Ep. #3 - The First 3 Things I Had To Learn How To Do For Purchasing My First Rental Property

What’s going on, everyone? Episode No.3! Thank you for coming back. This is a bonus episode, the second this week. As I said, occasionally, I would release more than one episode per week. I wanted to elaborate a little bit on the topic from the prior episode which was speaking about my first rental property purchase, a townhouse, that I bought in May, or actually got under contract, in May of 2015, and enclosed on it in July of 2015.

So, I wanted to speak a little bit more about that whole process, some of the underlying things that I had to do in order to get to the point of being able to make that purchase.

So, as I said, it started with my reading ‘Rich Dad Poor Dad’ on the cruise ship. In between that and actually making the purchase, I also read Brandon Turner’s book called The Book on Buying Real-Estate With Low (And No) Money Down, that you can get on Biggerpockets.com. I also started to post things to that website, listen to their podcast, signed up to participate in their webinars, pretty much just soaking up as much information on real-estate as I could. But there are three critical things that I had to be able to do to make that first purchase successful.

Number one, I needed to be able to evaluate a potential purchase. I needed to be able to put in the numbers for what the loan was going to cost me, and what the property was going to be priced, what the anticipated rehab was going to be, all of the different aspects that make up the profitability of a rental property purchase. You have to account for vacancy and repairs and maintenance and capital expenditures, and property management and, so, all of these things go into the formula that spits out the answer as to whether or not you’re going to make any money on a given property.

Biggerpockets.com has a bunch of calculators, two in particular, that I used then and I use now. They didn’t have the second one back then when I made that first purchase. Back then, they had what they referred to as the rental property calculator. Now, they have that and BRRRR calculator. BRRRR stands for Buy, Rehab, Rent, Re-finance, Repeat, and it’s basically just an acquisition strategy, usually related to acquiring distress properties with short term money like short term private lender or a hard money lender loan, that you’re going to then rehab into a rental, and re-finance into long term financing through a conventional lender like a bank. Whereas, the rental property calculator is usually for those properties that, even if they do need rehab, it’s not so significant that you can’t get conventional financing on it right from the start.

So, those are the two calculators that I use most often. They didn't have the BRRRR calculator when I got that first property. I didn't even know what BRRRR was, or have that concept in mind. But when I was using the original rental property calculator, it was already with the intent of using conventional financing. You probably shouldn't even get into a scenario where your very first project is one that requires such a high level of rehab that a conventional lender won’t finance it.

And so, the webinars that Biggerpockets has, will often teach you how to use the calculators, and then you want to get to the point where you know what you’re likely to get as far as terms from a bank for a conventional loan, so that you can plug those into the calculator. You want to know what your likely vacancy and rent, are repairs and maintenance and capital expenditures and property management. You want to call around to different vendors, and get those numbers so that you can then plug them into the calculator.

And in some cases, you just have to use estimates, like for instance; I believe I used 6 % vacancy and 2 % repair and maintenance, and 4 % capital expenditure, and 10 % property management. And then you just plug those numbers in. I think I realized that I was going to be able to get a sub 5 % loan, so I think I did my initial numbers on 4.75 %, which is exactly what it turned out to be. You just need to be able to quantify all of those numbers as required for the calculator to do its work; plug all those numbers in, come out with a value for this property as to what it’s going to return on your investment.

And you should be doing those assessments of property every day, even if you’re not going to buy a particular property. Every time you see another property on the MLS that might even possibly be a decent rental purchase, or not, run it through the calculator, and evaluate it as a potential deal. The more of those you do, the easier it’ll become, and eventually you'll get to the point where you’ll have enough of the information in your head that you’ll just be able to eyeball the average deal, and know immediately if it’s even worth further consideration to even worry about plugging it into the calculator. But you should do a hundred evaluations before you make your first purchase, and I'm sure I did more than that.

So, as I said, there are three critical things that I needed to be able to do to ensure my first deal, or to the increase the likelihood that my first property would be profitable. And the first of those, like I just said, was being able to evaluate the deal in the first place.

But the second was knowing what the property would rent for, which is ironically required to be able to do the first. You can't evaluate the profitability of a potential rental property if you don’t know what that property is going to rent for.

So, that’s the second thing. You have to be able to know what a property will rent for. Now, there are many online resources. You go to Zillow. They have the ‘Zestimate’, which usually relates to what the property’s value is. But they also usually have a rental ‘Zestimate’, and that will give you an estimate of what it will rent for.

Or you can go to Craigslist, and look up rentals of the same number of bedrooms and the general area in the same approximate square footage. And that can give you anecdotal evidence as to what a given property should rent for.

There is a website called Rentometer, or some people might call it Rent-O-Meter, but I think it’s a play on spirometer, so, Rentometer. And it’s Rentometer.com, and you can buy a subscription to the website, but they let you do a certain number of free evaluations where you just put in the address and the number of bedrooms, and what you can think you'll be able to rent it for, and it will tell you what something of a similar type and size in a close proximity to that address is likely to rent for.

And I always back that number down a bit, because I don’t want to be at the top of the market rent. I typically like the idea of renting properties a little bit below market, so to have an above average quality property that you rent for slightly below market rent, it makes it so that it’s easier to rent the property, and you get more interest in the property as a result.

And also, it’s less likely that your tenant is going to leave. I tend to keep my tenants for a long time. But through those sources, you will be able to get an idea as to what the property will rent for, and that number is critical to the first part of what I was speaking of in the overall evaluation, such as using the Biggerpockets rental property, or BRRRR calculators.

And then another thing that I do to gauge what a property will rent for, is that I consider what it would rent for as a Section 8 rental, and about half my rentals are Section 8. And I know that probably puts fear into your heart if you, especially, already have a bias towards being a landlord. But I can tell you that some of my best properties and some of my best tenants are Section 8, and I'll go over why that’s the case in another episode, but there are many reasons for it.

Knowing exactly what Section 8 will pay towards the rent of a given property lets you know immediately that it has atleast that minimum rent value. And in some cities, Section 8 pays above market rent. In other cities, it pays below market rent. And my city of Durham, North Carolina, it is not unusual for Section 8 to actually pay slightly above market rent in some cases.

The main determining factor is the bedroom count, but also the size and location and amenities play a factor in what they will ultimately pay, as well as the perceived affordability for any particular prospective tenant. For instance, they may pay more, or less, for one tenant than they will for another based upon that tenant’s income. But generally speaking, if I want to know what Durham County, where I live, will pay as a Section 8 voucher rent towards a given property, I can just go to Google, put in search keywords like ‘Durham County’,’ Housing Choice Voucher’, ‘payment standard’, and Housing Choice Voucher is the actual name of the Section 8 program. That will take me to their website, scroll to the bottom, they have a document, 2019 Payment Standard Schedule. Pull that up, and you can see that they will pay for a two bedroom upto $990 a month, a three bedroom upto $1356 a month.

So, that automatically lets me know that when I'm targeting my two bedroom properties, if I'm considering them for a Section 8, that I'm probably going to be able to rent that property for somewhere around $960 a month, because I back it a little bit off of the maximum that they state, of $990. Likewise, if it’s a three bedroom, I can probably assume that I can rent that for around $1300 a month.

And it just varies for each particular tenant, but those are general standards that I know. I can then plug that number into the Biggerpockets calculator, and come up with the estimate as to the profitability of this property as a rental. And then of course, I would confirm, using Rentometer and Zillow and other sources, and there are several others that I haven’t mentioned. Those are just the ones that I use most, and you can even compare further to Craigslist and other rental listings in your area to get an idea as to what are two bedrooms, or three bedrooms, or four bedrooms renting for in your area.

So, that’s two of the three things you need to be able to do. Overall, you need to be able to evaluate the property as a rental acquisition. In order to do that, you need to be able to know about what it will rent for, or what it is likely to rent for. And you want to be conservative on that number, so that if you have to lower your rent in order to get someone in there, you’re still profitable.

And then the third thing that goes back to the first, because you’d have to know it in order to be able to do the overall evaluation of the property, is what will the rehab cost. What will it cost to get this property to the point where it is rentable, where it is rent-ready? And in the case of my first purchase, I'm in the habit now of just automatically plugging in $9000 as the cost to get each rental unit ready. Sometimes I'll back that down to $6000 sometimes. if If think it’s probably a little bit more deferred maintenance, I might bump it up to $12,000. But you need to know what the rehab cost is going to be in order to make sure your numbers are correct.

So, those are the three things that I had to be able to do before I felt comfortable making my first purchase. I had to, number one, be able to do the overall evaluation of whether or not this was going to be a good purchase. I needed to know what my cash-on-cash return would be, what my overall annualized return would be, what my monthly cashflow would be. And the Biggerpockets calculators, the rental property calculator, and when you get a little bit more advanced, and you’re going to do a BRRRR deal, the BRRRR calculator will make those numbers known to you.

But you have to be able to do the second and third thing in order for the first to work, and that is you have to be able to know what the property is going for, and you have to be able to know what the rehab is going to cost.

Now, related to that thing one, the rehab, you should go look at a lot of properties, especially those that are vacant, and are being sold as is, or other tell-tale indicators, that there is a problem. And I'll be doing an episode related to getting connected with realtors so that they can send you those deals as they’re posted to the MLS. And you need to go look at as many of them as you can, and I'll put some information in that episode about how not to annoy the realtor by having them show you all sorts of things that you're never going to buy.

But that’s a part of why I decided to go ahead and get my own license, so I wasn't being a burden like that, and could go show myself a property whenever I wanted to. But you need to go look, first-hand, at as many properties as you can, so that you know what the typical things are that are going to be necessary. You're going to assume flooring, you’re going to assume painting, and then you're probably going to be replacing the appliances, and those are going to have a certain default cost to them that you should just assume. And then from there, you have to look at more; does it need a roof? Are the exterior sidings or boards in need of replacement or repair? Are the deck boards in good condition, or do you need a new deck, or do you just need a few new boards? Or does it just need to be stained? Does it need gutters? Are the trees going to need to be trimmed, or are there trees that are going to have to be removed? Does it need landscaping? All of these things are going to factor in.

And you also should just assume that you're going to have a $1000 plumbing bill, because I like to have a plumber come out and snick everything, so that I know that when I put that tenant in there, there were no plumbing problems when they got there. So, if any come up, I know they caused it and I have no problem then charging them for it. And I'll go into that as well that gets more into my lease and my style of landlording. I'll get into that in other episodes, but all of these factor into your upfront rehab cost, and you need to know what that is, so that you can get an accurate assessment as to whether or not this purchase is even one that’s going to be profitable for you.

So, that’s it for this bonus episode. Check out Biggerpockets.com. while I'm, by no means, wanting people not to listen to my podcast, there are some other podcasts out there that are just amazing with content. And so, listen to the Biggerpockets podcast. Join their webinars. I think they’re every Wednesday. Go to their website, and order some of those books. They’re great. And then get a subscription to Audible.com, and download some of those books, and all of this information will be on my website. I haven’t gotten it all there yet. I'm still working on it, but it will be a source for you to be able to just follow the plan that I followed in order to get to where I am now. But most of all, practice, practice, practice. You need to go look at properties and evaluate the rehab cost. You need to be evaluating properties on the Biggerpockets rental property calculator. They give you a certain number free if you’re not a pro member. But if you go ahead and sign up as a pro, then it’s an unlimited usage scenario.

And I've got a few episodes in the works. I haven’t decided which I will release next. It may be something on sacrifices that you have to be willing to make in order to be a successful rental property investor, or to become financially free. I have one in the works about realtors as I mentioned, so I may release that one next. But regardless, the regular episode will be out next Tuesday.