Hey #teamdebtfree!

We closed on the sale of a rental property with a unique story yesterday and profited $73,000 after owning it for just over 2 years.

In 2018, we purchased two houses. My F.I.R.E. (financial independence / retire early) dreams include purchasing 2 properties per year that profit $500/month. If we maintain this pace, in 5 years we would hit Phase I of our financial independence plan where our passive income = $5000/month and covers our primary expenses. (Phase II doubles that which allows us to save, invest, give, and travel frequently.)

Have you sat down and figured out a Phase I F.I.R.E. plan for yourself?

Dream out loud and brainstorm some ways you might F.I.R.E. up your future.

Back to 2018. We bought a house through an auction site I’ve used before for $60,000. Yes, a whole, fairly functional house in Chicago, IL. That’s a whole other story that I’ll share in the coming weeks.

The contractor who did a lot of the work on that auction house knew I was looking for a second property in a specific neighborhood. He was about to lose his house due to unpaid back taxes. He asked my husband and me to buy his house and rent it back to him.

Hmmmmmm….. I’d never done anything like that before.

He owed $50,000 in back taxes (including interest and penalties) and in Chicago, if someone else pays those taxes, you can be forced to turn over possession of your house after 3 years. He was coming up on year 3.

Why I Decided to Get Involved

Wonderman and I had a lengthy debate about whether this purchase was wise. Obviously, I was for it. He was a lot more hesitant.

So we listed the pros and cons.

Pros:

• We would have a tenant that ultimately wanted their house back and would take great care of the property.
• He had a fixed income source (a pension) that covered the rent and his expenses. He also did contractor work on the side (how I met him) that increased his access to disposable income.
• The owner had grown children living in the house who were expressing an interest in purchasing the property and helping with the rent (This turned out to not be the case.)
• If he didn’t pay, I could rent to someone else or sell the property at a decent profit. Our purchase price was only $50,000 and the appraised value was $120,000.
• I had no personal connection with the owner. If our arrangement fizzled, I would be able to make the tough decisions required.
• Our agreement included that he would handle all interior and exterior maintenance. That’s one part of investing that I don’t love. We agreed that he would not call me for any maintenance issues.
• The property had a brand new roof paid for by his insurance because of a recent hail storm. That increased the value by $10,000.
• Finally, we were able to help someone in a way that seemed to be a win-win for both of us.

Cons:

• He was in financial distress because he didn’t manage money well. If he didn’t pay taxes, how could I trust that he would pay rent?
• If something happened that required I take possession of the house, there were numerous unfinished projects that would need to be addressed before I could rent it out. I estimated the work would cost $25,000. The contractors always have the worst homes.  Right?
• I’d known this contractor for about a year and our working relationship was at times contentious to be polite. We were working on the auction home project and that was riddled with issues. Would those tensions spill over and affect his willingness to pay rent?

Long story short. He paid his rent on-time all but once. We had an intense heart-to-heart and that never happened again. He never called me about any maintenance issues. We put all of our plans in writing. He signed a lease. Everything was above board.

Then Covid hit. He contracted the virus and passed away in June 2020. He was only in his mid 60’s.

Needless to say, that was an unexpected and unsettling experience. He had a daughter and two grandchildren that he was utterly devoted to. Greg Amstrong was really a very decent individual with a good heart. I know that he is resting well in heaven.

 

Now We Have This House  Payment with No Tenant

As shaken as we were, we had to make decisions about this house. While our agreement was to sell the house back to Greg (In year 1, $90K; In year 2, $115K; beyond that market rate), I don’t think he would have ever purchased it from us. He paid his rent on time. I was happy to keep the arrangement for the foreseeable future.

After he passed, we originally agreed to sell the house to his daughter. That transaction fell through. She eventually moved out.

We listed the house on the MLS and received 14 offers in 24 hours. Because the sale was as-is, the first few deals fell through because the contractor bids were higher than the sellers could manage.

Our final offer was from a young man who was interested in a 203K loan. He would secure a loan to purchase the house and also cover the cost of the renovation as an intended owner-occupant. These loans can take longer to process than standard mortgages. The 203K loan process includes a construction consultant who has to approve the plans and inspect the work along the way.

While it’s a slower process because of the additional approvals needed, it’s a great way for individuals to look into properties that need work but are in better neighborhoods. If you’re willing to take your time, you can renovate a house and possibly lower your overall cost of ownership in communities with better rates of appreciation.

Something to think about.

 

The Numbers

Why do I say we turned $10,000 into $73,000 in two years?

• I used a personal loan for $50,000 from Sofi at an 8% interest rate to purchase the home. There was no money down required for a personal, signature loan. Having good credit is one way to qualify for these loans. We received the cash in 2 days.
• Unfortunately, Greg didn’t tell us about additional fees so to close, we had to pull $10,000 out of our savings. That actually should have been included in the cons list above. Greg was supposed to pay that back separately. He stopped paying us after about 2 months. The only reason I let that go was that he paid his rent and I would add the balance to any sale on the backend.
• I eventually refinanced the house into a 30-year fixed-rate (4.5%) mortgage. I was able to reduce his rent by $150 and still cover all expenses and profit $500/month.
• When I refinanced I pulled out $33,000 in cash. Another reason I didn’t sweat Greg’s default on our $10,000 personal loan to him. At this point, the loan balance was $80,000.
• We did have carrying costs of about $1000/month for the last 8 months since he passed away. I could have used Covid-relief programs and paused our mortgage up to 12-months. Since we have been able to pay the mortgage, I decided not to use that option. I think I also expected this sale to happen sooner. We’ve encountered a number of delays.
• Finally, we sold the house for $140,000 after owning it for about 2.5 years which yielded an additional $40,000.

We invested $10,000 of our savings and were able to pocket $73,000 via the cash-out refinance and ultimate sale. This doesn’t take into account overall rental profits, federal tax exemptions, and tithes on the sale.  Since we’ve held the property for 2+ years, the first $250,000 of profit is exempt from capital gains taxes.

 

The Moral

• Investment opportunities come in all shapes and sizes.
• Not being encumbered with debt and having a financial cushion allowed us to help someone in need while seizing an investment opportunity that blossomed beyond what we initially expected. I think that’s also why neither of us lost much sleep when Greg just stopped repaying his debt.
• Maintaining good credit helps!
• If you’re married, talking through options as a team can help you make better decisions. If you’re single, run your ideas by a trusted, responsible source. Iron sharpens iron. Don’t be afraid of divergent perspectives. In the multitude of counsel, you’ll find success.
• Taking calculated risks can pay off.
• Don’t ask to borrow any cash. Sorry, we won’t have it. This money will be going straight into the next investment property that we have under contract right now.  We’re dipping our toe into the land of Airbnbs.

One final note that helped me decide to take on this project. Greg agreed to allow me to take out a life insurance policy on him. I would use the proceeds if anything happened to him to make the updates needed in the house. He was in relatively good health, so I never got around to setting up the life insurance policy until May of 2020.

By then, he had already tested positive for Covid19 and was unable to qualify for life insurance.

If I do something like this again, I would make sure to set up the life insurance policy immediately. We may have decided to keep the house if we had the money to address all the problems.

If you need help ramping up your efforts to pay down debt so you can seize opportunities that present themselves, I may have help for you here.