Out of state rental property exit strategy advice

[Susan Owen]

Hi all.
Here is my scenario:

Bought a duplex out of state last year. I took a HELOC on my primary residence for $200k.

Used 35k down, 12k burned by a nefarious “contractor”, we eventually obtained a real contractor who did amazing work, got it rent ready and cost about roughly same amount as the first and finally got it rented.

Paid the mortgage and HELOC payment for 12 months while the whole debacle was finally resolved and the units are both rented.

During rehab, there was a break in and the furnaces were stolen. Property mgmt advised it was likely covered under my homeowners policy. Come to find out the insurer issued me a policy that didn’t cover vandalism since it was a dwelling policy and not a homeowners policy. The policy is coming up for renewal and I tried shopping around and have been told that either it is not insurable due to an old type of wiring or it will cost 100% more for the policy than I have now.

I tried to do a cash out refi and was told there isn’t any equity to take out. Those funds were intending to go back to the HELOC but I guess not now.

Just today I get notified by property mgmt there was a leak in the upstairs unit bathroom that leaked into the downstairs so that is the next problem in a long long line of problems.

So I have an interest only HELOC that is 50% used, and can’t refi anywhere in the near future and I am at negative cashflow.

Outside of all the mistakes I made, which are clearly vast, what would one of you seasoned investors say I should do at this point? Ride the wave and wait for more, expensive, repairs to come along or cut my losses and sell this property?

This is keeping me up at night so please, no scolding, I just want your opinions for solutions.

Should I keep it and hope it gets better or just get out and start over?

[Steve K.]

I would limit my losses by selling, unless the property is in a location where rents and values are increasing rapidly? Where is it?  

[Susan Owen]

Quote from @Steve K.:

I would limit my losses by selling, unless the property is in a location where rents and values are increasing rapidly? Where is it?  

Hi Steve, Cleveland.

[Nathan Gesner]

I guessed Cleveland before you even finished your question. Cheap properties are cheap for a reason. They look good on paper, but the realities of low-quality renters, high crime, unscrupulous vendors, and other problems can destroy the investment value.

Some landlord insurance policies have burglary as an additional rider you must add on specifically. In a high-crime city, I suspect that's the case and why you weren't covered. 

I would make the repairs, get tenants on track, and return it to the market while sales are still strong. You may take a loss, but you'll hopefully learn some lessons and do better next time.

[Ryan Arth]

@Susan Owen Try to distance yourself from what has happened previously and just look at what you have in front of you now. You have a leak to repair with some cosmetic repair to the lower unit, and your insurance is doubling. Then you would be back to business. You are tenanted and hopefully cash flowing, and it probably wouldn't serve you to sell it with an active leak or ceiling damage. So the question really is fix it and hold, or fix it and sell, which might seem reactive when viewed in the future. 

It really depends on the neighborhood, the type of tenants you have (and can attract) and what the financials look like on whether this situation was worth it ten years from now or not. 

[Steve K.]

Quote from @Susan Owen:

Quote from @Steve K.:

I would limit my losses by selling, unless the property is in a location where rents and values are increasing rapidly? Where is it?  

Hi Steve, Cleveland.

I’m not familiar with the specific market but if it’s not in a great location I would sell and cut my losses, then start over in a better location. The three golden rules are location, location and location after all. I always recommend investing in areas with strong underlying fundamentals: jobs, limited housing supply, desirability/ high demand, population growth/ net in-migration, affordability, etc. Fix that thing up and sell to the next first-timer out of state investor ;) 

[Allan C.]

@Susan Owen sorry to hear about your headaches. I’d fix the immediate issues and then sell the property - your issues will likely continue. OOS investing in low cost areas may work for a few, but likely won’t work for the majority.

Investing is about fundamentals, which mean returns are proportional to risk and effort. If you want lower risk and lower effort, you should expect lower returns.

What I find a bit interesting is people won’t consider buying a rental in a D-class neighborhood in their own city, but open to buying D-class 2000 miles away. Perhaps it’s proximity bias, but I think posts like these are very helpful to give perspective to new optimistic investors.

[Ryan Arth]

Quote from @Allan C.:

What I find a bit interesting is people won’t consider buying a rental in a D-class neighborhood in their own city, but open to buying D-class 2000 miles away. Perhaps it’s proximity bias, but I think posts like these are very helpful to give perspective to new optimistic investors.

Bingo. I feel like people lean more towards the possible cash flow and turn a blind eye to the risks and reality of owning a D property (not saying this one was) when it is 1,000 miles away and they only have to take phone calls from a third party about any issues.

[Travis Biziorek]

Hey Susan, I think we talked about a year ago.

While I don't invest in Cleveland, I imagine it's similar to what I do in Detroit. It seems like you aren't working with the best team... they could have given you better advice.

That said, I would consider potentially sticking it out unless the burden of the HELOC is too much.

For me, the insurance thing is not a big deal. I have 12-doors in Detroit and I don't add the coverage for theft. In fact, I go with the highest deductible as possible and plan to only make a claim if something catastrophic happens.

Duplexes (in my experience) rarely get broken into once occupied. I have a whole blog post about this. So I think you're likely in the clear when it comes to break-ins/theft now. 

I don't see the leak as a big deal. Yes, it feels like one right now given all that's happened. But at the end of the say, these are common issues you'll face as a landlord. 

Is the cash flow truly negative right now on a monthly basis? Happy to look at the numbers with you if you'd like. 

For me, I'd probably ride this out. I just wrote up a deep-dive on my 3rd ever rental property I bought in Detroit. It was far worse than this. I had a bad contractor I burned cash on, a break-in and theft, and then had to put more money into the rehab than I thought. The appraisal came in 20% below the total investment I'd made on that property.

9 months later and I had a major issue that ended up in a $20,000 insurance claim (I managed to get $15,000 of it back). 

I've owned the property for nearly 5 years now. It's worth 50% more than I initially invested and I've pulled out all of my capital via cash flow. I'm glad I stuck it out.

Again, happy to connect and chat about all this if you want to hear from someone that invests in these C Class areas (from afar) with success.

[Michael Smythe]

@Susan Owen not sure why you can't do a cashout refi?

What is the property worth? 

You should be able to get a loan for 70-75% of the value.

When did you hire the PMC?

We recommend removing mechanicals until tenant MoveIn. Can be a challenge when heat is needed for contractors, but the right ones bring portable propane heaters.

What specific repairs have you had done to the property?
On old houses, we always recommend upgrading plumbing (#1 on the list as can cause most damage) electrical and heat systems (if needed). 

Regarding what to do, what were your expectations when you bought this property? Obviously, you knew it needed work. Did you have a professional inspection done and have you really gone over it to project what other repairs may be needed in the future? Roof, windows, doors, furnace, hot water heater, concrete, etc.

What research did you do on the neighborhood and probably tenant pool? What credit scores do you expect your tenants to have given the location?

We've seen many investors buy Class C properties solely due to the low entry point, but then expect Class A property results. NOT GOING TO HAPPEN!

At best you may get luck and get a Class B tenant.

So, perhaps your expectations will never be met, thus you should sell and invest in Class A or B rentals.

Otherwise, real estate is a long-term game and hold your course.

[Rick Albert]

How do you know there isn't enough equity? Was an appraisal done? From what I see, there are a couple of options:

1. You don't have enough equity to sell, so stick it out and make a strong effort to buy down the loan enough to sell and move on. If there is enough equity to sell then move on.

2. It might be interesting if you actually invested MORE money into it and make significant improvements. I know it sounds counterintuitive but you may be able to increase the value and get a better pool of tenants if it shows better. The best option is to speak with an experienced Realtor and have them show you comps of a variety of conditions to see what makes sense.

3. I don't know the Cleveland market, but is there demand for mid term or short term rentals and do the numbers work? Could be interesting.

Good luck! Keep in mind real estate is a long term play. When I bought my second house hack here in Los Angeles, we ran into all sorts of problems. Fast forward to today and if we move out, our cash flow would be $1600+ per month. Even on my out of state properties when we had problems, in the long run it worked itself out. You have to take ownership and follow up with all vendors constantly until the job is done. Real Estate Buy and Hold is not as passive as it used to be.

[Theresa Harris]

Forget the money you put in and sit down and figure out the latest expenses and where you'd be if you sold vs if you fixed it.  The fact that the furnaces were stolen suggests it is not in a great area.  If it were me, I'd sell and buy in a better area.

[Jake Andronico]

@Susan Owen

I'm sorry to hear this. We hear it far too often. Numbers look great on paper. It's happened to my family as well. 

I'd recommend selling and looking at something closer to home if you're still wanting to invest in RE. 

I'm bias, but NV is right next door with the 4th lowest property taxes in the US, much more friendly landlord laws, strong appreciation, etc. I grew up in CA and this is what we've done. 

Vegas is nearby to you and could likely check up on it a couple of times a year if needed. 

I wish you the best of luck!

[Henry Lazerow]

How is the neighborhood? Is it C or D? If its D maybe sell is the best option.