So you find a distressed property at a great deal, what do you do? You can buy it, renovate it, and then keep it as a rental. Or, you can buy it, renovate it, and sell it at the increased value. There are pros and cons to both techniques; you’ll just have to figure out what suits you best.
Welcome back to the Real Estate Lifestyles series (Part 1, Part 2), where I put two heavyweights against each other. Today will be an instant classic because it follows in the mold of capital gains vs. dividends.
Research. I have been conducting a lot of research on the topic of real estate over the past year. When I retire from the military, I know I don’t want to work a formal job again, so real estate will help me earn some nice passive income.
Become a Private Money Lender
We currently own three properties, all of which have tenants. Our primary residence is our biggest wealth generator because of Mortgage Positive and House Hacking. We manage two properties ourselves, and we have a property manager for our home in Arizona.
The best book on the topic of renovation and rent is “Buy, Renovate, Rent, Refinance, Repeat.” Luckily, Brandon Turner also covers flix and flip in the book as well. These are both complex worlds where you need teams of people even to get started. I highly recommend you check this book out if you are interested in buying and renovating distressed properties.
Your goals. As with most of my articles, you will have to start with your goals. You can’t go anywhere in life without creating a detailed plan. Your plan may go to crap, but you can at least adjust it on the fly.
When it comes to real estate, you have to be laser-focused on your outcome. If not, the slight dips in the road will stop you in your tracks. My wife and I just got an $800 bill for our air conditioner in our primary residence. Crap happens all the time.
You need to ask yourself; am I looking for a recurring income for the long term? Am I looking to convert my real estate earnings into another investment opportunity? How much free time do I have to handle my real estate affairs?
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You may be a HENRY (High Earner Not Rich Yet) who decides to work 5-10 more years in the workforce. You understand that you will need 10-20 properties to provide you with the rental income and lifestyle you need for early retirement. Having a solid plan like this can help you achieve your life goals.
Getting started. One of the reasons I write so many articles is to help you visualize your goals. You don’t have to have all the answers up front; you’ll need to ask yourself the critical questions.
Buying distressed properties is much more complicated than purchasing retail homes. By retail homes, I mean homes on an MLS service, such as Realtor.com or Zillow.com. When you buy retail, you are most likely getting a turnkey residence, but the opportunity to profit is much lower.
You make your profit when you buy, in all investments. For both renovate & rent and fix & flip, you’ll need to crunch the numbers using the After Repair Value (ARV). Estimating the ARV is no easy task because you’ll need someone to give you a solid price for the damages and repairs, the renovation, and then the new appraisal.
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If you haven’t guessed, you’ll need a team of highly qualified professionals to succeed at this business. In the book BRRRR, the author states you need these top four professionals; lender, property manager, real estate agent, and general contractor.
Each of your top four serves an essential role on the path to real estate wealth. That’s why you need to know your goals and where you are heading in life. You can’t take this career path lightly. There is a lot of work, research, human connections, networking, etc., that goes on to find buy, renovate, refinance, rent, and sell these properties.
But I will not go into too many details about the lifestyle; let’s look at the outcomes. Again, read the BRRRR book for a deep look inside the world of a real estate tycoon. The book will change your perspective on what it’s like to be in the mix of real estate professionals.
Rent vs. Sell. So the age-old debate of rent versus sell comes back to rechallenge our mindset. Once you have worked with your team to buy and renovate a distressed “moth” property and turn it into a beautiful “butterfly” home—then what? You have two main options; you can rent it or sell it for capital gains.
Creative Financing in Real Estate 103: Home Equity
Renting your home. Using the Buy, Renovate, Rent, Refinance, and Repeat method, you will perform a cash-out refinance as you rent the property. This way, you can extract your cash from the property to buy more homes and receive some rental income.
You must work with a property manager and real estate agent “before” you buy and renovate to ensure your rent values are realistic. You don’t want to be upside down on your mortgage during the rental phase. Let’s look at a basic scenario of a “renovate and rent.”
You buy a distressed property for $100,000 and spend $50,000 to renovate it to become a lovely rental home. You spent $150,000 (cash) total on the property, and the final appraisal gives you a value of $250,000. Nice work.
You can then extract 75% of the value through a cash-out refinance, which puts $187,500 back into your pocket for the next home. Now it’s time to rent the house. Your mortgage on the property is $1,100, and the place rents for $1,400.
In total, you walk away with $37,500 (tax-free) and cash flowing $150 after property management fees. Obviously, this is the ideal situation, but you can succeed if you can run the numbers correctly (and realistically).
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The goal of BRRRR is to keep repeating this process while you build your rental property pension. Real estate can lead to financial independence, probably more than any other asset class.
Selling the home. We can use the same numbers for selling the home. You are into the house for $150,000 cash, and the place appraises for $250,000. You decide to sell the property. You walk away with $100,000, right? Not so fast.
You have to pay taxes at the short-term capital gains rate, which is usually your ordinary tax rate—you receive no preferred status. Let’s call your tax rate 30%. Now you are down to $70,000. Not too bad, right?
Ha! I got you again. You’ll need to pay real estate agent fees and other fees for selling the home. Those will come out to 10% (minimum). And that is 10% of the total, not of your profit. So, in this case, 10% of the $250,000. Yikes, that’s another $25,000. (Sidenote—You can save on some of these fees by becoming a real estate agent—read the book “Sold.”)
Can You Achieve Work-Life Balance 2
So, you’ll walk away from the sale with $45,000. Wow, that was a lot of work for $45,000. However, there may be some cases where selling is more appropriate than holding. Things like a market shift can change your investment thesis throughout the process.
What we learned. When we kept the property, we walked away with $37,000 cash, plus we kept it to rent. When we sold, we walked away with $45,000 cash and no home. Why the massive disconnect?
As Robert Kiyosaki teaches us in “Unfair Advantage,” you don’t pay taxes on debt. Learning how to use debt and leverage are primary ways to become wealthy. As he writes, “Is it faster to save $1 million or to borrow it?” There is good debt and bad debt, and you’ll need to study these methods to become wealthy and use real estate as your wealth generator.
Taking out a home equity loan prevents you from paying taxes on selling the property and the real estate fees. Eventually, rents and property value will increase, and you can leverage another cash-out refinance or TAP your home equity.
How to Buy Homes Today
Conclusion. Yes, holding rental properties for the long term can be a pain in the rear-end, I know from personal experience. But, if you want to build a fortune, holding something long-term is the only way.
I am a dividends-style investor, buy & hold—the same with properties. Once you get over the initial stress of dealing with tenants and housing issues, you’ll just accept that it’s a part of life. You’ll settle in for the long term and build significant wealth.
Having many properties to harvest cash-out refinances will be a boon to your net worth and investment opportunities. Once you get enough rental properties, you can diversify into stocks, cryptos, and business.
Anyone who has read my articles knows which side I was going to fall on. Hopefully, I gave you a little more detail on why holding properties is vital to long-term health, wealth, and success. If you like this content, please follow me on Twitter and my Facebook Page. Enjoy and Happy Investing.
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