History tells us that there is opportunity in every difficulty. The post-COVID world will provide MANY opportunities and true investors, like me and hopefully you, have already started planning for these opportunities.
In this article I will describe a low-risk high-return strategy - Buy-Fix-Rent-Sell - (NOT lease-option) that I used to significantly increase my net worth after the last major economic downturn that I plan to use again soon as we enter the next major economic downturn. You will see how this strategy makes sense going forward and how it increased my financial freedom as a part-time investor without driving myself crazy.
First, it is important to understand that in nature, valuable assets such as a forest in Yellowstone National Park are sometimes destroyed, such as by a forest fire, that prepares the ground for the rebirth of a strong growing healthier forest. We can’t always control the occurrence or outbreak of a tragedy, but we can control how we respond and rebuild after the tragedy.
The COVID-19 tragedy is upon us whether we like it or not. It has already resulted in widespread death, including one of my family members who survived the Holocaust (as a slave in both Auschwitz and Mauthausen). As I write this on May 10, 2020, the US has already lost a record 32 million jobs in less than 2 months.
I have no control over this tragedy. I do have control of how I respond responsibly by social distancing and wearing a mask and I have control over how I respond economically to this tragedy.
During the last economic downturn in 2008-2011, many people lost their jobs with peak job loss in one month of 750,000 in late 2008. We just lost 26 million jobs in a 4 week period!
The job losses that started in 2008, combined with a poor lending practices, resulted in a wave of foreclosures when high employment of about 10% meant that millions of people simply couldn’t pay their mortgage loans. Unemployment in April 2020 jump to nearly 15% from 3.5% just two months earlier and in the first week of May, we just lost another 3.2 million jobs.
Despite how financially strong our citizens were entering into this sudden recession and despite the strong economy and strong banking system when entering into this very sudden and sharp recession, this level of sudden high unemployment with monthly job loss 20 times higher than the worst month in late 2008, is more than likely to result in a lot of foreclosures. After an induction period, bank owned properties (“REO’s”) will come back on the market.
It has been reported that 15% of the unemployment filings in the past few weeks were marked "permanent" and 85% "temporary". Even at 15% permanent, that is still 3.9 million jobs lost in 4 weeks which is 400% more than the previous record job loss in late 2008! Since jobs pay mortgages and rent, it is very hard to make the case that this magnitude of job loss will have negligible impact on prices of distressed properties. While it is POSSIBLE that the prices of distressed properties will not be affected by this job loss, I for one, will be ready to buy low and closely monitor inventory and pricing of bank owned properties and other distressed home sales.
From 2010 to 2016, I bought REO’s and HUD homes almost exclusively. These single family homes always needed significant renovation and I bought them at a deep discount to their retail after repair value (“ARV”) even after accounting for the repairs.
I flipped some of these houses for attractive profit and I kept some of these houses as high cash flowing rentals. In some cases, I rented the houses with high cash flow, then I sold them when I saw significant appreciation during the recovery.
The strategy that I plan to deploy in 2021-2025 (or later) is the same as one of the strategies I deployed in 2012-2020, IF AND ONLY IF PRICES OF REO'S DROP IN 2021 due to high foreclosure. The general retail real estate market might not drop in 2021 as it did in 2008 due to very different underlying fundamentals such as strong banking system and strong economy pre-COVID in February 2020. That is why we MUST monitor the local retail real estate market AND the REO market as we progress through COVID and post-COVID.
Let’s look at an example of a single family HUD home I bought and renovated in 2014, then rented for 5 years then sold in 2020.
As you read these numbers and understand this strategy, keep in mind that I am a part-time investor who buys only 1-2 houses per year in order to improve my financial freedom while NOT driving myself crazy. I also take little risk because I do in-depth due diligence, as I teach in detail in the Smarter Investing home study course.
Purchase price: $56,100
Buying, Financing & Holding Costs: $8,000
Total Cost: $95,100
The ARV in 2014 of this 3 bedroom 1 bath 1,006 square foot single family home was $120,000, so the increase in equity after purchase and repair was $24,900. That was not a high enough amount to justify flipping this property, but the numbers as a rental worked out very nicely.
Monthly costs: $983 (including mortgage payment, taxes, insurance, vacancy, repairs and admin costs)
Positive cash flow after ALL true costs: $402 per month in the first year, increase by $25 per month every year thereafter
Loan balance reduction: average about $2,000 per year
I held the property as a rental for about 5 years while making roughly $5,000 per year in true positive cash flow and about $2,000 per year in loan balance reduction.
I sold the property in 2020 for 156,000 since we had appreciation during these years and I felt I didn’t want to wait for the next recession. Little did I know COVID-19 was coming.
What DID I know?
I knew that the property appreciated significantly and I could cash out the equity while paying low long term capital gains tax and redeploy the money in a more efficient “highest and best use” manner.
After selling costs (commissions, seller concessions, etc), and paying off the loan balance, the net proceeds were $82,000.
I other words, I bought a simple low level distressed property at a low price, rented it for 5 years, during which time there was appreciation, then sold it when the market was good (it didn’t have to be at the top) and I was left with $82,000 plus about $25,000 in positive cash flow.
That is more than $100,000 on a house that has an ARV of $120,000 when I bought it.
If one buys 2 houses per year, as a part-time investor, over five years starting with foreclosures following high unemployment, like we are about to experience now, it is not hard to see how one can add $1 million to one’s net worth as a part-time investor.
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