My annoying business partners convinced me to sell our 3-family investment property with 4 simple arguments.
Our original plan was to BRRRR this property and keep it for the long haul, but it doesn’t look like that’s happening anymore.
My business partners and I currently own 4 properties together and we have another 4 under contract to buy by the end of 2021.
Our structure is pretty simple:
I find all of the money, they do all of the work.
We split the equity 75 / 25 and they take a 4% management fee on gross collected rent.
We landed our first property in January 2020. It was a 4-family home in Camden County, NJ.
We successfully BRRRR’d that property and still own it today.
A few months after we bought that 4-family home, our General Contractor introduced us to his friend who wanted to sell a 3-family property a few towns over. That 3-family property ended up being the second investment we acquired in the partnership.
I can’t remember the asking price, but we ended up buying the property at $215,000.
The house required quite a bit of work, but we knew we were getting it at a really good price so we felt confident moving forward with the deal.
The unit mix is pretty basic:
Unit 1 is a 4 bed 2 bath. Unit 2 is a 2 bed 1 bath. And Unit 3 is also a 2 bed 1 bath.
The residents in Unit 1 have been there forever. They currently pay $1,450 per month.
The residents in Unit 2 have also been there for a while. They currently pay $950 per month.
Unit 3 was vacant and recently renovated when we bought the property. We were able to rent it out for $1,350 per month.
Our total rent-roll here is $3,750 per month and all the tenants are current.
That’s a Rent to Value Ratio of 1.75%. Any investor would KILL for this deal.
Our business plan was simple when we acquired the property. Once the leases expired for Unit 1 and 2, we’d renovate those apartments and bump up rents to market rate, ultimately increasing our rent-roll to $4,750 per month, which would increase our monthly cash flow significantly.
So WHY are my annoying business partners trying to convince me to sell this property?
It comes down to four simple reasons:
We Failed To Execute the Business Plan
The first reason is we weren’t able to execute our business plan. The residents in units 1 and 2 refuse to leave. Their leases expired soon after we bought the property and when we kindly requested for them to leave, they just said no.
We couldn’t do anything about it, our hands were tied. Everything that’s been going on in the world from March 2020 to…basically all of 2021 prevented us from taking any action against the tenants.
Truthfully, we were afraid they would stop paying their rent if we pressed the issue. So we settled on slightly raising their rents and issued new leases. It’s been almost a year since then and not much has changed. They still want to stay in their apartments and we still don’t want to be adversarial.
For context, the difference between where their rents currently are and where they could be is roughly $1,000 per month. So we’re leaving a lot of money on the table here.
Current Market Value
The second reason my partners are forcing me to sell is the current market value of this property.
We knew we stole this property when we bought it, but we didn’t realize just how good of a deal it was.
We had this property appraised on September 21st of 2021 and the value came back at $320,000.
Now let me remind you, we bought this property on August 31st of 2020 for $215,000.
Since then, we’ve spent zero dollars on renovations.
That’s a 48% annual return on investment!
I used Zillow’s Home Market Index tool to calculate the appreciation for this zip code for the time we owned this property.
In August 2020, the typical value of homes in the same zip code was $222K.
In August 2021, the typical value of homes in the same zip code was $273K.
Based on Zillow’s data, we can see the submarket appreciated 23% in the 12 months ending August 2021.
Normally, I don’t put much weight into Zillow data, but they were spot on with their Zestimate for our property.
Based on these numbers, we can say half of the value created in the past year came from the submarket’s appreciation and the other half came from our initial ability to buy this property at a significant discount.
The lie detector test determined THAT was a lie.
The 30 spot parking lot next to the building belongs to the state of NJ as a park and ride for public transportation. There are actually zero dedicated parking spots for this building. The only parking available for tenants is street parking.
The listing goes on to say all 18 units are one-bedroom units.
The third reason my partners are forcing me to sell this property is a simple cost-benefit analysis.
If the residents in Units 1 and 2 magically decide to leave tomorrow, we can execute our business plan by proceeding to spend $50,000 on sprucing the place up.
We will likely be able to charge $1,000 more per month in rent. However, I don’t know if spending that $50,000 on property improvements will yield an additional $50,000 in value.
We can say that with confidence because the appraisal report says there are 4 comparable properties offered for sale in the subject neighborhood ranging in price from $265,000 to $375,000 and there are 6 comparable sales in the subject neighborhood within the past 12 months ranging in sales price from $240,000 to $340,000.
Based on that data, it seems like the top of the market is somewhere between $340,000 and $375,000.
Since we already achieved a value of $320,000, there’s no need to invest $50K in an attempt to make an extra $20K-$55K.
However, it would make sense for a new investor to buy this property at $320,000 and complete the value-add renovations, which brings me to the final point.
Our Trash is Another Investor’s Treasure
The fourth and final reason my partners are forcing me to sell this property is because one investor’s trash is another investor’s treasure. We bought this property at $215,000 and were able to achieve rents of $3,750 per month.
Using those numbers, our rent-to-value ratio was 1.75%. That’s $3,750 divided by $215K.
Now that we have a new valuation of $320,000, our new rent to value ratio drops to 1.1%.
That’s $3,750 divided by $320,000.
Not bad, but not great considering it’s a drop of .65 basis points.
Now let’s say another investor buys our property at $320,000 with rents at $3,750.
That investor starts with the same 1.1% RTV we just dropped to.
Let’s assume they find a way to renovate the 2 units. They spend $50K and ultimately increase their monthly rent-roll to $4,750.
Their new Rent to Value Ratio would be $4,750 divided by $370,000, or 1.3%, an increase of 20 basis points.
So instead of us moving down in RTV from 1.75% to 1.3%, a new investor can take over the property right now and increase their RTV over time from 1.1% to 1.3%.
It’s honestly a win-win situation: We walk away with a nice chunk of equity in a short amount of time and they acquire a cash-flowing asset that has plenty of room for growth.
When we first received the appraisal for $320,000, I was super excited. That appraisal put us in the position to kill 2 birds with one stone:
First, we were going to refinance our 10% interest-only private money lender out and move into a 30 year fixed rate mortgage at an interest rate of 4%.
Second, we were going to get a new loan for 80% of the appraised value, or $256,000. After paying off our private money lender’s loan of $215,000 and closing costs of $10,000, we’d have roughly $30,000 in cash left over from the refinance to put towards the renovations we still needed to do.
If we combined the loan proceeds from the refi with the cash we already have in this property’s business bank account, we would have enough money to complete our value-add renovation without bringing any money out of pocket.
Needless to say, when my partners suggested we sell the property at the newly appraised value, I was slightly annoyed.
When we established this partnership, we agreed on a path that prioritized long-term wealth generation over short-term chunks of cash. However, after taking the time to write out the argument in their favor, I came to the conclusion that selling IS the right move here.
The residents in Units 1 and 2 don’t seem like they’re leaving anytime soon and the current economic climate doesn’t lean in our favor to remove them against their will. Even if they did leave tomorrow, it doesn’t really make sense to invest $50K in renovations to potentially gain $20K-$55K in value. Finally, we need to strike while the iron is hot. There’s still meat on the bone for another investor to make a good return here and that may not be the case for much longer if the market decides to cool off.
I’m glad we found ourselves in this position. There’s absolutely nothing wrong with taking some chips off the table when you’re on a hot streak. Especially if you’re up 48% in a year.