Hello again, Friends. I wanted to share a new strategy in how I’m planning to grow my real estate investment portfolio. I have shared how we’ve broken down a real estate investment rental deal. Since 2016, I’ve focused on long-term leases. These are investment properties that I’d hold on to for a long time, perhaps forever. Typically these deals we’d get off-market or pre-MLS and with motivated sellers to get these properties for under market values. With under market values, adding management, maintenance, repairs, and accounting for a vacancy we can charge a fair rental rate that would allow to cash flow a minimum of $200 per door.
Coaching Can Help
I had recently hired a business and growth coach to help with my strategy and help me increase my cash flow. We took the time to review my current portfolio of properties and examine my profit and loss statements. We reviewed my qualifying criteria for properties and examined where we can improve the process to help grow this business.
The Current Housing Market
The current housing market of Summer of 2021 is at all-time highs, it has been very difficult, if not impossible, to find the traditional buy and hold off-market property that I had in the past. Finding more turnkey, or minimal rehab properties, that would cash flow is and continues to be challenging. For example. Three of my rental properties are townhomes in the same association. I purchased these for approximately $135,000 a piece.
Another property had just come on the market in the same association right next to the other units. This is a nearly identical property, and the list price was over $200,000. Let me rephrase that. An identical property for $65,000 over what I’ve purchased the others for. This is almost unbelievable, but it’s true. The rents for these properties are around $1,495 per month. So, there is no way I could cash flow a new property at these purchase prices at the comparable, market rents.
Build a Growth Plan
As my coach and I reviewed our requirements, there were a couple of obvious things or the big rocks, we are going to tackle, right away. The first thing was that we identified my previous minimum cash flow per door/property was just not enough to sustain the business. This was a rule of thumb. When I first began investing and what I have learned from many others and listening to BiggerPockets.
We agreed, in running a cash flow analysis, we’d need to increase the monthly cash flow of each deal to $400-$500 per property, to better build up reserves to cover ongoing maintenance, repairs, and any vacancies that may occur. The next thing we agreed is that the current rental business model needed a change as we just referenced earlier, the market is too high for this model if we are not performing any significant rehab or renovation on the property.
One of the options that were discussed, was to provide leases with an option for our tenant to purchase the home after a set term, like 2 years or 4 years. My coach has had much success with this model and walked me through some considerations and how he proved out this model.
Let’s break down this model. A Real Estate Agent works with a family or interested party that would like to purchase a home.
These parties are unable to qualify for their own conventional loan. This can be because of poor credit, or perhaps they have had filed bankruptcy in the past or even are self-employed that can make it difficult to show proof of income required by the lender. This is especially challenging if they were out of work for a year during the pandemic. Many of these interested parties are professionals, with well-paying salaries. They make an income that meets our qualification standards of earning 3x the rent.
We work closely with the Real Estate Agent and the prospective buyers (or tenants) in doing walk-throughs of properties and in choosing a home. Keep in mind, these are homes that the tenants will want to purchase, and can picture themselves owning. All the other considerations are important to them as is homeownership. Schools, commute, utilities, yard, etc.
The Bidding War
Once the tenants (the future buyers) have decided on a home they’d like to buy, and we have also walked through the property and feel it’s a quality home that meets our standards. We then move forward and submit an offer to purchase this home. This process is the same process as traditionally purchasing a home. Using conventional lending, at thirty-year term. You can go back and forth with the sellers working with your agent to negotiate the best deal for yourself, and making sure it still will work out with your buyers as well.
With this current market, the home I had just purchased was on the market for one day and received 14 offers. I was at the top of the list because I was offering 20% as a down payment. There was a little negotiation with the closing costs, and in the end, my offer was accepted. This was also because of my Real Estate Agent’s reputation. The seller’s agent understood the professionalism, diligence and felt confident that my agent would do their best to get the job done. This is an example of why building a team that you can trust, and working on your side during your investing journey can be so important.
What’s In It For Them?
If we break down the terms of the lease it can truly help the tenants in purchasing this home, in which they wouldn’t currently qualify. It allows them to get into a home, perhaps a “forever home” years sooner. They can begin the journey with a much lower down payment as well. Once they come to the end of their lease, they have already made significant progress towards the down payment in purchasing the home. This also gives them time to rebuild their credit so that they are able to purchase this home, that they have already made it the home their own during the time of living there.
What’s In It For Us?
Once we have the tenants sign the lease and move into the home. We require what we are calling an Option Payment. This is a payment of ~$10,000. This can be negotiated and adjusted based on monthly payments. For example, maybe we lower the monthly payment but require a larger Option Payment or vice versa. This Option Payment is then used towards the down payment if the tenants purchase the home. We then collect monthly rent in which 10% is placed into escrow for use in the down payment in purchasing the home. As you recall, we needed to cash flow over $400, and a majority of this is placed in my reserves to cover any major repairs, taxes, and insurance.
The understanding is that these tenants or potential homebuyers are going to buy this house. We treat this as if they had purchased it. All utilities, such as electricity, water/sewer, natural gas are paid for by the tenants. Any minor repairs, under $300, are the responsibility of the tenants as well. These are quality properties, on a higher end. These are newer homes and shouldn’t have as many repairs or maintenance issues. Fewer issues than older units that may have been left in disrepair.
Who Manages IT?
This model also doesn’t have any management fees. As for my other, long-term rentals, I have a property management company that handles all the maintenance requests and repairs. They handle all the rent collection and communication with the tenants. With this new strategy, we’ll be taking on this responsibility. We’ve recently begun using the new rental management platform offered for free by Apartments.com. It seems pretty solid. Setting up the payment platform, creating the lease with the ability to upload my own custom terms was pretty easy. This platform will allow my tenants to file maintenance requests, pay their rent, or otherwise communicate with us. I’ve also outline alternate payment methods and communication preferences in the terms. They must always send communication via email, as may recall I still am rocking a day gig. So fewer interruptions and distractions the better.
As I may have several of these Lease Options running concurrently, an option is to have a third-party home warranty on each property. I’m researching this as well. This way, appliances, and other repairs can be covered and this relatively low monthly fee can be passed on to the tenants. This way they would have one phone number to call, and a single point of contact for repairs. I’m still working through this.
Like we had said earlier, my coach has had experience with this model, and the interesting thing is many times when the end of the term of the lease the potential home buyers opt-out of the home purchase. You heard this correctly. Many tenants, once renting for 2, 3, or 4 years either decide to leave the home or continue to rent.
Sell, Or Not
I had no idea that something like this could happen! Regardless of what the tenants decide, this model works. If we move forward with them purchasing the home, they’ll purchase for the predetermined price when the lease was signed at the beginning of the term. If for some reason, they have determined they’d not like to purchase the house and move, I’ll either sell the home or work with my agents and lenders to find another potential buyer. The great thing is we’ve had someone take care of this property for the past few years. Often the existing tenants decide to not purchase the home, either at this time or ever, we re-negotiate a new lease. Maybe they would like another year or two?
If we look at the numbers, you can see that I bring a significant down payment, however, we are able to achieve some pretty good cash flow for the term of the lease.
I’ve completed one lease with this new investing model, and I have two real estate agents and my lender that are working with additional buyers and will let me know when I can meet the potential buyers, and preview some homes.
This is a shift in our real estate investment strategy. I’ve officially created this “program” and will also begin to advertise and promote it on social media. I’m excited to continue with this growth model, as well as help people on their path to home ownership.