Investing in Gold Mine Houses

How to Uncover a Fortune Fixing Small, Ugly Rental Houses and ApartmentsBy Jay P. DeCima

The McGraw-Hill Companies, Inc.

Copyright © 2009 Jay P. DeCima
All right reserved.
ISBN: 978-0-07-160834-3

Contents

Chapter One

The Millionaire’s Recipe

Six junky little houses all tucked in together on an oversized city lot. They might have resembled a Norman Rockwell painting if you stood far enough away and had poor vision. They were older, rundown, and somewhat neglected—not much different from all the others I’ve purchased over the years. As you shall see before the end of this chapter, six little houses like these can make a very powerful contribution to your financial well- being!

My Cherry Street story began a long time ago. In the sequence of time and events, I’m currently living off payments from the promissory note after 26 years of collecting rents from my tenants. In case you might be trying to figure out my age, I can tell you this much: I acquired Cherry Street back when I didn’t mind having my picture taken! As it turns out, however, who could have ever guessed how handsome I would look with all my wrinkles.

The Cherry Street Transaction

Beating down the seller to a $145,000 purchase price seemed like a shallow victory at the time. My biggest problem was trying to find the $20,000 down payment the seller wouldn’t budge on. A truck driver by day and part-time landlord when he wasn’t hauling stuff, he was savvy enough to see that I wanted to buy his houses just about as badly as he wanted to sell them. Back then, I was still teaching myself not to fall in love with properties. The seller finally agreed to carry back financing for $125,000, and he would give me 15 years to pay. But the down payment he said would have to be cash on the barrelhead. I remember thinking to myself, where will I ever find $20,000? I even wondered if there was that much cash in the world. Eventually, I robbed Peter to pay Paul and got the deal closed. That would be the last out-of-pocket money I’d ever have to spend on Cherry Street. My tenants would eventually pay for everything else.

Lifetime Investing

Cherry Street is about making money for life. It’s about being a capitalist and living off your assets. That’s why I call it womb-to-tomb investing. My basic strategy is to acquire the right properties, hang onto them, then harvest the benefits as I go along. My plan is to pay a small down payment and come up with whatever funds are needed for fix-up. After that, all the money starts flowing in one direction: back to me! My tenants will pick up the tab for everything else. As time goes along, I’ll eventually be completely mortgaged out. That means every nickel I’ve spent will have been returned to me. I have often characterized my job as that of an arranger or financial plumber: I arrange to acquire the right property, I arrange the financing, and finally, I do whatever upgrading is necessary to make the property cash flow.

Today, as I write about Cherry Street, many wannabe investors are worried about real estate values plunging, mortgage funds drying up, and cash flow properties becoming more difficult to find. These concerns are not new; in fact, they are even older than I am. My good friend and investor cohort, the late William Nickerson began investing in properties just like Cherry Street during the country’s worst depression, and he did just fine. When Nickerson passed away, his estate was valued in the $16 million range. Pretty good, I’d say, for a do-it-yourself duplex investor! In his now-famous real estate book How I Turned $1,000 into Five Million in Real Estate (Simon & Schuster, 1984), Nickerson wrote:

The opportunity to make a fortune is with us every day. Under the free enterprise system, opportunity knocks not just for the favored few, but for everyone who aspires to better himself. And, opportunity knocks not just once, but many times. Obviously, it’s up to you to open the door.

Properties like Cherry Street are the kind of door-opening opportunities Nickerson writes about. They are not scarce or hard to find if you learn where to look and adjust your thinking to look for older multiple-unit properties as opposed to single-family houses. Single-family houses are not really income properties in the truest sense. Don’t misunderstand me here and think that I don’t like owning single-family houses! I do, and I own them myself. They make excellent investments, but they lack what most new investors—especially career changers—need to start with: cash flow! Buying in bunches will help you generate cash spending money much quicker. It will also eliminate a great deal of the risk associated with buying leveraged real estate—namely, going broke! It’s simply a matter of elementary mathematics: depending on six tenants’ paying monthly rents is much safer than depending on just one.

Show Me the Money

Cherry Street grossed $10,800 during my first year of ownership. When I sold the property 26 years later, my gross rents had reached $57,240 annually. Some years passed without any rent increases, but during boom times they jumped higher than puffed Rice Krispies. On the day I sold Cherry Street, the books showed a total of $999,010 in rents collected during my ownership.

You might be thinking to yourself, that’s a lot of money, but how much did you get to keep for yourself? I’ll tell you how much later on, but right now, I will tell you that the rents doubled during my first three years as the owner. They went from $10,800 to $20,560. By then, the green was starting to flow my way. Twelve years down the line, my average rents at Cherry Street had reached $540 a month. When you do the math, you’ll quickly see that my annual income had reached nearly $40,000—roughly four times higher than when I started.

People often ask me if I think rents will keep going up. My answer is, yes I do! Rents are like groceries: they’re a product of the marketplace. In fact, rental houses make the perfect hedge against inflation because rents adjust with the times. When you carry paper or finance your property sales, as I often do, you must always consider the long-term effects of fixed interest rates. They are not sensitive to inflation like rental house income.

Is it hard to manage your rentals and collect all the rents? It’s sorta like riding a bicycle. When you first start out, you’ll most likely crash a few times. But once you get the hang of it, you’ll find it gets much easier. Then finally one day, you’ll begin to realize that your tenants are making you rich. By then, you might even be enjoying it!

The Key to Profits: Sound Economics

To start with, I’m an investor, not a speculator. Don’t get me wrong here: when properties appreciate from natural causes or inflation, I’ll certainly be the first in line to take my bows and accept congratulations. But inflation profits are what I call fluff, or unearned profits. I get them automatically without doing anything, just like every other investor whose name gets printed on a deed. True investors never count on appreciation or inflation to make a deal work. The deal must work based on sound economics and good negotiating skills.

I paid $20,000 down for Cherry Street, and I’m expecting to receive a very good return on my money. When I made the deal, I also expected to have all my down payment cash, plus my fix-up expenses, back in my pocket by the end of six years or so. Subscribers to my monthly newsletter Trade Secrets and the folks who’ve read my how-to books already know that my average fix-up costs run about 10 percent of the purchase price for the properties I call light fixer-uppers (and about 20 percent for heavy fixers). My Cherry Street estimated fix-up costs were nearly $18,000, or roughly 12 percent of the purchase price. You must not forget that 70 percent of those expenses ($12,600) were estimated labor costs. But back then, I was doing all the labor myself. That meant that the only cash money I needed was $5,400 for supplies and materials, which, of course, maxed out my overworked Visa cards.

An Ideal Mom & Pop Business

A property like Cherry Street is where every do-it-yourself investor should start. It’s much less than a full-time job, yet big enough to give you all the practical experiences you’ll need to decide if you’re cut out to be a capitalist. Six junky looking houses are about the right size to cause you lots of grief if you attempt to finance them through a regular institutional lender. Five or more units put you in the commercial borrowing category. When your bank officer explains why she won’t give you a mortgage, you should immediately jump outta your chair and thank her. She’s done you a tremendous favor! You’ve now experienced one of the most valuable lessons you’ll ever learn in this business: it’s called rejection. Now you have no choice but to begin searching for sellers who are willing to finance their property sales. There’s no shortage of these sellers, but most new investors don’t try hard enough to find them without the extra push.

Six units are also about the right size for a total family experience. Although they’ll scream and holler, the kids can enjoy a boatload of benefits helping Mom and Pop with the family rental business. Several families I’ve known for years have actually paid for the kids’ college with rent money from their houses. With just a little accounting know-how, Billy Bob’s new 4×4 truck can be purchased with operating expenses—completely tax deductible. One benefit that doesn’t get talked about nearly enough is the family involvement part—kids who work with their parents learn more about responsibility. Sadly, this lesson has been lost in the dot-com shuffle in recent years. On a more positive note, what healthy young teenage boy would pass up a chance to cut grass at the family rentals in between video games? Don’t forget to mention the 10 to 15 percent maintenance allowance—that might be just the right carrot to dangle!

You needn’t lose any sleep worrying about your fix-up skills. At least 80 percent of all the work required is what I call grunt work. Even if you can’t grunt, you can probably paint, haul trash, hang curtains, fix a fence, or spruce up a front yard. Skilled work, the stuff that needs a contractor or someone who actually knows what he or she is doing, is only a small percentage of the total fix-up cost. Keep in mind that I’m not talking about remodeling houses, like moving walls around or ripping out the old plumbing system. That’s not the business I’m in. My job is to restore the property and do my best to preserve what’s already there. Rental houses must be clean, attractive, and functional to compete in the marketplace, but that’s it.

The Magical Power of Leverage

I can think of no other business that offers as much reward for such a small up-front investment. The $20,000 down payment I needed to acquire Cherry Street was roughly 14 percent of the total purchase price. That means that 86 percent of the property wasn’t even mine yet—and still, my deed entitled me to 100 percent of all the income. When you divide six houses into the purchase price ($145,000 divided by 6 equals $24,166), you can see that my down payment was $4,166 short of paying for just one house, let alone all six of them. This is how leveraging can turn small-time investors into rich tycoons.

When you play Monopoly, you must pay for all your little green houses and your hotel before you can start collecting the maximum “rent” money from the other players who land on your squares. At Cherry Street, my down payment gave me full rights to begin collecting income from all six houses long before I’d have them paid for. Leverage allows you to make phenomenal returns with a relatively small sum of money. In this case, my $20,000 down payment returned $10,800 in rents during my first year of ownership. That’s a 54 percent return without considering appreciation, tax write-offs, and the additional value I created with the fix-up.

Folks who have attended my seminars or read my books already know my feelings about selling good income properties. In case you don’t, let me shout it loud and clear so there’s no misunderstanding: I do not recommend selling income-producing properties!

If you buy properties the right way, and they begin producing a spendable income in a reasonable period of time, there can be very little justification for selling them. That would be like killing the goose that lays the golden eggs. The exception, of course, is when you reach the retirement mode and it’s time to kick back and smell the roses. That would be the beginning of a whole new phase of profit making.

Womb-to-tomb investing is my characterization of planning a predictable income from start to finish—or as my probate attorney calls it, “until my case matures.” Continuous income has always been one of my most cherished benefits,—you could call it my “old-age retirement fund.” The money flow never shuts off with the passing of ownership. After 26 years of collecting rents at Cherry Street, I succumbed to the fragrance of sweet smelling roses in full bloom! I sold my six little money-maker houses for the going rate at the time: $650,000, or roughly 11.5 times the gross rents. (See Appendix C, Figure C-1.)

Switching Horses to Passive Income

I sell properties much the same way I buy them. I offer attractive terms and provide seller financing. I always spend considerable time checking out my buyer to determine if he or she will be able to handle the land-lording chores. The key to receiving uninterrupted mortgage payments when you’re cruising around the world is directly related to how well your buyer can cope with the tenants. A traveler’s worst nightmare is that late-night panicked call to Barcelona from buyer advising you that he or she just can’t do this anymore and is giving you back the keys!

Pajama money, as I call it, is living off the mortgage payments you receive from financing your property sales. That’s about as good as it gets for retiring landlords! Sometimes it gets so quiet, that you almost miss hearing your ex-tenants’ voices! Generally that thought passes rather quickly I’ve found. Still, during my many years as a landlord, the tenants treated me extremely well financially. Looking back, I’m still amazed at my earnings from six little houses. During the last year alone, the property earned me almost three times ($57,240) the amount of my initial down payment.

After collecting nearly $1 million in rent money, I sold Cherry Street for $650,000. I received a $50,000 cash down payment, and I provided seller financing for the $600,000 balance. The buyer agreed to pay me interest-only payments of $3,250 per month for 20 years, with the remaining principal balance due at that time. This transaction worked quite well for both sides. It allowed the buyer to take over the property and immediately begin earning cash flow income. For me, my net income stayed about the same, but as the late Dr. King so eloquently put it, “I’m free at last!”

The Final Box Score

From beginning to end, Cherry Street will have earned 121.5 times the amount of my initial down payment:

$999,010 Rents
50,000 Cash down payment
780,000 Interest income
600,000 Final principal payment
—
$2,429,010 Total income

Chapter Two

Beth’s Success Story

Millions of folks just like me spend countless hours and huge sums of money shopping in home improvement stores. But unlike me, most shoppers are looking for new ideas and products they can use around the home for improvements and personal enjoyment.

Big Box chain store shoppers are an ambitious bunch, I’ve found—and many are quite skilled working with their hands. They love fiddling around the house, fixing stuff, and installing new gizmos.

When I was younger, I had the most overimproved house in my subdivision. I was constantly redoing everything, and when I finished, I’d start all over again, improving my improvements. One day a good friend of mine dropped by to see my house. He suggested, that rather than keep doing the same things over again, why didn’t I use my skills on another house? My friend’s visit that day would change my life forever!

It wasn’t long afterwards that I discovered how easy it was to convert my handyman skills and personal ambition into a profit-making opportunity. I can tell you from experience that there’s not a dime’s worth of difference between working at a hobby without any pay and being the highest-paid handyman in the neighborhood.

In my bestselling book Investing in Fixer-Uppers (McGraw-Hill, 2003), in the very first chapter, I inform my readers that big money is earned by working smarter, not harder! My book explains that with just a little bit of financial training, using the same house fixing skills that most handy folks already have, it’s very possible to create a sizable monthly income and financial security for a lifetime.

Most people are too busy earning a living to make any serious money. They simply don’t take the time to learn about investing or plan any kind of a financial future for themselves. In my first book, I show readers how one small apartment complex earned me the same amount of money as the mill worker would make in 40 years, but the big difference is that I earned mine 20 times faster. That, my friends, is the kind of financial knowledge you need to know about. The book you’re about to read will totally surprise you when you learn that building substantial wealth has very little to do with how much money you start with. And it has nothing to do with what school you went to, your current family obligations, or whether you’re male or female. In fact, one of my most successful students was a divorced mom with two small children to care for.

(Continues…)

Excerpted from Investing in Gold Mine Housesby Jay P. DeCima Copyright © 2009 by Jay P. DeCima. Excerpted by permission of The McGraw-Hill Companies, Inc.. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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