This is a follow up to my previous article on How To Analyze A Killer Real Estate Deal, where I show you an actual property I looked at and purchased. The property is now fixed up and rented out so I thought I’d take a moment to show you how it turned out!

Fixing it up! Before and After Pics

The house got new paint inside and out, carpet, air conditioner, microwave, dishwasher, light fixtures, doors, landscaping, and a few other cosmetic things.

Here you can see the new AC, the old one was rather beat up!

Here you can see the new microwave and dishwasher in the kitchen. Overhead lights have been fixed, cabinets painted, etc.

White paint on the outside and raising the tree line improves the curb appeal.

Keep in mind that I didn’t do any of these repairs myself. I hired contractors so it was zero work on my part. Total cost of the repairs were $14,500 and they took two weeks to complete. I had the contractors lined up and ready to go the day after closing.

Equity Capture

I bought the house for $76,000 and put $14,500 worth of repairs into it. In it’s newly repaired condition the lender appraised the house for $115,000. So I now own a $115,000 house.

115,000
- 76,000
- 14,500
———–
$24,500 Equity Capture

As you may recall from my previous article, I financed this deal with a lender who loaned me 80% of the after repair value. This allowed me to put very little money down.

I was hoping to get it with zero in the deal, but unfortunately that didn’t happen here (maybe on my next one). Still, it worked out quite well….there was no down payment, but including all repairs ($14,500), closing costs, appraisals, finance charges, etc…the total cash out of pocket that I have in this deal is $11,500. (I brought $5,900 to the first closing, repairs went $3,100 over what was escrowed by the lender, and $2,500 to refinance out of the hard money loan into permanent financing.)

(24,500-11,500)/11,500 = 113% return on equity

Note that I didn’t have to wait a couple years for this to appreciate. I raised the value of the property by this much in one month, just by fixing it up!

Of course equity capture is an “unrealized gain”. I can’t go out and spend that $24,500 because it is tied up in the house. But in a year or so I can do a 1031 exchange perhaps to sell some houses and get into an apartment, and I’d be able to get that equity out. The lenders appraisal of $115k is a conservative one, and in a year it may have appreciated as well. But even if it doesn’t (I don’t like to count on appreciation) it has still gone up in value just by rehabbing it.

Cash Flow

Getting a 113% return on equity is a nice way to raise my net worth, but the cool thing about this property is that it is also paying me with money I can actually use today. In other words it “cash flows”.

I listed it for rent at $1,100/month. This is slightly below rents in the area and it was in great condition so it only took about a week to get a lease signed. The mortgage at 7.75% interest is $647/month. Taxes are $270/month. Insurance is $80/month.

1,100
- 647
- 270
- 80
———
$103 per month positive cash flow

Right now the taxes are based on a value of the home of $112,000. But since I just purchased it for $76,000, I should be able to get the tax value reduced to $76,000. This would make the tax payment only $200/month instead of $270/month. Paperwork has been filed for this but it will probably take another few weeks.

That would bring the positive cash flow per month to $173/month.

173 times 12 months is $2,076 per year

$2,076 divided by my total cash out of pocket of $11,500 gives an 18% cash on cash return.

Conclusion

Overall I’m happy with how the deal turned out.

In the future I think I can make it work even better by doing a few things differently: First, I’m going to try a different lender to see if I can reduce the finance charges. I think I could do a lot better in terms of the origination fees, broker fees, and closing costs overall. Secondly, I’m going to try and end up with much less money in the deal. If that $11,500 was closer to zero the rate of return would go way up. I’ve seen a couple deals where I could actually get it to zero, or even better, get cash back! So I hope to do that soon.

That being said, the numbers really are quite staggering when you look at it.

113% return on equity
18% cash on cash return

Try getting that in the stock market! And of course, my equity will continue to grow by about $100 each month as the tenant helps me pay off the principal. Oh yeah, and I forgot to mention…the cash flow will be TAX FREE. The $173/month in positive cash flow is really equivalent to $247/month of ordinary taxable income that you’d get from a job or some other source (assuming a tax rate of 30%).

Finally a big point to keep in mind here is that this is passive income. It may be hard for some people to get excited about a couple hundred bucks a month, but the key point is that I will make it without doing any work (or very little). Get 10 houses and now you have something…and income stream you don’t have to work for! Plus of course the equity gain is much larger and will help build net worth quite rapidly.

Here are some common questions I assume people might have, so I will try to answer them. If you have others please post below.

Your cash flow won’t be $173/month because something will break in the house that you will have to fix. And won’t you be getting calls in the middle of the night to fix things? That doesn’t sound like zero work!

I put in the lease that the tenant pays the first $250 of any repairs. So all minor repairs are their responsibility and cost. Larger repairs like the air conditioner are under warranty right now. So hopefully this won’t be an issue. I have to admit that the one expensive item not under warranty is the water heater, so if that breaks I may have an expense (minus $250 from tenant). In the future I may try a home warranty company that I found which would be an easy way to cover all repair costs.

The house really only needs to stay in decent condition for about a year. I plan on selling it in a year or two along with a number of other houses to get into an apartment complex.

What if the tenant doesn’t pay rent or destroys the house?

If they don’t pay I’ll evict (entire process takes about 20 days in Texas) and keep their deposit. I did a criminal and credit check on them (and several other applicants) to try and select the best candidate. I required them to pay double deposit (two months rent, $2,200) because their credit wasn’t perfect, so this provides a buffer. Given that you can evict so quickly and keep two months rent, its possible to actually make MORE money in this type of situation, unless the damage is really quite substantial.

What if it floods, a pipe breaks, a tree falls through the roof, etc?

These type of claims are covered by the insurance.

What about vacancy? You should account for that in your numbers.

I didn’t account for vacancy because it took me 1 week to rent the house initially. It is now one of the nicer houses in the neighborhood and I deliberately charged a rent ($1,100) slightly below market value to attract more people. I feel confident that if I need to evict I can rent it again in a week or two.

You didn’t really make a 113% return because you can’t spend that money.

You are right. Return on equity is an “unrealized gain”. I can’t go out and spend it, but it is real money that belongs to me. It is just tied up in the house. Note this is different than saying “I think it has gone up” or “I think it will go up” like when talking about appreciation. The house is worth that right now, and I was able to raise it’s value by that much in one month by fixing it. This is much more certain than betting on appreciation because you can see what other properties in the area are selling for. The lender (who has an incentive to estimate conservatively) appraised it at $115,000 so I feel confident it’s worth at least that much.

Anyway, I am happy with how it turned out and learned a lot to hopefully make the next one better. If you see any errors or have questions/comments please leave a comment below! Thanks!