We bought our first multi-family property – a duplex in the trendy Riverside area of Jacksonville, Florida – and broke three investment rules in the process.
We did our due diligence (e,g, property inspection, cash flow calculations) and felt that the opportunity matched our philosophy of cash flow and value over the long-term. But to get the deal done, we did have to relax some of our investment rules that act as checks and balances.
Here are the three investment rules we broke and why we felt it still made sense to go ahead with the purchase:
Rents don’t meet the 1% rule
One of the often-quoted real estate investment rules is that monthly rents should be 1% or greater of the purchase price.
In the case of our duplex, it came with two sets of existing tenants, paying a monthly rent equivalent to about .8% so a good 20% off-target. With these rents, however, we are still able to be cash flow positive. Also softening the blow is that through our own research and speaking to property managers, the current rents are on the low side. This means there is rooms at the end of the leases to increase the rent.
Furthermore, we had been looking in this area for a while, and the price for the condition of the home pointed to the purchase price being a good deal – we could buy and have instant equity.
Finally, we are bullish on this area of Jacksonville and think it holds great appreciation potential. We buy for cash flow, not appreciation, but the appreciation made us feel better about taking the lower rents now (and breaking one of the popular investment rules in the process).
Investment was more than 10% of our total portfolio
Another of our investment rules that we set up as a check-and-balance is to limit any single purchase from totaling more than 10% of our existing portfolio.
So if we have $100k to invest, we aren’t going to put more than $10k in any single investment. With our real estate portfolio, we grew it slowly, such that each investment never accounted for more than 10% of our net worth. With this duplex, we need to come up with an all-cash offer to be competitive (a mortgage would take too long and would introduce uncertainty to the seller, making us less attractive buyers). An all-cash purchase would mean putting over 15% of our net worth into this one investment.
However, at the growth rate of our portfolio, the duplex wouldn’t be that large a percentage for too long. Furthermore, the net cash flow from having no mortgage would allow us to replenish our investment coffers.
Finally, while we didn’t have time to get a traditional mortgage, it didn’t mean all the cash had to come from us – if it didn’t, we could still meet our maximum-10% rule.
We borrowed from a friend
We did end up borrowing the cash, and that loan broke yet another of our investment rules – don’t borrow from friends and family. With our duplex, we made a personal loan with a longtime friend at 7% interest for 70% of the purchase price.
My friend had excess cash earning a negligible interest rate, and she had several rentals herself so was already familiar with this type of investment. We did a quick contract via Legal Zoom, and she wired the money within a week.
We closed on the duplex less than three months from this writing, so it’s too early to tell how well it will perform. But so far, the tenants have been paying on-time and low maintenance. The rest of our portfolio is doing well, so we are still anticipating this purchase won’t violate our maximum-10% investment rule for too much longer. My friend is already asking me if I have other lending needs, so she’s clearly still my friend and another lending opportunity!
So, while we broke three investment rules we set up specifically to provide checks-and-balances, since we went in with eyes wide open, we should still be OK.
What about you? What investment rules of thumb do you use? Have you ever broken one or more of these? How did that turn out?