How I Picked My Properties and a Rental Income Update

It’s been over four years since I shared the Financial Details of My Real Estate Investments.

I’ve been wanting to give an update for some time and since I’ve just completed the process of getting all my numbers together for tax purposes, I thought this would be the year to do so.

In addition, I thought I’d share the highlights of the process I used to select my properties.

For those of you who are unaware, let’s quickly review my journey into real estate investing.

How I Got Started in Real Estate Investing

It all began sometime in late 2011 or early 2012. There was still blood in the water from the financial meltdown. Things had started to turn upwards, of course, but people remained pretty skittish, wondering if another crash was around the corner.

Nowhere were people more on edge than in real estate. Obviously real estate had a big part in the crash and many of those owning investment properties were either in tough situations or simply had enough and wanted to get out.

I had some cash on the sidelines (making a good income and keeping expenses low allows for giving, saving, investing, AND having some left over). I thought this might be the time to get into real estate as prices would probably be fairly low.

My only problem: I didn’t know anything about real estate investing.

Not letting lack of knowledge stop me, I proceeded by listing what I wanted to accomplish with my real estate investments.

From there, I found a mentor to teach me the ropes and we created a win-win partnership (he taught me the ins and outs and I used him to buy my properties (he was a realtor)).

My Process for Determining a Suitable Rental Property

Over the course of a few months, my mentor, Eric, and I used the following process to decide what properties to buy…

I would generally become aware of a property either through an automated email of new listings I received daily or from a specific listing found by Eric.

If something looked interesting, we would discuss the property a bit, covering the basics to determine if it was worth seeing in person. These included what part of town it was in, the age of the property (which could hint at fix-up costs), any history of being rented (or at least estimated rents), potential costs (including real estate taxes), potential selling price, and so on.

Assuming all of the above were at least somewhat acceptable, I would do a quick calculation to see if the financials of the property were in line with my expectations. At this point I relied mostly on the Gross Rent Multiplier (GRM). The GRM is the sale price of the property divided by the property’s annual gross income. It works like this:

• The property sells for $90,000.
• It’s a duplex (two apartments) and each could rent for $500 per month (or $1,000 per month total.)
• Annual gross income is therefore $12,000 ($1,000 x 12 months).
• The GRM is 7.5 ($90,000 / $12,000).

Wikipedia said that a GRM of under 9 is acceptable, but, as you know, I’m a bargain hunter. I looked for places that were around 5 or less.

In addition, I would play with the numbers to see what was possible if the selling price went down or the rents up. If the property passed this measure, then it was worth a look. (FYI, I had seen properties sell as high as 8 GRM and as low as 2 GRM (the latter were generally in very sketchy neighborhoods). There were many for sale with GRM of 15+ which probably never sold until the price dropped.)

We would then go check out the property in person — me, Eric, and my wife (if she was available — if not, Eric and I would go and have her come on the second visit). We looked it over, discussed issues/options along the way, etc.

If all looked good after we saw the place, I developed a pro forma income statement for it. I created a spreadsheet that has spots for various inputs (including purchase price, potential rents, all costs, and so on) to look at a property’s profitability. Eric would get me cost estimates either based on his experience (which were especially helpful if we’d seen the property and knew what needed to be fixed) or, if available, financial statements from the seller. We then made adjustments as needed and end up with a profit estimate.

In the course of developing these numbers, I put in every cost I could think of including both a management fee as well as a plug fee of one month’s rent for vacancy reserve.

If, after all these costs were added in, it still delivered 10% before personal income taxes (not property taxes — these were expenses already included) and depreciation, then it made financial sense to move ahead.

At this point we discussed pricing, what we’d offer, terms (like inspections), and so forth. Then we made an offer.

Next we would sit and wait for a response and eventually respond ourselves as needed.

If all worked out well, we’d sign the deal, complete the inspection, adjust if needed, and buy the property.

Over a year and a half we looked at hundreds of houses online, spent numerous hours looking at places in person, put offers on many, and had three accepted. In the end I purchased three properties comprising five buildings and 14 total rental units spread throughout the city of Grand Rapids, Michigan.

Our strategy with all of these was to use timing and cash to get great deals, then remodel the places and raise rents to make them more profitable (FYI, we always waited until leases expired to remodel — we did not kick anyone out of their home. When the lease was up we told them we were remodeling, shared what the place would include, and gave them the new monthly rental costs. All moved out on their own volition since rents were going up on average $200 a month.) And that’s what we did.

All-in, including purchase prices and remodeling costs, I spent about $600k (FYI, I didn’t have all this available at the start, but as I knew we would be buying more, I started saving more and more cash for that purpose). They were bought for cash (which allowed us to negotiate hard and move with speed — beating out some who needed loans) and I hold them in an LLC.

You can read the details of each property in my last financial update.

You can also read my take on what I did well and what I didn’t do so well in this process.

Working with a Property Manager

I never had any intention of managing the places myself. Life was too busy to add that responsibility plus I didn’t want the headache (and I knew nothing about managing anyway).

The original plan was that Eric would manage my places in addition to his own. Then, after we bought the first place, he told me he didn’t really have time to manage my properties. Yikes!

So while we were remodeling property 1 (it was bought from the government who had taken it over), I had to figure out what to do.

Thankfully, we bought property 2 in the meantime. It had a property manager who I eventually hired to manage all three places.

This turned out to be a very good thing because soon after buying property 3 we moved to Oklahoma City and then Colorado Springs. So I have way more time under my belt managing the properties (with a manager) from afar than I do actually being in the market with them. In fact, I haven’t been back to see them since we left Grand Rapids almost seven years ago now.

Here are the highlights of how I work with the property manager:

• At the end of each month (usually a few days before month end), they send me an email letting me know how much they will be depositing in my real estate checking account for that month (income less expenses for that month).
• Around the 3rd or 4th of the next month, I get a detailed income and expense statement for each building (five) as well as receipt copies for any major expenses incurred.
• I comb through the numbers and send my manger an email with specific questions. I usually have about 10 or so, most of them centering on what a specific cost was for or where we are with various tenants (if their lease is about to expire).
• She sends her responses and that’s generally that. We then repeat the process the next month.
• Every once in a while something will pop up and we’ll need to chat, but that’s a couple times per year at most.

I spend about two hours each month “managing” my end of the process, which is very do-able, of course.

What’s Happened Since Purchasing the Properties

We’ve had a steady return of roughly 10% income each year — some years better, some worse, but generally in that range every year.

I’ve also had significant appreciation in my places and now they are probably worth $1.2 million to $1.5 million based on the deals I see in the market from time to time.

Owning rental properties has significantly complicated our tax accounting and I’m thankful to have a great CPA who handles it for me. She’s still in Grand Rapids and we communicate a few times per year in addition to tax time.

BTW, in addition to the rental units I own my home free and clear so real estate as a total makes up over $1 million of my net worth (assuming the rental properties are valued at cost and not market value).

2019 Results

Now for the financial update.

Just to note, these are the raw numbers, what I provide to my CPA. From there she works them over, calculates depreciation, and gets an adjusted income.

INCOME

• Rents: $146,482.26
• Laundry: $166.78

Total Income: $146,649.04

EXPENSES

GENERAL

• Christmas gifts to property managers: $50.00
• LLC Annual Report: $25.00

Total: $75.00

PROPERTY 1

Gross Income: $31,189.51

Expenses:

• Cat Fees: $80.00
• Dog Fees: $167.00
• Fees and Permits: $1,150.00
• Grounds: $1,056.00
• Insurance: $1,139.00
• Leasing Commissions: $536.25
• Maintenance: $3,337.68
• Management Fees: $2,133.96
• Real Estate Taxes: $4,539.99
• Water: $299.13

Total Expenses: $14,439.01

Total Property 1 Net Income: $16,750.50

PROPERTY 2

Gross Income: $77,531.37

Expenses:

• Cleaning: $1,701.00
• Electricity: $551.74
• Grounds: $3,772.50
• Insurance: $2,754.00
• Leasing Commissions: $2,314.00
• Legal: $770.97
• Maintenance: $10,506.40
• Management Fees: $6,381.00
• Miscellaneous: $12.00
• Natural Gas: $3,904.10
• Real Estate Taxes: $6,243.94
• Retention Fees: $1,047.50
• Trash: $1,233.60
• Water: $1,819.61

Total Expenses: $43,012.36

Total Property 2 Net Income: $34,519.01

PROPERTY 3

Gross Income: $37,928.15

Expenses:

• Appliance: $546.00
• Cleaning: $52.75
• Electricity: $678.16
• Fees and Permits: $479.08
• Grounds: $1,596.00
• Insurance: $1,008.00
• Legal: $481.84
• Maintenance: $6,153.35
• Management Fees: $3,001.33
• Natural Gas: $2,155.54
• Retention Fees: $598.75
• Taxes: $3,527.07
• Trash: $672.72
• Water: $803.31

Total Expenses: $21,753.90

Total Property 3 Net Income: $16,174.25

Grand Total Net Income: $67,443.76

Explanations

Lots of stuff to explain. Here are the highlights in the order they are mentioned above:

• Laundry income: In the three multiple-unit buildings I own, there are laundry facilities subbed out to a service. The pro is that they do everything (including providing and fixing the equipment). The con is that they take a lot of the profits. These were all managed by the previous owners when they had the properties but since I don’t live there and my management company doesn’t manage laundry facilities, I went with the service. I end up making about $500 from laundry fees but some is paid through my management company and is in their numbers (the amount above is for what’s sent directly to me).
• Cat/Dog Fees: When tenants have pets, we charge them a fee for doing so. These are the management company’s portions of that money.
• Fees and Permits: Municipalities charge fees for renting properties in their areas. These hit roughly every three years or so.
• Grounds: This covers both snow removal (which is substantial in Grand Rapids) and lawn care.
• Insurance: It is what it is.
• Leasing Commissions: When a tenant leaves and we get a new one, the management company gets a fee worth roughly 75% of one month’s rent for most of my places. They do the work of finding the tenant, paying for advertising, running background checks, etc.
• Maintenance: The two main reasons for maintenance are wear and tear and remodeling/updating after one tenant leaves and another moves in. We’re now far enough from my original remodels that some of these can be substantial. These costs would be less if I lived there and could manage the repairs myself.
• Management Fees: This is what the management company earns for managing my properties.
• Real Estate Taxes: Never seem to go down. The people of Grand Rapids can thank me for my contribution.
• Water/Electricity/Natural Gas/Trash: I pay utilities in two cases: 1) If there’s no tenant and/or if the tenant doesn’t pay for some reason (which we collect later) and 2) if the utilities are not metered to specific apartments (i.e. one charge for the entire building with four apartments).
• Cleaning: This happens when a tenant moves out and we prep for the next one. I also pay for one property to be cleaned in the common areas (primarily stairwells).
• Legal: These are usually fees for evicting a non-paying tenant. They are charged back to the tenant and taken out of their security deposit.
• Retention Fees: If a tenant renews his lease for another year, the management company gets a fee worth roughly 25% of one month’s rent for most of my places.
• Appliance: Have to replace one now and then.

What I Could Earn

The return rates are very good on these places even with a property manager.

But they could be better.

If I was in the market and wanted to manage these places myself, I could eliminate the management, pet, retention, and lease fees listed above. I could also cut the maintenance costs.

Then again, I’d have to deal with a lot of issues and that would cramp my retirement style. So even if I did move back, I’d probably still use my management company.

Plans for the Future

I would like to buy additional properties in either Grand Rapids (where I could have my manager supervise them) or Colorado Springs (where I live and could manage myself or find someone to do so), but both markets are over-priced IMO (at least for me they are).

So I’m waiting. If the situation presents itself, I’ll buy more. If it doesn’t, I’ll hold firm.

I have considered simply cashing out my properties since the market is so good, but it would be really hard to replace the $60k in annual income with another investment, so I’m planning on keeping them for the foreseeable future.

That’s my update. Any thoughts or questions?