Last week we looked at a ‘Super Strategy’ that mixed the best of ‘Fix and Flips’ and ‘Long-Term-Rental’. You can review that at:
With this strategy we:
- buy a property that is really beat up at a wholesale price;
- renovate it;
- get it rented out at higher rents;
- refinance it, based on its new, higher value;
- get most or all of your original investment back, and then
- continue to hold it as a long-term investment.
This merged strategy helps to eliminate the major drawback of flipping; which is selling into a down market. It also helps to eliminate the major drawback of long term rentals; which is the long time required to recoup your money. It also works with any type of property and any budget – from single family homes to multi-family to commercial and industrial.
It makes sense that this strategy would work best in an economy where real estate prices are increasing (or even flat; i.e. you original budget shows the finished product being worth $x and it actually is when you are done). In these markets this strategy is a ‘home run’. But how does it work in a market where values are falling? Even in that scenario it is still a solid ‘double’.
From 2011 to the end of 2014, in the area where I invest, the economy was very positive and robust. Real estate values were increasing at a very healthy rate. In late 2014, with the fall of the value of oil, the local economy started to retract and eventually started to recede. Currently, in the Spring of 2016, with the price of oil not showing any sign of a quick rebound, values continue to drop.
In the Summer of 2014 a partner and I bought three apartment buildings with a total of 33 ‘doors’ in a smaller market. We didn’t get a screaming deal but we didn’t overpay either. They were well bought. We took possession in November of 2014 which is about the time that oil started to drop. Still, at that time, we had no real fear of the economy going into a tailspin.
The buildings didn’t have any major issues; the previous owner had owned them for close to 30 years and simply hadn’t put a penny into them more than he absolutely had to. They were simply run down and needed some love. He also had let anybody rent a unit if they paid a bit more money.
Our plan was to fix the units at an even rate over the next four years as tenants turned over, with major common and exterior issues being dealt with in the first year. We had a higher interest, private lender mortgage for the first year with the plan to refinance after one year with traditional lenders.
Almost immediately however, with a contracting economy and a new sheriff in town, we had 1/3 of the tenants move out. That meant that through most of 2015 our projected rents were significantly lower and our renovation costs were double our original estimates. Cash flow became an issue and we had to have a cash call from the owners. Not good.
However, by the end of 2015 we had the situation under control, the units were full with better tenants and we were ready to go back for refinancing as per the original plan. As we went back for refinancing, even though we had spent all of this money on renovations and the buildings were full, the newly appraised values were barely higher than what we paid for them. Instead of being able to get most or all of my partners money back we barely refinanced for enough money to repay the higher interest lender and get the partners back 10% of the money they invested.
The economy really kicked us in the butt. We were able to get better tenants into the suites but the sluggish economy and higher vacancy rates meant we couldn’t raise rents. It was considered lucky that we had full buildings. Remember that the values of apartment buildings are based on the profitability of the buildings and comparable sales in the area – both of which are compromised in a down market.
So we have little choice now but to continue to own the buildings (which was always the goal) with a significant amount of money still invested (which was not the original goal). We also had no choice but to lock in the new financing for five years (to even get financing in a small market and to get a decent interest rate).
As time goes on and the economy inevitably improves we will be able to refinance and get a second mortgage to help get the partners more of their money back. The buildings are in much better shape than when we first took possession with a tremendous upside in both future rents and valuation. The underlying assets remain strong. Not the home run we had at first thought but still a really good investments and our plans were just delayed a couple of years – a good solid double.
So, even when it doesn’t work out perfectly, the Super Strategy should still work out okay no matter the economy – good, flat or down. Just keep the above, real life example in mind if you try to do this strategy in a falling economy.
Read more about this in Comparing Real Estate Strategies.