This article is by staff writer Adam Baker. Baker recently outlined his ambitious 2010 goals for his blogging, business, and life.
When I was 23, I bought an eight-unit apartment building with no money down. And I walked away with $1,000 cash at closing! Sounds pretty fancy, right? Wrong.
It was one of the dumbest real estate investing mistakes I've made in my young life.
I escaped without a scratch, but it was due to an over-sized dose of sweat, tears, and luck. None of it was due to savvy investing skills.
The sound and the fury
I was 23 years old and had just earned my real-estate license the previous year. My first couple of months were spent buying and selling a few upper-end units for individual homeowners. The commissions were decent, but as a new Realtor, my split with my company was high. To complicate the problem, I had financed my association, training, and union fees to get started. (This was before I had decided to cancel my credit cards.)
After several months, I began to work more in the booming foreclosure and short-sale markets that were plaguing central Indiana. Out-of-state lawyers, doctors, and other high-income earners (mostly from the West Coast) were swarming our local market.
They were buying up $30,000, $40,000, and $50,000 houses like they were toys — albeit over-priced, over-financed, and only half-functioning toys at best. With rents ranging from $400-$1000, they simply couldn't resist what their spreadsheets were telling them the return would be. They bought many of the homes sight unseen and used the first real-estate company that would sell to them.
We represented a lot of the banks that had no idea about the local market prices. They also didn't understand the current condition of their properties (even after we told them several times). Well over half the deals fell through. Either the banks were too unrealistic to negotiate, or a closing would be interrupted by the discovery of a mystery lien, a second mortgage no one knew about, or some other problem with the title that we didn't even know was possible!
It was harder work for lower commission, but there were hundreds upon hundreds of properties, which helped even out the paychecks from month to month. And I was learning a lot about how to avoid real estate investing mistakes.
Property management comes calling
After most of the out-of-town investors closed on their new rentals, they began searching for a company to manage/rent them. After several dozen requests for an affordable and trustworthy property management company (and no clear-cut option), we decided to start offering the service ourselves.
I joined forces with a broker who spent his time focusing on acquiring more leads for buying/selling. I set about figuring out how to actively manage and rent the vacant units (which almost always needed repairs first).
Since many of our clients were repeat customers already, they were ecstatic to have the option of having their properties managed by us in-house. Within just six months or so we had over 125 units under management.
I was working countless hours and answering the most bizarre phone calls you can imagine at all hours of the night. Overall, though, we were turning a profit and looking for ways to scale our system over the next couple of quarters.
A perfect storm
As part of our networking and lead-generation work, we regularly attended private meetings where local brokers would pitch each other their current clients wants and needs. In one particular meeting, another broker was pitching one of his own properties for sale. It was two side-by-side four-plexes (eight units total) with each unit being one bedroom. It was in a low-income part of town, but he was only asking $125,000 for both properties.
“$125,000 for eight units?”, I thought. “There has to be a catch.”
There was. Seven of the eight units had tenants, but only three had any history of paying on time. Even after kicking out any non-paying tenants, each unit would need a couple thousand dollars of work to get anything decent in rent. In addition, there were four furnaces in total all of which were probably made in the 40s or 50s.
In other words, it was a project by anyone's terms. It would require some up-front repairs, several months of eviction filings, court visiting, and re-showing the units, but… “$125,000 for eight units!”
If only someone would loan me the money…
I dug deeper and deeper into the numbers. I was already managing property, coordinating repairs, negotiating prices on materials, and renting units for dozens of other clients. It made sense that if I could get a loan, I could plug a property right into this current system I was running.
There was a big glaring issue, though. Neither my partner nor I was credit-worthy in any sense of the word. The chance of me getting approved for a mortgage was zilch (let alone a non-owner occupied, low-income commercial loan). With regret, I pushed the property to the back of my mind and continued about the process of building the management business.
At our next networking meeting, though, we caught wind of some additional news on the properties. The broker who owned them was in serious trouble on about a dozen different pieces of real estate. He owed $76,000 on both the buildings, which were financed through a popular investor/hard-money lender.
The private lender was getting scared that the investor would soon default (giving the lender a property he wanted nothing to do with). The owner was only looking to get out of the property, so he could focus his energy on his salvaging his other properties.
Without much thinking, we pulled the trigger.
A bold offer
We called up the private lender (an individual) who was currently financing the properties. Then we pitched him the idea of us taking over the loan and purchasing the property from the current desperate owner.
We offered to both sign onto the loan, giving the investor two names opposed to the one he currently had. Then showed how we would remedy the situation, evict all the tenants, and plug it into our management system.
Neither of us had a penny to our names, so we even had the guts to require that the private lender actually invest more money into the property. In order for us to take it over he'd have to loan us an additional $15,000 to replace the furnaces and repair two of the units after evictions.
It was a bold offer. We'd give nothing but a management plan and our signatures on a $91,000 private mortgage (at 12%) for eight units and a $16,000 cash loan. The lender must have known even more about the current owner's dire circumstances then we did because he took our offer. The current owner was happy to get out for what was owed, and within the week we sat down to close.
After the paperwork was signed on my first-ever real estate purchase I was handed a $1000 check (for prorated rents/deposits for the month). I gave nothing tangible, just my worthless signature, and walked to the bank to deposit the money.
“So this is how real estate works”, I gloated. “I could get used to this.”
I had no idea what was in store…
J.D.'s note: This is a glimpse into a world I've always wondered about. Though Kris keeps trying to dissuade me, I have a fascination with rental properties. I look forward to reading part two of this story. And although GRS is not about to become a real-estate blog, this Sunday's reader story is actually about how one of you folks decided to take the plunge by buying a rental property, so we're going to have a mini-theme here for a week or so…