How to Purchase Rental Property at a Discount

A few months ago, I wrote a piece about another investment property purchase I was considering.  If you want to make money as a landlord in real estate, you must be able to purchase rental property at a discount.  As it turned out, that property never materialized, probably for the best.  I was going to be a partner on a $1.4M property, put up $100K+, and be a partner on a $1M loan.  I did not want to get stuck on a large loan, with limited mechanisms to get out.

As it turns out, all good things come to those who wait.  Here is a recap of my recent investment property purchase.  Remember, if you buy via the MLS, you are probably paying too much.

All my renters know I own several rentals.  All my friends know I am a landlord.  When you are a property investor, you need to get deals from anywhere you can, you need to be sure to let people know you are a capable real estate investor.

The Initial Tip

One of my tenants called asking if I wanted to buy any more property.  I am always looking to buy deals, and if the property is a deal, I am interested.  I assume it was just someone selling an over-priced home, and needed a buyer.  I let it go from there.

I received another call from my tenant’s brother a few weeks later.  His parents were selling their home.  They needed a buyer, one that could close the transaction in as soon as three weeks.  They purchased a 3BR 1BA home in 2012.  It had a new roof in 2012, and they paid $60K for it on a contract for deed with $7,500 down.  The final balloon payment was coming due soon and they did not have enough money to pay it off.  They had made all the monthly payments, but the final balloon was too much for them.

The Downside

This is a 100+ year old home, vinyl siding, newer furnace and water heater.  It comes with an extra lot next door.  The owners added an additional bathroom after they purchased it, so it was now a 2-bathroom home.  It is not my typical purchase.  Too old of a property.  Not in my definition of a ‘good’ neighborhood, but not too bad either.

The Potential Value

The son did most of the negotiations with me.  The sellers wanted to sell for $45K.  That seemed like a reasonable price, so I did a bit of research.  Zillow’s Zestimate says the property is worth ~$97,000.  Trulia says the estimate is $113,000.  The property tax statement says it is assessed for $75,500.  None of these estimates takes into account the vacant lot that comes with the property.

I think the actual value is closer to $75K, with the extra lot.  Possibly slightly more, but not much more.  There are plenty of homes in the area that sell for 100K+, so it could be worth a bit more.

Spend Money to Make Money

I initially went to look at the property to make sure it was in reasonable shape.  There was a serious hording problem, but otherwise the property was as expected.  I hired an inspector to do a “Truth in Housing Inspection”, and paid $185.  It is typically a Seller’s expense.

That is a law in St Paul, you need a property inspection and it gets sent to the City for their records.  The sellers made a couple of repairs before the inspection, and all inspection items came back OK; at least as far as a 100+year old home can be.  So I signed the purchase agreement with the seller for $45K.

The ‘Catch’

Once catch was the sellers either wanted to live there for ~6 months before they moved out, or be allowed to rent the property back from me.  I contacted the Contract for Deed holder and explained I was buying the home from the sellers and to expect a payoff in the near future.  He mentioned that it may be easier to just do an assignment of the contract for deed.  I thought it may be a cleaner transaction with a ‘normal sale’, so I passed on his offer – at that time.  He did say the sellers always paid on time, or early.  They just did not have the ability to come up with the cash, or a mortgage.

The Paperwork Starts

The original purchase agreement was written for $45K.  They would pay off the contract for deed of $38,353.27, and have a few dollars in their pocket after all was said and done.  It was a cash deal.  The best deals as a real estate investor are cash deals.  Without cash, this deal would have never come to fruition.  There was not enough time to procure a mortgage.  Cash deals are fast.

A Chink in the Armor

I sent the purchase agreement to the title company to prepare for a closing, and they came back and asked “What do you want to do with the tax lien?”  The seller neglected to tell me about a $23,998.38 federal tax lien.  I explained it to the seller that this lien kills the deal.  We signed a cancellation of purchase agreement.  A purchase agreement is always ‘live’, until it is cancelled or one of the terms makes it invalid.

Switch to Plan B

I then went back to the Contract for Deed holder.  I said his original idea was actually a great one.  I asked him to get an Assignment of contract ready, as I was ready to purchase it from him.  I got a check for $38,353.27 ready and signed all the documents in his attorney’s office on 12/30/2015.

Now I owned a contract that has a balloon payment due in one day.  And I knew it was not going to be paid.  I now needed to cancel the contract, which is similar to a foreclosure, only faster.  I could have also had the sellers sign the property over to me, via a Quit Claim Deed, but that may not have extinguished the Federal Tax Lien.

Killing The Tax Lien

This was not a property tax lien, which would be completely different.  It is a income tax lien.  When the Federal Government attaches a lien on someone’s home, it is a lien on the equity in the home, not the home itself.  A cancellation of the contract for deed extinguishes the equity of the former owner.  Once the equity is gone, so is the lien.  It does not remove the obligation of the former owner to pay it, just removes it from the property.  It becomes a personal lien on them.  My attorney did send a notification to the IRS about the contract for deed cancellation, although there Minnesota case law that says it is not necessary.

The cancellation gives the owner up to 60 days to redeem and payoff the balloon payment, and any payments that were due during that 60-day period.  The 60-day period expired on 3/16/2016.  The property became mine on that date.

Freebies to Sweeten the Deal

The former owners received January, February and March rent/payment free.  They also requested that they get April free, so I requested to them that they pay a half-month’s rent for April and another half in May.  That is the same as getting four free months’ rent.  They were still disappointed they did not get ~$5K in cash, as was the original purchase agreement.

Another request that they wanted is to hire an electrician to change out the fuse box for a circuit breaker box.  My estimate I received is $2,000.  I have no problem doing that, as a fuse box is not the safest.  My insurance company doesn’t like them either.

These people just lost a bunch of equity, it was the least I could do.

Setting The Rent, Getting the Return

We determined the rent to be the sum of the contract payment, the taxes, $100 a month for insurance, plus the average water bill.  That way, the payments will be almost identical as what they were paying, for two years.  The rent will be a total of $830 a month, which is artificially low.

The lease also specified that the appliances were owned and maintained by the tenants.  Another part of the lease says the tenants are responsible for the first $250 of any maintenance item.  All in all, there should be ~$500 a month after all my expenses are paid.  Not bad for a ~$40K investment.

That is a solid 15% return, assuming the property can be sold for $40K.  Anything above that and I make an even better return.  In reality, I am sure it will not be quite that good, but will be better than .001% interest that a bank would offer.

In my quest for financial independence, this should add another $6K a year.

Have you ever made a non-MLS real estate deal?  Ever bought a property with a creative deal?  What about your own home, or rental you live in, did you negotiate anything other than the list price?