Review The Tenants Too When Taking Over a New Building

Recently I bought three apartment buildings from the same owner and, even though I have been doing this for fifteen years, these buildings taught me something new and invaluable. Watch out for the tenants you inherit.

As we progress in our real estate rental investing from single family homes, through duplexes and fourplexes and then into multi-family we tend to focus our diligence on the building itself. We get an inspection done, we plan in our head what renovations we need to do once we own the property and we watch out for the really bad stuff like foundation issues.

However, we usually don’t pay that much attention to the people who already live in the building. We just assume that, while they probably won’t be angels, they probably won’t be devils either. I have talked to a bunch of other investors over the years and I don’t think I am alone in this. We tend to think that the quality of the tenants will match the quality of the building itself. But even then, how bad can it be. The current owner had to manage this property and surely he wouldn’t have wanted to rent to the worst of the worst – right?

I specialize in buying apartment buildings that are mismanaged or physically run down and need some love. I assume that the existing tenants will have issues and that over time I will weed out the bad ones and replace them with better ones as I improve the quality of the building.

These three buildings surprised me though. They were really run down, nothing earth shattering, but the last owner had owned them for 30 years and hadn’t put a penny into them that he didn’t absolutely have to. But, in my mind it was nothing that some paint, new flooring, some new fixtures and time wouldn’t fix. The rents were actually higher than I would have expected given the condition of the buildings which I saw as a bonus.

That should have tipped me off. I found out, after I bought the buildings, that the prior owner had rented to anybody. Got a drug issue? No problem, pay an extra $150 a month and in you go. A drug dealer? Who cares? Buy your way in. Have three cats and two yappy dogs and nobody else will touch you? A little extra on the rent and here are the keys.

Inspections don’t reveal these types of things. Personally walking through each suite (which I always do before I buy all of my buildings) won’t necessarily reveal these issues (mysteriously cats and dogs are usually absent during walk throughs). The existing owner surely won’t disclose what he has been doing so sometimes you just have to find that out the hard way. I bought the building and, literally, within the first two weeks, eight out of 33 tenants moved out due to there being a new sheriff in town.

I did not expect that. That put a serious dent into the projected cash flow. I had been planning on renovating the suites as they became vacant and using a lot of the positive cash flow to subsidize my reno costs. Almost right away revenue was way down and cash out of pocket was way up. Not good.

Two weeks into my ownership the S.W.A.T. team broke into the building and busted down the door of somebody who was a known drug dealer. The next day I went down to the police station and learned that these buildings were the worst in town. I didn’t know this but, just like there are rap sheets on individuals, the police keep a file on buildings too. If you have some concerns about the quality of your tenants before you buy the building, I would recommend going down to the local police station and seeing what they know about your building.

So, word to the wise, pay some attention to the existing tenants at the same time as you are reviewing the building itself before purchase. Before, I always asked for the existing leases but that was typically just to verify the rents were as advertised. Now I will do more checking into the tenants themselves and save myself a bit of grief (or at least go in with my eyes open) next time.

Read more about this in Comparing Real Estate Strategies.

A Road Map To Financial Independence in Real Estate Investing

As we get into real estate investing we sometimes get overwhelmed with advice on what to do. Based on my experience here is what I would recommend for a realistic road map to financial independence.

I am going to assume that most of you are in this position – either just starting with no properties yet or maybe just a couple under your belt. I am also going to assume that you don’t want to get into real estate investing full time; that you just want to augment your existing income and plan for a better retirement down the road. Here is my recommendation for what your game plan should be going forward.

I would start in long term residential rental properties. Try to purchase five duplexes as quickly as you can, own them 100% and get them fully paid off within fifteen years. How you buy them is up to you and your own realities. Your own reality will control how many you are able to buy on your own, how quickly and how many you will need partners on.

I would recommend that you try to buy duplexes wherever you can as you start out. These types of buildings get you two sources of income from the same property for, typically, less money out of your pocket.

Buy as many as you can as quickly as you can with your own funds and then purchase the rest with joint venture partners. As your mortgages come due over time I would recommend trying to buy out your J/V partners if you can (don’t force it and keep it a win/win). The goal is to own all your properties 100% at the end of fifteen years.

At the end of fifteen years I would like to see your own personal residence paid off as well. As you get a bonus from work, or a large gift or an inheritance put as much as you can towards the pay down of the mortgage of your properties and your own personal residence. A large portion of your positive monthly cash flow from the properties should go towards mortgage pay down too.

I mention fifteen years as the goal since that is a reasonable time for most people to accomplish this goal. This gives you time for the market to appreciate and for the mortgages to be paid down via your positive monthly cash flow and your tenants paying rent. I also mention fifteen years since I am assuming that most people reading this book will be in their 30’s or 40’s. Fifteen years from now is a nice retirement age for most.

This shouldn’t be too taxing on your personal life. If you do it properly and make sure your properties are cash flow positive, that you take the time to ensure your tenants are qualified and that you are buying in good areas; buying residential properties should fit in nicely into your existing lifestyle.

Read More About This in ‘Cash Management in Real Estate Investing’.

Sometimes It Is Okay to Take Profits In Real Estate Investing

If you are a long term, buy-and-hold, rental investor your goal should be to hold your properties for at least five years and, ideally, longer. You want time to work for you and appreciate the value of your property while the tenants pay down your mortgage and build up your equity. If you parcel land or are a land developer or new home builder, projects can take a long time – several years in fact.

Sometimes, though, an offer comes along that is too good to pass up. Don’t be afraid to seriously consider that offer, and if it truly makes sense, then sell. For example, if you are dealing with multi-family apartment or commercial buildings, and somebody comes along who wants to buy your property at a 3% cap rate (see Comparing Real Estate Strategies for a full explanation of Cap Rates), then jump all over that.

Another couple of examples from my own history: My father was a lifelong farmer who owned 160 acres of land and rented more. One day in the early 1980’s, during a particularly hot market, a land developer came by and offered my father a stupid amount of money for the land we owned. The developer was real and so was the offer. My father wasn’t ready to retire (at that time he only would have been in his early 50’s) but the money was too good to pass up. We talked it over as a family and decided to go for it. Unfortunately, shortly after that the market turned and we never heard from the guy again. The story has a happy ending though. Dad waited until the height of the 2007 boom to finally sell out and, this time, he did get his hard earned money.

When I was in the early stages of my villa project back in 2004, I purchased 4 acres of land. It cost me $250,000 per acre and people thought I was crazy to pay that much. Within months, however, as I was busy meeting with engineers and planning the project the economy took off and the land was suddenly worth $400,000 an acre. If you back out the money I had already spent on loan interest, reports, studies, plans etc.; I was looking at making a quick profit of over $450,000 without even breaking ground!!!

Due to my inexperience in land development and construction a lot of people urged me to take the money and run. I seriously thought about it but I really did want to see my dream through to reality. The reality was that mid way through the project the market crapped out (in 2008). I eventually did complete the project but actually lost $100,000 over the eight years I was involved with it.

I don’t really regret the decision. I learned a lot more from the failure than I would have from the quick win. Plus if things had of worked out as planned I would have made $2 million. Although, a life time of single and doubles can eventually add up to a lot more than a bunch of strike outs with the odd home run. Only you can decide what avenue is right for you when a really crazy offer comes your way. Just don’t be too stubborn or get stuck on one particular path.

Read More About This in ‘Cash Management in Real Estate Investing’.