A path to building wealth through small apartment buildings.
Choose your path
The subtitle for this article is “A path to building wealth to real estate.” We called it “a path” because there are many roads that can lead to building wealth through real estate. There are mobile home parks, syndications, condominium conversions, single-family homes, commercial space, industrial space, strip malls, offices, malls, you get the idea that the list could go on and on and on. Everything around us and everything we touch and see is somehow related to real estate investing.
The version I’m going to cover in this article focuses on buying smaller rental apartment buildings. Right now, in the rental market where we run our property management business, there is a gold rush of investors both seasoned and new who are racing along full throttle to get their hands on a deal. We hear some people say “there are no deals to be found out there anymore.” The truth is, you need to create your own deal. Sure, it’s true that for every listing that goes on the market these days, the offers flood in at $20k, $30k, even $50,000 over asking price. We have seen insane terms for call cash offers and waving all types of inspection contingencies. Don’t get me wrong. The strategy could work during the right time of the market if you know your numbers and have a sound investment, and exit strategy.
We have been through two different real estate cycle since we begin our journey in 2001. Based on what we have seen in the past I think we are near the top, if not there already. No one can say for sure, but we are showing signs of a top market. I called is the “taxi driver phase” of the market. When everybody you know including your taxi driver is talking about real estate and how they want to buy investment property, it’s probably at the peak and too late to get the best possible deal. But there are ways to find that fish in the bottom of the barrel. That would probably be a really good topic for another blog post but right now let’s focus on getting big profits from the smaller deals.
Where the road began
Back in 2001 when we first started investing we knew nothing about market cycles. We were as green as a spring toad. I guess you could say we were following the taxi cab drivers when we first jumped into the market. We didn’t know it, but the market was still going up when we jumped in. The first property we ever bought was a modest 3-unit small rental apartment building. The unit breakdown mix were three units, two 2-bedroom units and one 1-bedroom unit. Nothing super fancy to look at but it was our first property. We did it! We had arrived! We had purchased our first real estate investment property! Woo Hoo!!
We fumbled our way through our first lease which was fraught with legal errors. We discovered and thought 1 ft.² sticky tiles were the best invention since sliced bread, and started to make modest repairs as we could figure out how. But the market was still going up. One of our first mentors, Norman Lapointe only invested in commercial properties. He gave us a piece of advice way back then that changed everything for us.
When you buy a property and the market is going up, this will create equity in your property. Most beginner landlords figure the only way to buy more property is to sell that property and invest it into another property. You can do this with a 1031 exchange where you buy like kind property for like kind property. Or just a straight sale to a larger purchase. It seemed to make sense. But Norman gave us a strategy that we have employed since 2001 and this tactic has helped us to catapult our portfolio to build wealth.
What Norman told us that even though the market was going up, and the value of the property was rising, you did not need to sell the property to reap the benefits of the equity. Today, every landlord I know or that we manage property for, is looking for ways to refinance their property. Now why would you want to refinance your property? Well the answer is really quite simple. It gives you all the leverage, perks, and benefits of selling the property and taking that equity to buy a new property, but you get to keep the original property! Without paying the capital gains taxes. I know! Pretty incredible!
What has always amazed me about rental investment real estate is that you can purchase the property, rent it out to someone, and they will help you cover if not pay all of your mortgage costs and expenses. You provide a home, they provide the cash flow to pay down the principal. As this happens equity grows. So how can you capitalize on this?
Yes, there are several ways in several different types of real estate for several different types of investors with different flavors and styles and appetites for investing. We like the smaller multi-family deals. Back when we started $20,000 to $40,000 would get you a 3-family property. Which is exactly what we did. The first deal we ever did we actually put $40K down but in hindsight that was probably too much to put down into one deal. Over the next three years we refinanced that property twice and were able to cash out an additional $90,000. In today’s market, $90,000 might be enough for a down payment for one of these same properties. But back in 2001 to 2003 $90,000 bought us two more properties.
We took the $90,000 and bought two more properties. And the market was still going up! We did what we had learned to do and refinanced property number two and property number three. With the cash out from that refinance from property number two in Property number three we were able to purchase property number four and property number five. We found a system that worked and continued to work that system.
It was exciting for newbie landlords like us to put this theory into practice and see how we could turn $40,000 into over $1.2 million worth of real estate in 3 to 5 years. But don’t be star struck by the glitter and shiny objects. We held these properties for 15 to 20 years before we could cash out. I always try to explain to people that real estate is a slow-moving train.
Chart your course
Yes, there’s all kinds of strategies to build wealth. For us it was small apartment buildings. At one point we were up to 60 units over some 18 different properties. We were told by another mentor in 2010 that this part of the real estate cycle was the “Millionaire maker.” They advised us to buy every real estate property we could get our hands on. And that’s exactly what we did. Over the next two decades we raise rents, refinance cash out, and put the proceeds back into our investment portfolio.
We are older now and I hope much wiser than we were back in 2001. There is a fortune cookie that reads “once your mind is expanded it will never contract to its original size.” It is our belief that even if we lost everything we would be starting over with 20 years of experience. What we see now from our experience is getting close to the top of another market cycle and time to unload and sell.
When everybody wants to buy. That’s the time to sell. This is called a sellers’ market. In retrospect when property values take a dive, this is a buyers’ market because you can usually buy for pennies on the dollar. This is why we say real estate is a slow-moving train. At the same time that you can sell for a high price, you’re usually going to turn around and buy for a high price. Then again, at the same time you would be buying for a low price, you’re going to have to wait for the market shift change to be able to sell at a high price.
My best advice is to know your numbers in by right. When you make that purchase make sure your numbers work. Make your offer based on the actual rent rolls and expenses. Do not be fooled by the pro forma numbers. Every pro forma sheet I have ever seen presented by a broker has a paragraph on the bottom of the page that tells you these numbers may not be true! You have to do your homework.
Further down the tracks
In our strategy for buying small apartment buildings, it took about a decade for the values to rise. If you’re a younger investor, this may be a strategy for you. If you are an older investor you probably want to seek something with less risk involved. At this time in the market over the past year we have been strong sellers of our portfolio and have cashed out at premium profit prices. Now we will sit in a cash position and wait for the market to turn. Market cycles always follow the same path. They go up, then they go down, then they go up again. If we are at the top there is only one direction to go from here. When that happens, we will be buyers once again.
There is one more hidden gem to this whole strategy of refinancing and cash out from an existing mortgage. When you refinance a property and cash out from the mortgage, this is not considered as income. There is no income tax due when you refinance a property. When our first property investment of $40,000 was refinanced to produce $90,000, then property number two and three were refinanced for an additional $80,000 to buy properties four and five. Just in cash value alone our initial investment of $40,000 generated almost $130,000 that we poured back into our portfolio. By now we were doing all commercial loans with much more creative strategies to purchase these properties. Our $40,000 investment snowballed into a multi-million dollar portfolio all consisting of small apartment buildings.
Probably the main reason this worked for us is because we reinvested the profits. If we had taken this cash and gone on fancy vacations and bought expensive sports cars than the money would be gone on assets which depreciate or become memories, not building real wealth. Instead, we refinanced cash out of our portfolio, not taxed as income, and reinvested it to grow the real estate portfolio creating wealth.
This is one way to do it. If you talk to 10 different investors they will have 11 different ideas on how to make money off of real estate. It all depends on your investment strategies and your risk tolerance. Younger investors can take on more risk. Educated investors are not afraid of risk. There is risk and every investment. If you are educated and know your market that helps you mitigate the risk and invest wisely.
We hope you found this article useful. Hopefully it will add some value to your real estate investing toolbox. I would urge any of you to keep on learning. There are so many different ways to play real estate. It is not a one size fits all game. The more you learn, the more choices you will have, and the more options and opportunities will present themselves. At this stage in our investment lifecycle journey we are looking at more secure investments with less risk as we have less time to recover because we’re older now. That is not an excuse to stop investing. But time changes all buyers and sellers. We wish you all the best in your journey.
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