We have known John for a while. We first met over 10 years ago when he attended the first real estate seminar we ever held. Over the past decade we would see John from time to time at real estate events. John continued to be a student of real estate and purchased some of our real estate education products. Fast forward to 2012, John reached out to inquire about our consulting/coaching services. After listening to his goals and reviewing his current situation, it became clear that John was looking for more than coaching and consulting. What John needed was a complete overhaul, a full transformation of his financial assets.
John owned four investment properties for a total of 11 units. John’s vision was to have all four of these properties produce passive income so that he could stop taking money from his pension to cover property expenses. John had recently retired and was concerned about his legacy. His goal was to live off of his pension and reinvest all of the cashflow from his properties by putting the money he made into acquiring more investments. When he passes, John wants to be able to leave his real estate to his nephew and have it continue to produce income and wealth for his family.
John faced obstacles on many different fronts. For starters, three of the four properties were vacant and non income producing properties. As a result, John fell behind on his bills and real estate taxes. Three of his properties were about to be lost and sold off at an auction by the City.
John didn’t have the resources and funds available to turn around the properties and he was running out of time. Even if he found the money, he didn’t want to manage the contractors because he had managed renovation projects in the past and they hadn’t gone well.
Even though John was about to lose three of his properties to the City, the good news was that he had equity in three of the four properties. In addition, if the properties were turned around properly, each of them could be income producing rentals.
Most would look at the situation and recommend John sell his properties right away. This would prevent him from going into foreclosure and it would allow him to pocket some money.
But after sitting down with John and really understanding his vision, that isn’t what he wanted. John had purchased these properties years ago (in some cases over 20 years ago) and he had been trying hard to keep them up and running and making money. John didn’t want to sell them. John lived in the same neighborhood and he wanted to see the fulfillment of his vision—to have these properties performing well and producing income.
John’s financial statement (see income statement and balance sheet below) was in bad shape. The good news was that he had a pension that covered most of his personal expenses, but he had a lot of bad debt, a low credit score with delinquencies, and his tax returns showed he was losing money.
We suggested that John start with the property that was the closest to foreclosure, which also happened to be in the worst condition. Turning this property around would not only save him from loosing his property, it would also improve his Personal Financial Statement (PFS) significantly by giving him more equity and once up and running, it would produce over $1,500 per month in cashflow. Then once it was renovated, John could move on to renovating the other two properties, save them from foreclosure, and turn them into income producing rentals.
Due to John’s financial package and lack of real estate development and renovation experience, it would be difficult for him to acquire financing, so we suggested John partner with someone that had strong financials and real estate experience. Once he turned around this property and improved his credit he should be able to get financing on his other properties.
After discussing the financial strategy we prepared for John, he decided that he wanted to partner with us on this first project. So we formed an entity, became partners, and John became the silent partner while we got to work. We secured a construction loan and spent over $250,000 in renovations to turn the property into an income producing four-unit student housing rental. (Click here to the project.)
Financing, Construction Management & Property Management
In addition to acquiring the financing, we also managed the construction, leased up the building, and managed the property for John.
Upon stabilizing the building and improving John’s credit, John was then able to obtain a new loan, payoff the construction loan, buy us out, and now owns the property—100% himself.
Here is what John’s financial scorecard looked like before and after, we transformed this building from a negative cashflowing property into an income producing rental with some additional equity.
Maximizing Value & Tapping Into Equity
After having turned around the first property, we felt John would now be able to obtain financing on his own. Although we had improved John’s credit and his financial statements, the lenders weren’t comfortable giving John a construction loan, but they were comfortable lending him money on his other income producing property. This was a four-unit building with one vacancy. We immediately rented the last unit to maximize the property’s cashflow and then we refinanced the building. We then took the proceeds and used it to renovate a vacant duplex, a third property, Cobbs Creek.
Asset Transformation #2
We spent $20,000 to rehab the vacant duplex—Cobbs Creek. Previously it had been rented as two one-bedroom apartments, but we knew we would be able to turn one of the apartments into a two-bedroom/one-bath apartment by utilizing the basement as a bedroom, which already had a legal means of egress. As a result we were able to maximize rents and rented the one-bedroom for $625 and the two-bedroom for $725 per month. Upon stabilization, the building produced $750 per month in positive cashflow and he had $28,000 in equity even after pulling out an extra $63,000 in cash upon refinancing.
The picture below shows Cobbs Creek’s financial scorecard before and after the property’s transformation.
Asset Transformation #3
When you looked at the final property that John owned by itself, it didn’t make financial sense to renovate it. The property had $24,000 in back taxes and was worth only $20,000 as it was. However, John lived next door and was committed to improving the neighborhood. From turning around the rest of his portfolio, he now had the wealth and resources to renovate this property and still come out ahead. We entered into a payment agreement with the city on the taxes and spent the $63,000 he got from the Cobbs Creek refinance to renovate this property. This one needed a full gut job and upon completion this four-bedroom/one-and-a-half-bath appraised for $125,000 and rented for $1,200 per month. We then refinanced the property, paid off the remaining taxes at closing, got paid the balance of our fee, and John was able to pull out an additional $65,000 cash tax free and makes $300 each month in positive cashflow.
Above all management services, cashflow management is an important aspect that we are extremely passionate about. Having learned the hard way, we know from first-hand experience the pain bad casfhlow management can cause as well as the sense of empowerment, good cashflow management can bring. We recommended that John take the $65,000 and allocate it as follows:
- Eliminate the remainder of his bad debt. He had accumulated more than $35,000 over the years in bad debt.
- Make sure any security deposit accounts were fully replenished and never touched again, except for its appropriate purpose.
- Put sufficient cash reserves aside for each property. This would allow John peace of mind knowing he had money set aside for repairs and capital improvements.