As a rental manager, I have always paid extremely close attention to the rent vs buy ratio. In fact, a large reason why I chose to move to Raleigh was because of the amazing rent vs buy ratio. When I moved here in 2010 the median mortgage payment was around $1000, and that same home would rent for $1300. There were individual bargains however easily returning double the payment on a 30-year mortgage. I began tracking individual properties closely in the summer of 2012. At that time nearly every home on the market still offered phenomenal returns on capital invested. During this time I found out about an extremely interesting financing method for multi-family homes. Basically, I could buy a 4 unit building with 3.5% down at 3.9% interest as long as I occupied one of the units. Coming back to the fact that I get a commission rebate at closing of 2.5-3%, this means I could buy a building with massive cash flow potential for about 1.5% out of pocket including closing costs. I could also buy a much more expensive property than otherwise because the rent income would be included in my own personal income for underwriting purposes.
This in addition to the fact that FHA has lower standards on income to payment ratios and even credit scores. These same benefits can lead an inexperienced investor straight to foreclosure, but keep in mind I have a huge margin of safety. While I have historically shunned debt, I intend to take on as much sub 4% debt as I possibly can at this moment so long as I have my margin of safety with price, scarcity, and cash flow. I however despise 30-year loans, so a 15 year offers the opportunity to benefit from helicopter Ben Bernanke without plunging me into life-long debt. Within my price range, I identified a glut of listings around the 250-375K range in the Raleigh market. This range would allow me to take on a large amount of dirt-cheap financing while still offering a monthly payment I could cover should there be no rent income whatsoever. I identified 8 or so properties that were extremely interesting. While I was open to properties anywhere in Wake County, I undoubtedly zeroed in on those inside the 440 beltline. What I mean is that I wanted to stay close to the city center rather than in the suburbs. I’ll discuss why in the post on macro trends considered before making an offer. Essentially it revolves around my belief that the millennial generation and rising energy costs will drive trends in urban growth for most of my lifetime. In addition to the 8, I was highly interested in, there were at least 8 others that were similar but didn’t appeal to me. From the fall of 2012 until the spring of 2013 I watched every single one of these 16 properties sell save one. This is the one I ultimately ended up making an offer on. While it didn’t hurt that everything else sold, this property had always been at the top of my list. You’re probably wondering why this one didn’t sell if it was so interesting. Well, it is essentially a boarding house and therefore a management nightmare. It’s also in a rough part of town and the combination covered up the potential. Several boarding houses did sell during that time but they were closer to NC State. I’m assuming many people saw this as easier and less risky than the home I went after. I disagree however as college kids can cause an awful lot of drama very quickly, especially when they’re the type to rent a dirt-cheap boarding room. In addition, you often end up dealing with multiple sets of parents as well as the tenants themselves. Furthermore, these homes were almost all in low-density residential neighborhoods with little chance of ever changing that. I viewed another building that had phenomenal cash flow potential, and that significantly increased my confidence in the home I settled on. On paper, I had identified that the rents were certainly below market, and assumed I could increase them rather quickly through our skill as rental managers. It’s possible we could have but it turned out not to be worth the time. It was 4 units, meaning 4 kitchens, 10 baths, and 4 water heaters, HVAC units, etc. Those are the big-ticket areas that haunt cash flow buyers. The units were in rough shape and the tenants no better. Finally, the area was rough, to say the least. It was basically a few run-down multi-family buildings, and at least a dozen low-end apartment complexes. Cash flow was still great, but appreciation might be market average, probably less. If I had a mountain of cash I probably would have bought it and held forever. The home I ended up going after embodied the uniqueness that I so desire when buying real estate. The largest factor was that it is 6 blocks from the Raleigh Amphitheater and Convention Center. Essentially the heart of downtown Raleigh. There is no doubt that the immediate area is extremely rough. In fact, in years past it was well known as one of the roughest areas in town. It was at first glance a worse area than the complex I mentioned a moment ago, and also 30K more. That however was about to change… While doing an initial walkthrough I was shocked to find that the home was in decent shape. This home is a 9 bedroom boarding house with shared common areas, and despite that, I had to ask if the owner had a cleaning service come through. There were tenant-made signs on the cabinets directing everyone to clean up after themselves, (a tactic I used constantly in college haha) and essentially no mess in the common areas. The bedrooms for the most part were well cared for as well. I met a couple of the tenants and while eccentric, they seemed quite reasonable. I also realized something, this home had a higher rent roll, and most likely significantly less maintenance. We only had three water heaters, two HVAC units, and two rarely used kitchens. In fact, the stoves /ovens were original and worked. By original, I mean 50 years old! They really don’t make ’em like they used to… No microwaves, no washers or dryers, only 6 baths, and less overall square footage by a fair amount. This means significantly less maintenance, less depreciation, and less to replace. At this point, I was getting excited.
The experience was better in every way from the other 3 places I viewed, and two of them had sold for more money. The potential cash flow was higher than the other three, although there was a little more risk that could change as we’ll be carrying utilities and those rates keep rising. Most importantly I saw this location as having massive potential. I had mentioned the past 30+ years were marred by violence, prostitution, and drugs. Despite that though, something dramatic had begun to occur. This property is located on a small strip of land approx 15 total acres, located between an extremely popular community for young, aggressive professionals named Boylan Heights, and the heart of downtown. 3 blocks north is where the new high-speed rail station will be built. A large developer just bought 9 nearby acres. Directly across Western Blvd is the proposed 300+ acre Dorothea Dix park that looks both promising, and groundbreaking for the entire city. The new development immediately behind this building was deep in the process of being gentrified with urban-style houses situated on tiny parcels, and selling for nearly 200K a piece. The lot for this home is long and narrow without a ton of road frontage. I do believe however a sharp engineer could manage to place at least 4 similar style homes on the land, at some point in the future, but that isn’t what I have in mind. I had already used my patented move of riding through a neighborhood on a Friday and Saturday evening to really get a feel for the rowdiest neighbors. About 4 blocks away is a housing project of sorts with approx 75 units on at least 5 acres and no more than 2 stories high. This land in itself is some of the most beautiful in the area as it sits high on rolling hills, and is not even close to being used to its full potential. I fully expect this complex to be relocated at some point before I leave the earth. Immediately beside my property are two auto garages with a ton of junk vehicles out front. A serious eyesore, I see this as opportunity. I’m assuming should I feel motivated in the future to do so, I can force the removal of the majority of vehicles rather easily. My goal though is to buy the properties… There is a corner store and food mart across the street, and this is still a problem in the evenings. The risk in this situation is that the area never cleans up. Another gentleman actually owns a huge portion of this small area, is currently in his 80’s, and probably thought the same thing I did when he first began purchasing. Due to his age, his holdings at some point soon will most likely go on the auction block, and whoever the buyer is will most likely look to develop rather than hold. My attorney recommended I speak to a great lady who has been running a small grill on the corner for over 30 years. She proved to be a wealth of information. She explained that after nearly 30 straight years of crime and violence, the area had cleaned up more in the past 12 months than all years prior. She cited issues such as massive nearby developer purchases and the soon-to-be-built high-speed rail station as reasons she expects that change to not only continue, but intensify. Furthermore, she was just notified that the city planned to do a large streetscape renovation which is guaranteed to add a lot of life to the aesthetics. They are also exploring rezoning the area to mixed-use and allowing 3-4 story buildings. I nearly hit the floor when I heard this as my plan all along had been to build the largest low-income senior housing complex possible on the lot at some point in the future. The streetscape isn’t slated to run directly in front of this property, however, I plan to attend every possible meeting trying to convince them of the huge benefits of extending the project a mere 600 feet and into the popular Boylan Heights area. Basically, at very little cost the city could quickly transform this area from problem to pearl, and it seems they have identified this potential already. In fact, Raleigh has a proven track record for doing exactly that. There is a soup kitchen located by a popular park in the heart of downtown. As a result, there is a massive homeless population in that area. Amid complaints, the city ponied up the cash and bought the building, and are now in the process of relocating that building to a better location for all. Almost gives you hope that the state and federal governments may someday be able to get it together. A huge issue of late is the possibility of transforming the former Dorothea Dix Hospital land (across one main highway) into a 300+ acre park to rival some of the the most famous parks in the United States. There is opposition, but most agree the plan will go through in some dramatic form. If this occurs, this will further motivate the city to clean up the area. Finally, along with the development behind the property, a small new park is being built, as well as greenway (famous Raleigh 70+ mile bike trail) access. So in conclusion I saw the benefits of this home to be…
Strong potential for city-led gentrification
Less maintenance than similar gross rent properties
Niche rental market with a surprisingly strong interest
Potential to transform use to higher value
Potential to remove the main eyesore of auto junkyards with city petitioning
The urban location keeps with what I expect to be a generational trend
Existing gentrification of the neighborhood behind the property
Potential for 300+ acre park across the street
Addition of parks and greenways
Large nearby developer purchases
Moves by the city signaling intended gentrification
In the next series, we discuss potential options to further add value to the property. You can find that here