My Real Estate Education Continues With My Second Purchase
Following my first experience in real estate, detailed in my first blog post: How I got into Real Estate as a young U.S. Air Force Office, I was feeling, naively, pretty good. Now, a single Captain in the Air Force with no kids, I felt confident that I was well on the path to financial Freedom. I had acquired my first property with a long-term plan to acquire one additional property every 3-4 years upon each move to a new military location. I was thinking to myself "by the time I reached retirement age at the young age of 42, I wouldn't have a worry in the world…
In my mind, I was only losing about $380/month, and I could easily cover that with my income. My “math” only took into account principle, insurance, taxes, and insurance (PITI), condo fees, and management fees at $850, $232, and $123, respectively. I did not realize that you also needed to account for vacancies, maintenance, and capital expenditures (CAPEX )on top of that to get a true indication of potential cash flow. Adding these to the mix, my actual cash flow was -$585/month. Ouch!
Upon my move, I figured I could save some money by paying off the second mortgage, which had a remaining balance of about $11k. This dropped my actual loss down to ~500/month on a $23k investment. My property, originally worth 115k, for which I paid full price, was now worth ~$90k. Mind you, my stock portfolio had also dropped significantly by about 35%. For my next military assignment, the Air Force moved me to Edwards AFB, CA in 2009, which is in the Mojave Desert about 1.5 hrs. Northeast of Los Angeles.
My investment career wasn’t looking so hot. However, rattled as I was, I was an avid fan/reader of Warren Buffett (still am as a matter of fact). I was confident that times of panic were the best times to look for golden opportunities. Ok, I was fairly confident. If I would’ve been REALLY confident, I would have bought up everything I could get my hands on. Instead, I stayed the course and stood by my plan. I kept contributing to my IRA and 401k, and began looking for another property to purchase with the intent of living in it while stationed in the area and renting it out when I moved.
Now, looking back, I realize that I made another rookie mistake. When searching for the property, I did not educate myself and become an expert in my new market. Granted, it’s a little more difficult for military members to accomplish this as we only get about 8 – 10 days to find a place to live. However, I could have started the process from Ohio.
Nevertheless, for those that know the area, I found a foreclosure in a great neighborhood west of highway-14 in Lancaster, CA about 40 minutes from base. The previous owners had purchased the property at the peak of the market for ~$450k. It was now being listed at $195k. If I were in their shoes, I think I would have taken the hit too and walked. Well, as I think seriously about it, I probably would not have due to my security clearance, but I digress.
I offered $185k which was immediately accepted. I was surprised by how quickly I picked this up because I had made 3 other “low’ offers on other units that had all been bid up well above the original asking price. I say "low" because I was only under-bidding by about 5%. I thought 5% below asking was a good deal, but now I know you should look closer to 20-30% below market value.
In hindsight, I did some things right on this property. It was a 4bed/2.5bath at 2550 sq. ft. purchased at about the trough of the downturn. During the three years I lived there, I had four roommates at various times. This is known in the BiggerPockets community as "House Hacking". This gave me an extra $21k total in additional annual income, and I was virtually living for free. I also wised up and used my VA loan, so I only had to pay closing costs of about $3.5k. Unfortunately, this area was in what’s called a “Mela-roos tax” zone for roads/neighborhood upkeep which added an extra $350/month to my PITI. Therefore, my total payments were $1600/month.
When I moved in the summer of 2012, it looked like mortgage rates had sunken to about as low as they would go. I was wrong, however, as rates dropped another .75 basis points… Based on my continued education, I don't know a soul who can truly time any market cycle, so I still call this a win. I decided that I would refinance to get a lower monthly payment. For $2k, I was able to reduce my monthly payments by $230. Add this to the fact that real estate prices were rising fast. My Ohio property was now worth about $95k, and the one in California was at about $240K!
I was able to find the perfect tenets who were actually the best friend of my current neighbor. This tenet and his wife were both doctors with one pre-teen child. They had bought their place at the height of the market and were just wrapping up a short sale. I was able to get them on a 2 year lease at $1600/month with a $1600 deposit and no property management. What a great opportunity! In fact, they continue to be absolutely fabulous to this day! I was cash flowing $230/month. Well, that is not true. I still have to remember those other pesky expenses Frankie... I was a pretty happy camper at this point.
So let’s look at the numbers:
Investing time-frame: 4.5 years
Total properties: 2 SFRs
Total equity: $62k
Total Investment: $44.5k (includes 3 years of negative cash flow from Ohio and roommates)
Total Cash Flow: -500/month (breaking even on the CA property when accounting for all expenses and still have the thorn in my side in OH)
CoCR: 139% over 3 years (~40% annually)
Not too shabby for a newbie…but I was still lacking the resources of the BP community! And my next purchase would also be made without it Woe is me.
THAT story will continue in the next installment.