I was having a conversation with an investor friend of mine who had shared with me that he was selling off his smaller duplexes and doing 1031 tax-deferred exchange into larger multi-unit properties.
I knew his portfolio well, as we have had many conversations in the past. So I asked him about his fourplex and told him, “I would be interested in purchasing that one when you are ready to sell it.” His reply still rings in my ears, “Oh, I will die with that one; it is a trouble-free money-maker for me.”
Through previous conversations I knew all about the property. I knew the income it generated and that the property was paid for, and as a result it was a definite cash cow for him, which is why he had no interest in selling it. This property continued to interest me, as I saw so much potential for it. The owner, on the other hand, was completely a passive investor who simply cashed his check when the property manager sent it over.
Not letting the fact that it was not for sale deter me
I dug deep into learning more about this property.
I believed the property was under-utilized and under-rented. Shortly after this property was built, condos and villas started springing up all around it. For all practical purposes, this property was sitting in the midst of condo/villa central and this property was really a condo/villa. It
The investment property that was not for sale and owned by another investor.
was just not titled as one. I thought the property should be rented as condos and thus bring in much higher rents than he was currently getting.
I also believed that if the properties were titled as a condo/villa, the value would be much higher.
Subscribing to the philosophy of (SIBKIS) See It Big, Keep it Simple, my mission was to envision owning this property and converting it to its highest and best use (a condo/villa).
To do this, I had to identify what I could get for rents, what I could afford to pay for it, and what the end value would be, and then make an offer that would persuade the owner to sell.
Read about my research and diligence on my previous post titled, “The 5 Ways to Increase Cash Flow On Your Rental Properties.”
Next step: the conversion to condo/villa
I quickly set out to learn what needed to be done to convert this fourplex to its highest and best use, which were condos. I learned that there were only three steps involved.
No. 1: I needed an architect’s opinion on what was needed to utilize each of these units as a private ownership from a code standpoint. Fortunately, as I expected, he said for all practical purposes these were built as condos so no work was needed for the conversion.
No. 2: A survey to divide the property and common areas.
No. 3: A set of documents such as condos doc, budgets, etc., basically some legal work from a real estate attorney. In the state of Minnesota at this time the process was pretty simple, and it was a combined cost of $7,000. This property was very conducive to this venture and a project I was eager to do.
I only had $26,000 in cash and the owner was not interested in selling
First I needed to own the building. And, I only had $26,000 in cash to buy from an owner who was not interested in selling.
Negotiation is all about price or terms. As the property was not for sale and I only had $26,000, I had to create a win-win. The value of the property as it sat was nearly $430,000 and I knew I had to offer a premium to persuade him to sell it, especially as I also wanted him to do some seller financing.
As he was interested in bigger units, I found a few properties I suspected he would be interested in and suggested he sell me this unit so he could buy one of these larger buildings of the type he had recently been acquiring.
Seasoned investors like the art of the deal
When he asked why I was so interested in this property, I told him about my desire to do the conversion to condo/villa. This was a concept that was new at the time, and he was actually interested to see if it could be done. Also, seasoned investors tend to like the art of the deal and he loved my vision and as he did not have the desire to do this himself, he agreed to sell it to me. We of course needed some creative higher-priced financing, but we created the win. Here is how we structured the deal:
• Purchase price $455,000
• $26,000 down payment
• $65,000 seller financed (with a one-year moratorium on payments)
• $364,000 (80% conventional finance)
As the current cash flows were low, the seller agreed to a one-year moratorium on payments so that I had ample time to increase rent revenues or refinance out of this original loan.
My first order of business was to increase the rents. But I needed to wait until each of the leases was due before I could make the rent adjustments. I got the rent increase of $200 per month per unit, and I did not lose any of the tenants. See my post here on how I retain tenants. Meanwhile: The conversion to condo/villa took place over the course of three months.
Within seven months of the purchase, all rents were now updated and my cash flow increased by $1,000 per month. I was now in a nice positive cash flow position and the property was now classified as condo/villas.
Time for the big value play
It was now time to get appraisals for the four units. As individual units they were worth much more. The appraisals came in at $175,000 per
The new appraisal for each of the units like this one came in at $175,000 each.
unit. At four units this totaled $700,000.
My initial investment was $462,000 which included the $455,00 purchase price plus the $7,000 in conversion fees.
Getting four single-family loans refinanced produced a much cheaper interest rate than the higher-priced creative finance rate I started with.
In fact, I reduced the interest rate by more than one percent. I refinanced at 80% of value and withdrew cash from each unit. The four combined loans at 80% of value gave me $560,000 to work with.
After paying off all the initial loans and fees, I had approximately $95,000 in cash left over to reinvest.
Here are the results of what this property added to my portfolio:
1. $700,000 worth of real estate
2. $480 of monthly cash flow or $5,760 annually
3. $166,000 worth of equity (down payment and value increases)
4. $95,000 in cash to re-invest
All this from a $26,000 investment.
The take away
SIBKIS: See it Big, Keep it Simple. Seeing the big picture. Keeping the process simple, doing your due diligence and putting the wheels into motion.
Visit Larry’s website here.
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