I am going to try to add a new “deep dive” post about one of the assets I own each Sunday. This may end up being a monthly feature, as I really don’t own that many assets – we’ll see as I go along.
The first asset is the one property I love to hate. It shows that as long as you don’t run out of money, even a bad deal can become a reasonable deal over time when you are talking about real estate investing. I introduce: 1110 Kenwood Ave.
What Is It?
1110 Kenwood Ave is a single family home in what I would call a transitional area on the west side of Beloit, Wisconsin. It has 3 bedrooms and one bath, and a little under 1,300 square feet of living space. This is a split-level house, which is unusual for this area and year (it was built in 1937.) It actually looks pretty nice on the inside – the pictures on Zillow are from the original listing around 2 years ago. The biggest red flag to me was the fact that it has a boiler for heating, which can be very expensive to service. Boilers are also fairly rare in single family houses in this area that are not late 1800s/early 1900s houses.
How Did I Find It?
This property was an MLS property.
What Did I Pay For It, And How Was That Price Negotiated?
The property was listed in early November 2018 for $74,900 and had a price drop 10 days later to $69,900. This is a terrible time to list a house due to the upcoming holidays. It is worse in Wisconsin, as the weather is starting to turn nasty for the winter. I was not going to buy this house due to the boiler, the location, and the fact that I had already purchases 4 other houses in late 2018. The real estate agent I was working with wanted it, so I agreed to buy it and sell it to him on a lease option – he was not lendable for what turned out to be many reasons. The purchase price ended up being $62,000, which was the counter to a $59,900 offer. I closed on the property on 1/18/2019. At this point, I had not actually seen this house – I wasn’t buying it for myself, so I assumed that the agent did his due diligences on it. That turned out to be a big mistake.
How Did I Fund It?
This property was purchase using a commercial mortgage from a smaller regional bank in the area. They require 20% of the purchase price as a down payment, and will loan the other 80%. the rate/term at the time was 5.5% interest, 20-year amortization, 5-year term. Total loan origination costs were $460, which included the appraisal. The other 20% plus the rehab funds came from my personal funds – which includes various lines of credit, proceeds from other businesses, and my W-2 salary. I didn’t track where exactly the funds for this property came from, as it was the 7th in a string of 12 properties I bought between September 2018 and February 2019.
What Did I Do With It?
We did get an inspection on this house, which I pretty much ignored since I wasn’t going to be the final buyer. It turned up a few items, but nothing seemed major. Our contractor priced out the required repairs from the inspection report, and we scheduled him to start the work immediately after closing. The estimate was around $8,000.
At the same time, the agent was marketing the property for rent and secured a tenant with a Section 8 voucher to move in on 2/1/2019. Part of taking on a Section 8 tenant involves a property inspection. We only had two weeks from closing to tenant move-in to get everything done, so this was a very tight timeline. Less than a week before the tenant was to move in, I received a call from the contractor. He told me that the house failed the Section 8 inspection due to none of the windows functioning, and that all of the windows would need to be replaced. He offered me a “special” price of around $8,000 to replace the windows prior to the move-in. I approved the work since we had to have it finished before move-in. I then spoke to the agent, telling him that these additional repairs would require him to put some money into the project. He informed me that he did not have any money and that I would need to keep this property and a second one he also wanted to purchase a month earlier.
The property appraised at $64,000 prior to the new windows. The loan was based on the purchase price of $62,000. I ended up with around $12,400 in the property for the purchase, plus around $16,100 for initial repairs, for a total of $28,500. The property was rented for $1,200/mo starting February 1st. While I wasn’t happy with how this all turned out, I was still looking at around a 4.2% cash-on-cash return ($7,200 of cash flow (50% of gross rents) divided by the $28,500 I had in the property) – not great, but at least was something. Plus, I still had the loan paydown, appreciation, and tax benefits of real estate going for me. Probably the worst thing here was that I had $78,000 in a property that appraised for $64,000. The windows would help some, but certainly not by $14,000. I was upside down in this one pretty badly.
The next problem turned up around a month and a half later, when the agent/property manager’s accountant informed me that he had been stealing security deposits and horribly mismanaging the property management company, and that he hadn’t paying income taxes for 7 years and the IRS was coming for him. At that point, I cut ties with him immediately and started a kind of hybrid management company where I ran the books and set up the payments and rent collections, and a friend of mine did the day-to-day management of the properties. We then started the difficult task of untangling the mess that the former manager had created. For this property (and a few others), we found out that he had been defrauding the Section 8 program, giving them a lease for a lower amount that they would approve and giving the tenant a lease for a higher amount. After working with the Beloit Housing Authority, we came to an agreement of $1,000/mo for this house – the tenant paid some portion of this amount and the BHA covered the rest. That cut the cash flow by ~17% on a property that wasn’t cash flowing very well to begin with.
I left the property alone through the spring, summer, and early fall of 2019, and it performed pretty well. It did incur over $900 in expenses, which isn’t uncommon for a house that had not been occupied for a while. I also had 100% rent collection, which helped quite a bit. In early fall, I decided to make two moves. First I replaced the roof, which had been leaking and was not in great shape. Then, I had the property re-appraised and refinanced in October 2019. The roof was another ~$7,000, which brought my total investment up to $85,000. The hope was that with the new windows and new roof, the new appraisal would get me close to this amount. There was data to back this up – several other recent sales and recent appraisals in the area show a large increase in prices, and the $64,000 appraisal from back in January seemed really low to begin with. I thought that worst case, I would be in the upper $70K’s, which would have allowed me to recoup a good chunk of the money I had in the property at this point. Sadly, things did not work out. I had three properties appraised appraised as part of a single commercial loan, and two of the three came in ridiculously low in my opinion. This particular property appraised at $68,000, which was extremely disappointing. I was not able to even recoup the cost of the roof, so I ended up with even more money in this place and an even lower cash-on-cash return.
Fast-forward to today – the tenant is coming up on 2 years of tenancy an does not plan to leave. She has been great, keeping the property looking nice and paying rent on time via ACH payments. There really isn’t any room for rent increases just yet – maybe next year we’ll see rent go up a little. Nothing much has happened to the house – repairs have been a little on the high side at ~7% gross rents, but the bulk of them could have been considered more capital expenditures. Property taxes are a little on the high side at 17% gross rents. Hopefully we are done with cap ex for a while – the boiler is apparently pretty solid in this house, which is the biggest wild card right now. It has been cash flow-positive since I have owned it, even after depreciation. Zillow has a Zestimate of $90,500 as of January 2021, which is likely where I would list it if I wanted to sell it – 2020 was a good year for property values in the Beloit market.
What Did I Learn?
The biggest thing on this property was to be very careful who you trust in the rental property business. Landlords (“slumlords”) have a horrible reputation, and that reputation is deserved in many respects. The agent/property manager who was involved with this property is one of the individuals that gives the industry a black eye. It is entirely my fault for trusting him, and this property serves as a reminder of this. Fortunately, I had the money to spend my way out of the problems with this property. If I had been in a different financial situation, I could have ended up as a “distressed seller” who would have had to fire sale the property to avoid losing it to the bank.
What Are My Future Plans With This Property?
At this point, I have no plans to do anything with this property. I might look into a refi in a few years assuming interest rates stay low. Other than that, I’ll just be keeping an eye on market rents and watch the loan paydown and appreciation work for me.
