How to Profit in Real Estate

Investment Opportunity: Owning Rental Units

Interviewee/Local Highlight: Joe Patton

“The main draw to owning rentals is to grow wealth in a way other than working a 9-5” Joe

Joe Patton, president and CEO of Premium Builders, contractor, and now property investor, candidly shares his experience in purchasing a multifamily property, and the value-add opportunity he recognized. (Don’t miss the impressive before and after photos).

Benefits to owning rental properties:

Establishes a strong source of passive income.
Gives you control of assets that appreciate over time.
Allows you to own/control/leverage multimillion dollar portfolios while only needing a fraction of that to get in.
Get rid of rental payments and have your money go toward building equity in an asset over time’.

Joe, a local Seattlite and 2016 UW grad (go dawgs), bought his first investment property a little less than a year ago. He has kindly agreed to share his experience, offering sound advice on his trials, tribulations, achievements and the lessons that he has learned along the way. Potentially revealing key information that could save time and money in your own journey. He is now a triplex owner with two tenants paying off his mortgage. Find out how you can do this, too.

(Note – for readability, Joe’s own words have been kept in blue text)

First off, what are the types of investment opportunities?

Single family, small multifamily and commercial multifamily are the main 3 options in residential real estate. The difference between small multifamily and commercial multifamily is the number of units the property has. Typically, anything above 4 units can be considered commercial. Making that distinction is actually pretty huge in terms of financing and property valuation.

Why were you initially interested in multifam?

I wanted a property that was going to provide me with a place to live while also producing some income to help with the mortgage. In my particular case, I found a value-add opportunity in an unfinished basement and finished that space into an extra unit. I now live in the basement, rent out the existing two units above and live for free.

Value-add opportunity

This is where you make your money. There are value-add investors and turnkey investors. Turnkey investors invest in a property that is ready to rent and they hold long-term to bank on an appreciating market. Value-add properties allow you to force appreciation in a shorter time window. A common phrase is “you don’t make your money when you sell, you make it when you buy”.

There are quite a few thought processes on the best way to get started. I am a firm believer in learning by doing; however, doing your research beforehand is always important. There are tons of books, podcasts, YouTube videos and articles on how to best invest in real estate that are pretty valuable. What I found is that there can definitely be a “paralysis by analysis” situation you can find yourself in if you spend too much time researching and looking for “the perfect deal”. In reality, and I think I can speak for the majority of real estate investors on this, there is no such thing as the perfect deal. There are so many people who do this, and you can always bet that if there is a perfect deal, it will be snagged up in a matter of hours. The best way to mitigate this I think is to put together a list of what you prioritize in your investment property in descending order and find a property that hits your top few.

When trying to find neighborhoods that will appreciate, what are some important factors to consider?

Job market – Extremely important. If there’s no work, people won’t come. If people don’t come, housing demand decreases, higher potential to lose money on your deal.

Immigration patterns of target location – are people leaving or coming? When people come to an area, housing values generally increase due to demand.

Demographic and average income of potential renters – This is somewhat of a controversial topic but it is important to think about your candidate pool of renters who will live in a property you own. You ultimately have to look out for yourself if you go into this business because nobody else will.

Landlord vs. tenant friendliness in target city and state – This is big. City of Seattle and Washington State are extremely, extremely tenant friendly. If you get into a property deal in Seattle, get a good lawyer on deck. I had to learn this one the hard way.

Accessibility – is it close to where many people work? Close to the airport? Close to good schools? Stores? Restaurants? The way I see it is the easier it is to get to the property the higher the value. That opinion will vary from one person to the next. Some people find great value in being as far from a city as possible.

Geographic Location

This is important but there is not really a direct science to it. A lot of people will buy outside the city and bank on gentrification. This is a long-term game but so is real estate as a whole. I personally invested in Seattle because many people are still migrating here and I didn’t want to gamble on a place too far away from the city. Just personal preference – there’s no real right or wrong answer here.

Somewhere I would live?

If you decide to buy a duplex and live in half and rent out the other half, it’s important to take into consideration whether or not you would like to live in that area. It’s not glamorous regardless, but it would be less glamorous if you did it in an area of high crime, etc. Not a deal breaker on a property if it hits all the other points, but it is definitely something I took into consideration when purchasing the property.

What did the buying process look for you? (You’ll most likely be working with a team: real estate agent and lender)

1. Pre-Approval

Find a lender and get pre-approved & pre-underwritten to see what exactly you can qualify for in terms of price range.

2. Property Search

Joe looked at 16 properties in person, and over 100 online. (Your real estate agent can help guide this search and ensure key elements are discussed.)

a. Find the property. (Real Estate Agent, NWMLS, Zillow, Redfin, Trulia, etc.)

b. Tour the property if possible (we couldn’t tour our property until the inspection due to COVID and renters occupying the property).

c. Try to figure out how much competition there is on the particular property. This will determine how much you should offer (asking, over asking, escalator clause, etc.). We lucked out due to COVID and did not have a ton of international cash competition like we had had earlier in the process.

Other key factors that should be taken into consideration:

Are there current tenant(s)? When are leases up? How much are they paying? Are they paying on time?
Electrical and plumbing? This is something that would be covered in an inspection/sewer scope prior to writing an offer.
Year the house was built: pre 1978 there’s the potential for lead paint. Asbestos in older homes (popcorn ceilings).
Type of foundation the house sits on: try to find poured foundation.
Condition of the roof
Schools
Market rents in the neighborhood
What needs to be updated to be livable
Parking? Attached, detached, street, covered, etc.

3. Submit an Offer

a. Submit an offer and begin the negotiation. We offered asking and added an escalator clause to beat out any offer by $5,000 up until $66,000 over asking price. This is also where you add in any contingencies (financing, appraisal and inspection contingencies are the three most common you’ll see).

b. Wait for an answer from the seller. Either an offer-accept or a counter-offer. If the latter, Review the counteroffer.

c. Decide if you will settle on their counter, send another counter, or back out of the deal.

We ended up settling for $58,500 over asking

4. Title and Escrow

a. At this point you go under contract and enter into the feasibility period (aka “escrow”). This is when a lot of things happen all at the same time:

b. Deposit earnest money – This is a deposit (5-10% of the down payment requirement is common). This gives you some skin in the game and shows the seller you are serious about the property. If you establish contingencies in your contract and if any one of the contingencies is not met, you can get your earnest money back. If all contingencies are addressed and you move forward in the contract, you are typically unable to get your earnest money back and it goes to the seller.

c. Your lender will require a ton of paperwork to get the financing ball rolling. This is typically the longest time requirement and needs to get initiated as soon as possible after mutual offer-accept

d. Schedule an inspection/sewer scope. Buyer *often* pays for both. If something comes up in the inspection that is detrimental and you have an inspection contingency, you are able to rescind the contract with no consequences and get your earnest money back. Or, you can require it to be corrected by a professional before closing. (*this is also commonly done before submitting an offer or before offer review date in a competitive market)

e. Your lender will schedule an appraisal. The appraiser will typically land on the sale number because they are lazy. If the appraisal comes in way under the sale price and you have an appraisal contingency, you are able to rescind the contract with no consequences and get your earnest money back.

f. If all contingencies are satisfied, this is typically the point where you will not qualify to get your earnest money back. This is sort of where the lending process really begins. Your lender will reach out with tons and tons of requests (more on this later) and you just have to get it done. There is a weird lull after this where everything is out of your hands for a couple weeks (depending on closing time set out in contract) and you go a little crazy waiting.

g. A couple things may come up here and there that you have to sign but at this point you are just waiting for the closing date. You’ll have to sign the closing documents and once they are returned to the seller you reach binding acceptance.

5. Closing

Closing date will come, the title company will handle the conveyance of deed from the seller to you and once the title is recorded you get the keys.

Joe’s Project: What did you do to add value to your property?

Finished out an unfinished basement to add AADU to existing building.

Added heat and AC to all 3 units
Re-plumbed house from PVC to pex
Replaced any residual knob and tube wiring
Poured 13 new footings and set 7 structural beams
Framed 14 new walls
Poured new concrete floors
Set 12 new cabinets, 9 new windows and all new appliances
Re-built two new entrances and decks to main house
Tiled shower and kitchen backsplash
Project start: 7/11/2020
Project finish 1/2/2021
Project budget: $75,000 | Actual: $82,500
Project value-add after comparative market analysis: $282,500.00

Looking back now, what are three things you wish you knew before starting?

1. It will be hard. There’s no way around it – if it was easy then everyone would do it. Going through the purchase process, undergoing renovations, dealing with existing tenants, maintenance, expenses, ongoing tenant management, funding, etc. are all not easy to do and take a serious level of involvement. It’s all about how you handle the issues that arise and how you learn from there. It really is a full time job (unless you hire a property manager) and will take up a lot of your time.

2. Understand landlord-tenant law and be very aware of what you may be getting yourself into with potentially problematic tenants and what liberties you may have in worst-case scenarios.

3. Know your numbers and don’t let your emotion get in the way of your business decisions.

Investing in real estate is stressful. There is a lot of money involved, a ton of risk, dealing with people, handling improvements, renting out your units, dealing with tenants and issues, building maintenance, refinancing, making payments, the list goes on. Try to keep your eye on the prize that is financial gain and independence and just remember what your end goal is.

Any last pieces of advice you’d like to share with readers?

Below-market rents?

Know your market and where rents should be set. It’s pretty easy to google “rent per square foot in (blank)”. Take the square footage of the units and multiply by your RPSF value and see where the existing rents lie. If they’re low, that’s good news. However, when you buy, you automatically inherit the existing leases and tenants in your building. This means you may not be able to raise rents immediately, but it remains an option for the future. COVID has had some drastic affects on rent increase and tenant protection in Washington state and the city of Seattle in particular. It’s good to be aware of the legislation regarding tenant protections before going forward with a purchase.

Cap rate

Capitalization rate is an equation where value=total net income/cap rate. This is an equation used by many investors to estimate the value of a home based on a desired cap rate. For example, if your building brings in $70,000 and you are shooting for around a 5% cap rate, the value of your home would be $70,000/0.05= $1,400,000. Now, if you raise your rents and your total net income raises to $80,000, your new home value would sit at $1,600,000. Most times, people will buy an investment property, add some value to it through renovations, raise the rents and in turn raise the value of the property. At that point, refinance and take some cash out for another project or sell for a profit. That’s a very simplified explanation!

Learn!

Read books, listen to podcasts, get involved on Bigger Pockets, read articles, talk to people in your network, lean on experts (lenders, brokers, contractors, investors). In general, people love to help but you have to be the one to drive your knowledge acquisition.

Book recommendations:

“Profit Like the Pros: The Best Real Estate Deals That Shaped Expert Investors” by Ken Corsini
“Best Ever Apartment Syndication Book” by Joe Fairless
“Building Wealth One House at a Time” by John W. Schaub

What’s next for you, Joe?

Short-term goal: Aggressively grow my portfolio of multifamily properties in Seattle proper. My stretch goal is to own +/- 50 units within the next 5 years. I may also look into a few small flips here and there as opportunities arise. I am hoping to close on my next deal by mid to end of this year.

I will remain in the small multifamily realm until I graduate up to a couple small-scale joint ventures and ultimately apartment building syndications.

Long-term goal: Syndicate large-scale apartment deals (200+ units).

Contacts:

Mike Urquhart from Paragon was one of the first guys who I spoke with when embarking on my journey. He had just closed on a small-scale joint venture and went through something very similar to what I was hoping to accomplish. He was a great source of knowledge having just gone through the process and he turned out to be the one who brokered my deal.

My lender, Jon Wagher, was with me in the early days of the deal. He worked with me on the preapproval letter and provided a ton of guidance on the best way to go about financing the deal (FHA vs. Conventional were our two options being exercised). He also helped me understand what I could afford and whether or not my deals would pencil out given the various scenarios.

Joe Patton:

joe@premium.builders