Right around this time last year I got the bright idea to acquire a rental property as a means to support my own business pursuit. At the time, I had just listened to the audio book “Rich Dad Poor Dad” by Robert T. Kiyosaki. Of the twenty-one (2!) audio books I listened to in 2018, “Rich Dad Poor Dad” was one of the shortest, but possibly left the biggest impression on me.
A quick Google search will reveal a public debate balanced on the veracity of the author’s narrative. Did he stretch the truth? Was the rich dad all he was written to be?
Regardless of the literalness of the text, one lesson in the book stood out to me:
Wealth is the ability to live without working. Richness is purchase power.
In my own words, if a man needs $2,000/month to live, and makes $2,000/month without working, he is wealthy, but not rich. If a man makes $10,000/month working and makes no money without working, he is rich, but not wealthy.
Possibly the most accessible form of wealth for the past decade has been real estate investing. Market interest rates have risen only now into the middle single digits. Down payment options still start as low as 3.5% of the purchase price for a US Federal Housing Administration mortgage that could acquire a multi-unit property. This is a significantly lower barrier to entry for wealth than say buying the royalty rights to a hit song, or quirky invention.
From an owning and operating perspective, just about any Joe the Plumber can sink a percentage of their hard-earned money into a profitable* real estate investment, hire a property manager, and literally start making money without working. (*that’s easier said than done)
My interest in all this wasn’t directly connected to the wealth building aspect of real estate. For me I saw a rental property as an opportunity to double leverage capital, essentially put money into a property and then borrow those same dollars against itself at a rate equal to or lower than the property generated as a profit. Essentially, I saw real estate as a unique opportunity to give myself my own small business loan.
Traditional business loans, for a presently non-existent business, were not an option. Instead I looked to real estate to create my own business loan because lenders historically have extended lines of credit on equity held in property.
I surveyed the regional real estate market for six months. During that time I consumed what I could from the Internet on sites like biggerpockets.com and listened to the following audio books which I found to be insightful and helpful:
I found one book to be the most useful for functionally understanding the landlord/property manager/tenant relationship and how to best find tenants:
“The Book on Managing Rental Properties: A Proven System for Finding, Screening, and Managing Tenants with Fewer Headaches and Maximum Profits” — Brandon R. Turner, Heather C. Turner
These other books were also helpful:
“The Real Book of Real Estate: Real Experts. Real Stories. Real Life.” — Robert T. Kiyosaki
“The Book on Investing In Real Estate with No (and Low) Money Down: Real Life Strategies for Investing in Real Estate Using Other People's Money” — Brandon Turner
“The Real Estate Rehab Investing Bible: A Proven-Profit System for Finding, Funding, Fixing, and Flipping Houses...Without Lifting a Paintbrush” — Paul Esajian
“The Book on Rental Property Investing: How to Create Wealth and Passive Income Through Smart Buy & Hold Real Estate Investing” — Brandon Turner
During the first six months of 2018 I placed several bids on foreclosures. The competition was stiff at the county auction for the most desirable properties, to the extent that the bigger players that were winning consistently, were also paying tens-of-thousands of dollars more than I was willing to commit even if I had unlimited money. The typical foreclosure audience was comprised of a handful of curious onlookers, a dozen or more general bidders clustered around a few select properties, and a handful of flat out professionals.
Each week, dozens of foreclosed properties are auctioned for sale “As-Is” at the county courthouse. What you can see from the street or through the window before the auction is what you get. By the time a property reaches the auction block the owner has been foreclosed upon anywhere from 6-18 months prior depending on how vigilantly the owner has fought their case. Often the property is vacant, but I’ve actually bid on and lost listing before where I knew there were still tenants.
When a foreclosure is occupied after being sold at auction the outcome goes a few different ways. If the owner is still living there, they will likely stay until they’re dragged out. The deed to the property won’t clear for 6-8 weeks, so the winning bidder won’t have legal recourse for almost two months. Then they can begin formal eviction proceedings which may take a few more weeks and a few thousand dollars. The good old fashioned alternative to this route is to offer the owner cash to leave and change the locks.
When there are tenants involved the new owner can attempt to negotiate and take over the lease, ask them to lease, offer them cash to leave, or begin formal eviction proceedings.
I’ve included a snip below from one Sheriff Sale I attended. The properties are listed online at least a month in advance which gives bidders ample time for due diligence. Each property has a Minimum Bid which according to state law in this case was 2/3 of the Appraised Value.
Within a couple weeks I surmized the “Appraised” value was not a reflection of the property’s condition, tax basis, market value, or selling price. Most of the time the “Appraised” value correlated more closely with the amount of money the bank was owed on a mortgage and the hasslement the bank would have to deal with if the property didn’t receive a minimum bid. I’ve witnessed instances where the “Appraised” value of a property listed for $50,000, the same property had a taxable market value of $75,000, and the same property sold at auction for $100,000.
A few different results happen to a foreclosure listing at auction.
Sometimes the listing will be withdrawn at the time of the auction, likely because of legal extensions of the foreclosure case.
Other times a legal representative of the bank will bid up to the value they are owed on the house, which can be tens-of-thousands of dollars more than the appraised value or even nearest bidder. The bank is likely betting they can sell the property for more money themselves or through a service like Auction.com. The banks don’t bid more than they are owed on a foreclosure because the excess funds actually go back to the owner that was foreclosed on.
Sometimes a listing won’t get a bid at all, at which point it’s listed again the following week with no minimum.
And sometimes people win.
I was actually once in a scenario where I lost to a well established landlord. I offered $7,000 more to him after the auction just to get the house. He would’ve made the profit that day, but declined. I then offered $15,000 more to him a few weeks later. He declined. Ultimately he ended up selling the property many months later for ~$10,000 more than he paid at auction. You don’t always get more by holding out…
The best properties always attract multiple bidders. Only the worst viable properties get by with a minimum bid at auction.
Through the magic of the internet and capitalism there is more money than opportunity in every real estate market in the US right now. If a property doesn’t sell within a week, there’s something wrong with it.
I would refresh the real estate sites a few times most days, waiting for new listings. The tired old listings would remain, but every once in a while an actual deal would pop up. I’d call the realtor and the house would already be taken.
Twice I made full price offers within the first week of a listing and lost. The listing agents wouldn’t even accept an increased offer.
I’ve come to learn that $10,000 more for a $70,000 house might be another few hours of work for the listing agent, but only $300 more dollars of commission. When trying to deal in this low end of the market the listing agents aren’t as willing to engage in the back and forth that might only marginally increase the sales commission, with increased risk that an accepted offer would fall through.
I won my first rental property on my fourth foreclosure auction. I consider my rental to be a 1 in 100 find. I say 1 in 100 because of the top 100 opportunities I pursued in 2018 I feel this was the best, and one of only a few that would meet my criteria. For each house I even consider a potential opportunity, there are 10 more non-viable bloated listings.
How did I purchase my first property? Prior to searching for any property, I established the financial criteria necessary for other people to give me their cash to sustainably fund the real estate venture and position myself to fund my future business pursuit. What I was financially able to personally guarantee was ~$250/month in return on loan-equity. This was what I was comfortable I could afford cutting from my day job’s pay check in perpetuity if I failed miserably and lost the entire investment.
An interest only payment of $250/month at a rate of 6% has a loan value of $50k. This percentage rate was simply a market competitive guaranteed return. In different financial market conditions I would have to offer more or less.
I then back calculated the scenarios in which I could buy a house, renovate it, and have the rent cover all owning and operating costs as well as the interest to the investor.
Most $50,000 projects in Cleveland look like the house below:
This house was listed for many months at $10,000. The house fell into foreclosure and was purchased by someone who got in over their head. The outside looks promising at first glance with newer siding and windows. But ultimately the owner needed to cut their losses.
Most of the metal in the house was stolen. They took the gutters. The siding would’ve been stolen too if had it been aluminum.
Could this house be brought back to rental condition for $40,000? Maybe, but I wasn’t the only one on the market taking a pass.
My first rental property, the house I won at auction, sold for $38,000. The house had sat vacant for 18 months. The previous owner had purchased the house for $105,000 during the peak of the real estate market back in 2005. Through my due diligence I was able to conclude the house had been “flipped” at some point in the early 2000s and would’ve included some substantial improvements compared to the typical 100 year old house at auction.
My first move after the auction was drive right to the house and get a locksmith to let me in. Some of my initial assumptions were confirmed right away. But soon I would find the inevitable surprises.