost us $800 instead of $1600.
We did get a few years out of the HVAC units, but spent quite a bit in maintenance and added headaches from tenants calls to try to keep them running. We eventually replaced both units at the same time for around $10,000 after a few years. Fortunately, we were getting good cash flow and we still turned a profit for the year even with that. But looking back, we should have been more prepared for some of the major capital expenditures and taken care of them up front.
In addition, the property has had ongoing drainage problems due to how the land is laid out, and we have spent quite a bit of money trying to fix it to prevent water intrusion. I am hopeful our latest fix is the final one, but this is another area we certainly didn’t plan to spend thousands of dollars on over the years, and one that we look at much more closely in new properties we buy.
Mistake #2 – Don’t Buy a House with a Flat Roof!
Let me just say that I will never buy a house with a flat roof every again. They are a maintenance nightmare.
The duplex has a normal sloped shingle roof in the middle, but the roof over the bedrooms is flat. One side has been relatively trouble-free, but the other seems to leak pretty much every time there is a storm no matter how much repair, patching, and re-tarring is done. We’ve gotten bids to re-frame and add a pitch to the roof to take care of the problem once and for all, but it will be very expensive to do. If we decide to hold on to this house for the long term (20+ years) we will probably bite the bullet and invest in that upgrade.
Mistake #3 – Managing Contractors
We met with several contractors, got a few bids, and found one we liked and saw he did good work. We signed a contract and paid him 50% up front (I think you can see where this is going).
Everything started smoothly, and he was making quick progress and doing quality work. But all of a sudden work slowed to a crawl. He was never around, nothing was getting done, and we couldn’t get in touch with him when we tried to call. When we did get in contact he assured us things would get back on track, but his promised never panned out.
After several weeks of this we eventually drove to his house and confronted him. He had a story about how he had injured his hand, and this and that. Shortly after that, he completely stopped returning our calls and skipped town. I assume what happened is he got behind and was using the next job to pay for the previous, and it was us (and maybe others) who eventually got caught holding the bag.
All told, we lost around $15,000 to that contractor for work we had paid him for but he never completed. We learned the hard way what every investor has to learn – never pay your contractor for more work than has been completed.
Fortunately we learned our lesson and now have a much stronger contract that details the payment schedule and what has to be completed before the next payment is made. We found another contractor to finish the job, who actually helped us on our next several projects.
Where We Ended Up – Still A Happy Ending
While we thought we were going to be all in for around $60,000, after our mistakes, adding to the timeline and holding costs, and adding some other repairs that came up in the process, we ended up putting in about $83,000.
All told, for our very first foray into rental property investing, it still ended up being a great cash-flowing property. In the 6 years we’ve owned it, we’ve averaged about $11,000 in cash flow + principal paydown per year, and it has appreciated by $120,000. If you look at it in terms of overall return, our initial $83,000 has made an average annual return of 21-24% (depending if you use CAGR or IRR), compared to an average return of 12% for the S&P 500 over the same time period.
In fact, our biggest problem right now is that the property has appreciated so much that the taxes are increasing much faster than we can increase rents. There may come a day in the near future where it doesn’t make sense to hold it as a rental anymore and we will sell and deploy the cash elsewhere. But that’s the best problem a real estate investor can have!
Have you thought about getting into rental property investing? What’s holding you back? Let me know in the comments!
Andrew Herrig is a finance expert and money nerd and the founder of Wealthy Nickel, where he writes about personal finance, side hustles, and entrepreneurship. As an avid real estate investor and owner of multiple businesses, he has a passion for helping others build wealth and shares his own family’s journey on his blog.
Andrew holds a Masters of Science in Economics from the University of Texas at Dallas and a Bachelors of Science in Electrical Engineering from Texas A&M University. He has worked as a financial analyst and accountant in many aspects of the financial world.
Andrew’s expert financial advice has been featured on CNBC, Entrepreneur, Fox News, GOBankingRates, MSN, and more.
Great article! Also impressed you just went for it and bought it in the first place. I’ve been stuck in the analysis-paralysis phase for months!
I definitely understand the analysis paralysis. I think for me it came down to finally having a big enough “why” – to pursue financial freedom for my family and allow my wife to stay home with the kids. The biggest encouragement I can give is it’s ok if your first deal isn’t a home run. We made lots of mistakes and came out ok in the end!
Great story! I like how you’ve shared your real life experience complete with before and after pics. 🙂 You really cleaned it up nicely.
I love real estate investing as well, however, I made a huge mistake with my first “rental” property… I couldn’t rent it! Yup, pretty big oversight on my part, but thankfully I was able to recover by selling the property once it appreciated enough. I then ended up purchasing a property across the street which had no restrictions and still hold it today.
Glad you were able to get out of that first property without a loss! We’ve definitely run into our share of “interesting” situations, and made some big mistakes. But we’ve learned a lot and it’s made us better investors over time.
Great story, Andrew! I can relate to a lot of this with our first rental. The water heater suddenly failed within a few months of the first lease, and I had to jump on a replacement while in the middle of my work day.
Another setback was learning we couldn’t put down new hardwood flooring because of the hard breaks / slopes in the floor. So we were stuck putting in carpeting, which doesn’t command a higher rent like hardwood. Oh well… Can’t complain about 18% CoC and marginal property tax increases (unlike a few other of our later rentals!)
Always something new to deal with as a landlord! Our property taxes are killing us. Good problem to have because our houses have appreciated, but we’ve started selling some that just don’t cash flow anymore.
Thanks for this article. As a beginner I want to go into real estate development, but first I’m starting with a property management company. I’m doing property rental agency – maintenence, value, etc. I’m looking for a software that can connect property owner and property management company together and how can I start as a real estate developer with no money.
Property management is a great way to start in real estate. There are plenty of out-of-the-box PM software solutions such as Buildium or Rentec. As a small investor, I use a free online option called Cozy.
Great lessons from you to us! We’re riiight on the edge of purchasing our first property but we feel like there’s always something else to learn. Mostly we’re trying to understand the best way to get investor financing before jumping in. Also, I’m really glad to see your recommendation to use both roof stock and cozy. I had heard these from a few other professionals in the real estate business so I guess we might be on the right track? Great article! Thanks again!
Good luck on your RE investing journey! My best advice is learn as much as you can, but don’t let it keep you from jumping in. Learning from experience has taught us way more than any blog or course.
My husband and I just bought our first rental. It’s a single-family, these are some great tips. Some I’ve heard before, and I couple I’ve never thought of. Thanks!
Thanks for sharing all of the pitfalls that you had on your first rental property! I wish I had read your post before my wife and I bought our first rental at the beginning of last year. It was a two dwelling property and we live in one while renting out the other, but both dwellings had two sections of flat roof each. We initially had a contractor replace all the flat roof sections with new bitumen rolled roofing and after the roofs kept leaking for months, we finally bit the bullet and hired another contractor replace the flat roofs again. It essentially doubled the price that we paid for the roofs, but we now no longer have leaking homes! I’m not sure if at this point you’ve already addressed the flat roof portions of your rental, but if not, I highly recommend having TPO type roof installed instead of dealing with redoing the decking. The TPO is able to hold up even if water pools on the roof. It’s primarily what they use for flat roofs on commercial buildings and as soon as it was installed, we no longer had leaking issues. We definitely made some expensive mistakes with our first rental, but we learned a lot and ultimately I think it will still be an ok investment.
Good to know about the TPO roof, and glad it worked for you! We ended up slightly sloping the flat portions of the roof a few years ago, and putting rolled roofing over that. So far it seems to be holding up well…
In your blog you said your “wife wasn’t a real estate agent at the time” has she since become an agent?? If so is having a licence helping you find properties more easily? I want to pursue my licence but alot of articles I read stated it isnt worth the fees of maintaining a licence just to find propeeries to flip or to use as rentals
She did get her license. It’s been worth it for us. In addition to our own transactions she does 3 or 4 friends/family transactions a year. If you’re just buying 1 or 2 houses a year it probably isn’t worth it. The cost to maintain your license (at least in Texas) is around $3-4k per year.