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For you passive rental folks, how do you handle all the debt risk?

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I've looked into purchasing quadplexes and things like that with very little down, improving them, and then renting them out. This seems to be what most folks do to generate a passive income... I don't get the impression folks are putting a bunch down. So let's do a thought experiment on that... if I want to have a really good monthly income flowing in, I'm probably going to need quite a lot of units. That means multiple very large mortgage loans tied to my name. So maybe I achieve financial independence as a result of this.

But there is quite a lot of risk baked in here in that maybe I end up carrying a few million in loans as a result. If everyone bailed on their rental payments at the same time... hell if just a significant percentage did... that could be really bad really fast. Obviously there would be lease agreements in place, and priority one would be building up a large bankroll as a buffer, but if 2008 happened again people might just walk away and not care about breaking their leases.

So how do you guys protect yourselves against something like that happening? Or maybe the easily more likely scenario of a combination of a few freeloaders and a few a**hole tenants that trash your stuff? From the numbers I have run, it doesn't take much of that before your profits are wiped out.

Are you guys just living with the risk, it is what it is, or are you mitigating it somehow?
 
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There's risk in everything. If you want to live a fastlane life you need to get used to it. Yes, you would be responsible for the debt. By running the numbers, understanding the financials, and running it like a business and a proper landlord you should be okay.

-Don't over leverage yourself
-Don't buy for appreciation
-Don't do what everyone else is doing
-Don't buy with your emotions - follow the numbers

When you get into larger assets in the millions you can get unsecured loans which essentially means that you get the asset but if you were to ever default on it or fail to pay the note you could just give it up and walk away.

Edit: If you dont like banks you can buy real estate through seller financing in which you would be responsible for paying the note holder and not a bank. Still the same effect your just dealing with a person rather than an institution
 

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I've looked into purchasing quadplexes and things like that with very little down, improving them, and then renting them out. This seems to be what most folks do to generate a passive income... I don't get the impression folks are putting a bunch down. So let's do a thought experiment on that... if I want to have a really good monthly income flowing in, I'm probably going to need quite a lot of units. That means multiple very large mortgage loans tied to my name. So maybe I achieve financial independence as a result of this.

But there is quite a lot of risk baked in here in that maybe I end up carrying a few million in loans as a result. If everyone bailed on their rental payments at the same time... hell if just a significant percentage did... that could be really bad really fast. Obviously there would be lease agreements in place, and priority one would be building up a large bankroll as a buffer, but if 2008 happened again people might just walk away and not care about breaking their leases.

So how do you guys protect yourselves against something like that happening? Or maybe the easily more likely scenario of a combination of a few freeloaders and a few a**hole tenants that trash your stuff? From the numbers I have run, it doesn't take much of that before your profits are wiped out.

Are you guys just living with the risk, it is what it is, or are you mitigating it somehow?

Risk? Depending on which side you are looking at. What is the risk of not doing the rental property thing vs doing something else for income.

Passive? I am not sure what that means. I have never felt like I could completely not be involved in the rentals.

Rental risk is mitigated by various methods. Buying well below market prices is probably the best, first step. Second for me was to standardize my units so that all fixtures, paint, trim, and flooring was the same in all units. This allowed me to purchase materials in larger quantities and to make use of what was in storage. Contractors seem to always be a wild card, I try to get recommendations from my fellow REI guy. Location helps mitigate also, my units were located on busy streets and usually on corners.

I didn't have a large turnover in 2008. Mine hit in 2012. We went from 100% occupied to 50% vacancy in May 2012 for various reasons. There was nothing passive about it. My wife and I worked 16-18 hour days, hired cheap, cash labor, and busted our a$$ to pull things back together. We had several small cleanups and 2 major rehabs going on at the same time. We pulled back to 100% rented in July 2012 and began to calm down in August 2012. The rental pool has changed over time. We have sense sold most of our rentals.

As far as renter damage. I have had a couple of asswipes do some intentional damage to the units. The highest cost was around $2-3000. It pisses you off more than the damage though.

One of the least expensive but most aggravating damage was a clever tenant. He rented exactly one month and didn't pay second month. I chased him out easy enough. We did a light cleaning on the unit and was leaving it in the evening. When I turned the lights off, the walls of the unit began glowing with translucent glow in the dark painted profanities. The words were not visible with the lights on, only in the dark. My wife began tearing up because it was so sorry. The damage was fixed in a day and it only took the painter 4 coats of primer sealer to cover that mess up.

To stay in business the profits have to exceed the expenses and allow for more growth. Having cash on hand cushions the bumps in the road. Overall, we wanted to be more mobile and decided to move in a different direction.

There are several other REI guys in here that can share war stories as well. @SteveO @MidwestLandlord @JScott
 
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Do either of you pay a property manager to handle everything for you? Why or why not? Thanks.
 
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I'm in more rural areas, so location diversity is a big factor for me. Largest town I have rentals in is 275,000 people...smallest is 28,000

My rentals are spread between 4 towns in 3 states.

The smaller towns all have a specific industry that supports them, and did just fine during the recession. Rental demand went UP in my area during the recession.

I use 3 different property managers. Besides being spread out so there is no way I could run them myself, I just don't want to run them myself. I carefully screened the property managers through referrals from other landlords and realtors.

I don't really have any tenant horror stories. I don't buy crap properties, so I tend to not get crap tenants. The biggest problem I've had damage wise is a guy that liked to put holes in doors, instead of his wife's face, and those doors needed to be replaced. That damage was discovered by the property manager when they came by to replace an old screen door. He was military, and was concerned that the damage and eviction would be reported to his CO, so he paid to have the doors replaced, paid his rent in full, and left quietly.

As for financing, I pay cash. Later I have an appraisal done and then take a 5 year commercial loan (not a mortgage. 15 year amortized with 5 year balloon) for 70% of the property value. I have 1 unit that is seller financed though.

All of my rentals are in individual LLC's so that one lawsuit or loan default can't take down the whole operation, only that individual business. Each loan is secured by the property it finances and is not in my name, only the LLC's name.

Each property/LLC has it's own bank account with 6 months of expenses in it as emergency backup. I can survive a 6 month vacancy in each unit before I start having to throw cash at it myself. At 4 months though, if lowering the rent to my lowest doesn't work, I put the thing on the market and sell it.

Each rental is a business and is operated accordingly.
 

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I've looked into purchasing quadplexes and things like that with very little down, improving them, and then renting them out. This seems to be what most folks do to generate a passive income... I don't get the impression folks are putting a bunch down. So let's do a thought experiment on that... if I want to have a really good monthly income flowing in, I'm probably going to need quite a lot of units. That means multiple very large mortgage loans tied to my name. So maybe I achieve financial independence as a result of this.

For starters, your questions sound like you want to understand. But the real issue is fear. Cast this aside and figure out the business based on skills and experience. Your concerns now are about something way out in the future.

What is sounds like you want is to have a lot of units with little debt. You want significant cashflow from the operations. It is possible to achieve this but will likely take a lot of work and strong process.

Lenders tend to like smooth running buildings with strong cashflow. You referenced properties that you can fix up. Fixing up usually requires empty units. This will initially hurt cashflow and cost for repairs. I have had the most success with poorly operating properties using large down payments and having money in place to cover negative cashflow and upgrades. Once upgraded and rented at higher rates, the property is sold and money goes into the next project.

Once enough capital is acquired, then you can buy a property for a few million that will give you the cashflow that is desired.
 

SteveO

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-Don't buy for appreciation
You can buy for appreciation and make a lot of money doing so. Fits right into the term "Buy low, sell high". Purchase in a temporarily depressed market is one way. Buy a poorly operated building and make it run better (forced appreciation). Combine the two, execute well, you have gold!
 
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SteveO

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Do either of you pay a property manager to handle everything for you? Why or why not? Thanks.
You can use a property manager. You will need to know more than them though. So learning the process is a must. Then you will need to lay out very clear guidelines as to how you want your property managed. It is vital that you keep a close eye on operations and physical conditions.
 

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You can buy for appreciation and make a lot of money doing so. Fits right into the term "Buy low, sell high". Purchase in a temporarily depressed market is one way. Buy a poorly operated building and make it run better (forced appreciation). Combine the two, execute well, you have gold!


Right, Im more so referencing in 2008 when people were like, "I can buy 6 homes and they will appreciate 50K and I can sell them all" with no strategy other than "it'll go up"
 

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I don't really have any tenant horror stories. I don't buy crap properties, so I tend to not get crap tenants.

Yep, agreed. However, neighborhoods change and markets change. My market changed around 2011 and the pool of renters got worse. That is one reason I sold out of that market. It can change fast, major employer lay off, gas drilling completed, new rental construction, etc
 
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Do either of you pay a property manager to handle everything for you? Why or why not? Thanks.
I use one for my properties because I no longer live in the city they're in, and they aren't exactly A neighborhood properties. If they were higher quality, I would self-manage, but these properties require too much babysitting.
I have not found a manager that cares as much about my assets as I do. They enjoy getting their commission check, and overcharging me on repairs for turnover and code compliance. As @SteveO said, you need to keep a close eye on everything.
 

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Thank you all for your replies. As some more background, I currently manage a $20 million/year business in the corporate world. I own my house outright and have no debt. I am confident I can manage just about anything (which also means I am smart enough to know when to hire someone to manage for me).

The reason I used the word "passive" is because my primary interest is to leave the corporate world and start a technical business; however, what I am thinking about, while it could have a massive payoff in the end, will take time to build and execute. So as a means to keep generating money to live off of, and not have to touch my savings, I have been thinking about and looking into things I could do that would generate some income for not very much effort... was thinking perhaps real estate might fit this bill. I totally agree, I would want to run it like a business. For my "passive" business, I have no desire to manage the properties myself and would hire property managers to do that for me. Part of my strategy is to build a diverse portfolio of various businesses; real estate would not be the primary business but it might be the first one.

Knowing all of this now, does it change any of your advise to me and if so in what way? Thank you for your replies!

Edit: To be super clear, I am trying to free my time as much as possible to work on something else. The houses are not the end goal.
 
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I'm in more rural areas, so location diversity is a big factor for me. Largest town I have rentals in is 275,000 people...smallest is 28,000

My rentals are spread between 4 towns in 3 states.

The smaller towns all have a specific industry that supports them, and did just fine during the recession. Rental demand went UP in my area during the recession.

I use 3 different property managers. Besides being spread out so there is no way I could run them myself, I just don't want to run them myself. I carefully screened the property managers through referrals from other landlords and realtors.

I don't really have any tenant horror stories. I don't buy crap properties, so I tend to not get crap tenants. The biggest problem I've had damage wise is a guy that liked to put holes in doors, instead of his wife's face, and those doors needed to be replaced. That damage was discovered by the property manager when they came by to replace an old screen door. He was military, and was concerned that the damage and eviction would be reported to his CO, so he paid to have the doors replaced, paid his rent in full, and left quietly.

As for financing, I pay cash. Later I have an appraisal done and then take a 5 year commercial loan (not a mortgage. 15 year amortized with 5 year balloon) for 70% of the property value. I have 1 unit that is seller financed though.

All of my rentals are in individual LLC's so that one lawsuit or loan default can't take down the whole operation, only that individual business. Each loan is secured by the property it finances and is not in my name, only the LLC's name.

Each property/LLC has it's own bank account with 6 months of expenses in it as emergency backup. I can survive a 6 month vacancy in each unit before I start having to throw cash at it myself. At 4 months though, if lowering the rent to my lowest doesn't work, I put the thing on the market and sell it.

Each rental is a business and is operated accordingly.

This is an excellent post; thank you for your reply. That's really interesting about the commercial loan. So you pay cash for an entire property outright, and then take a commercial loan out against it. What are you then doing with that money... are you using it to buy the next property?

Really good comment about the multiple property managers... you didn't say it, but this would also limit risk such that if you had a bad property manager you had to replace it would only effect one of your businesses.

Also good comment on the LLC... if I do this I was thinking I'd setup an LLC but had not considered setting up multiple LLCs to limit risk. Thanks for that.

I also am considering geographic diversification.

So one thing I have been doing is scanning regions of cities and getting a feel for rents, and then scanning another system looking at for-sale properties in that same area, trying to find something that is being sold for a low price compared to what I could get from it monthly in rent. If it meets that criteria I put it on a list and keep going. Once I have a few I then go through them and look into them in further detail looking for certain things. Is this how you identify your properties too? It is very tedious.
 
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You can use a property manager. You will need to know more than them though. So learning the process is a must. Then you will need to lay out very clear guidelines as to how you want your property managed. It is vital that you keep a close eye on operations and physical conditions.

Do you generate a contract or a requirements document or anything like that? I would assume so. Are the terms fairly negotiable or are things pretty much in the same zone throughout this industry? Asking because I have noticed at least a casual look seems to indicate they all want x percent of the rental price per month, and then everything else such as repairs are extra. It seemed very nickel dime-y to me. Is that typical for the industry?
 

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Knowing all of this now, does it change any of your advise to me and if so in what way? Thank you for your replies!
Yes. I have always liked to buy from people that used management companies. They are usually the most motivated.
 

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I'm in more rural areas, so location diversity is a big factor for me. Largest town I have rentals in is 275,000 people...smallest is 28,000

My rentals are spread between 4 towns in 3 states.

The smaller towns all have a specific industry that supports them, and did just fine during the recession. Rental demand went UP in my area during the recession.

I use 3 different property managers. Besides being spread out so there is no way I could run them myself, I just don't want to run them myself. I carefully screened the property managers through referrals from other landlords and realtors.

I don't really have any tenant horror stories. I don't buy crap properties, so I tend to not get crap tenants. The biggest problem I've had damage wise is a guy that liked to put holes in doors, instead of his wife's face, and those doors needed to be replaced. That damage was discovered by the property manager when they came by to replace an old screen door. He was military, and was concerned that the damage and eviction would be reported to his CO, so he paid to have the doors replaced, paid his rent in full, and left quietly.

As for financing, I pay cash. Later I have an appraisal done and then take a 5 year commercial loan (not a mortgage. 15 year amortized with 5 year balloon) for 70% of the property value. I have 1 unit that is seller financed though.

All of my rentals are in individual LLC's so that one lawsuit or loan default can't take down the whole operation, only that individual business. Each loan is secured by the property it finances and is not in my name, only the LLC's name.

Each property/LLC has it's own bank account with 6 months of expenses in it as emergency backup. I can survive a 6 month vacancy in each unit before I start having to throw cash at it myself. At 4 months though, if lowering the rent to my lowest doesn't work, I put the thing on the market and sell it.

Each rental is a business and is operated accordingly.

Ah the perfect person to ask.

What kind of returns are you getting on your properties? Are they SFH or MF? What price range are they in?

My goal was to exit a slow lane by acquiring 1 property at a time in the midwest in a more flat rental economy and continue to build up a portfolio, eventually turning that into a full-time "job" and somewhat fastlane.

I spent a lot of time on biggerpockets and looked into turnkey properties and such and quite honestly, a lot of people get screwed by doing that. What's your take on Turnkey?

Given that youre an out of state investor, any tips on how to manage your management so you dont get screwed and what you specifically look for in terms of indicators for a market to invest in? I know about actual houses and a good home inspector can tell you more than you can find out flying out there yourself but Im more interested in the bigger things like rental and housing trends, etc. Lately I've been looking at job growth for potential markets.

What markets are you currently in? I was considering West Cleveland, at least west of parma and B or A level properties. East Cleveland sounds like a mess despite the enticing 20k price point. My initial goal was to save up $70-100k and either buy one B level+ SFH in the midwest or use some leverage and buy THREE SFHs in 1 or 2 different market to diversify my risk a bit. Other places I have interest in would be Milwaukee, some parts of texas and tennessee. Indianapolis is touted to be affordable and flat but heavily varies street to street and is generally a lot more risky.

There are even some parts in SoCal near me, where $180k can give you a B- SFH but the return just isnt very good and the travel is about 2 hours+. Might as well get on a plane at that rate.

Would love your thoughts
 
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MidwestLandlord

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Also good comment on the LLC... if I do this I was thinking I'd setup an LLC but had not considered setting up multiple LLCs to limit risk. Thanks for that.

I also name my LLC's with weird names. NOTHING that would indicate the name of who own's them (me)

Once I have a few I then go through them and look into them in further detail looking for certain things. Is this how you identify your properties too? It is very tedious.
What kind of returns are you getting on your properties? Are they SFH or MF? What price range are they in?

I'll be the first to admit that until I came to this forum, and got set straight by @SteveO and @JScott , I was not very good at BUYING properties. Lots of mistakes were made. My returns are horrible.

Given that youre an out of state investor, any tips on how to manage your management so you dont get screwed and what you specifically look for in terms of indicators for a market to invest in? I know about actual houses and a good home inspector can tell you more than you can find out flying out there yourself but Im more interested in the bigger things like rental and housing trends, etc. Lately I've been looking at job growth for potential markets.

I don't use home inspectors.

I buy in places I already have one of my B&M businesses in, and travel to frequently. So I'm not going in blind. I know the towns I am in very well.

I use my social circle in each area to get a feel for things. I'm extremely social, so in all these places I end up knowing realtors and such just because they do business with me, I strike up a conversation, we swap business cards, and then I text them and such until we are basically friends that I'll take out for a beer when I'm in town. Get LOADS of info that way haha.

But really, I can't give advice on buying the right properties, cause I suck at it.
 

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I also name my LLC's with weird names. NOTHING that would indicate the name of who own's them (me)
@MidwestLandlord might already do this, but a tip that makes it nice for everyone to keep track of (you and your accountant alike) is if you name the LLC with the name of the property.

Example: you buy 123 Main Street in the entity 123 Main Street, LLC. Just make sure that name isn't taken in your state before you try to register it. Your accountant will also love you because it will make it easier to keep track of once you start racking up the properties.
 
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What kind of returns are you getting on your properties? Are they SFH or MF? What price range are they in?

My goal was to exit a slow lane by acquiring 1 property at a time in the midwest in a more flat rental economy and continue to build up a portfolio, eventually turning that into a full-time "job" and somewhat fastlane.
There are a lot of different ways to make money on RE. I like the NNN route where the tenant pays for all aspects of the property and there is very little work to do.

I believe houses are the tough way to go but there can be a lot of money there as well. It is all in the processes. Up and down value cycles can be your friend. Scarcity of land and barriers to development can help as well. It is possible to just rely on cashflow from rentals if you have a strong process and keep the repairs/improvements up. And, of course, buying right.
 
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Do you generate a contract or a requirements document or anything like that? I would assume so. Are the terms fairly negotiable or are things pretty much in the same zone throughout this industry? Asking because I have noticed at least a casual look seems to indicate they all want x percent of the rental price per month, and then everything else such as repairs are extra. It seemed very nickel dime-y to me. Is that typical for the industry?
All companies that I have dealt with had a contract. We usually negotiated it. We dealt with mid to large sized apartment complexes which are very different than you are talking about. They always had maintenance workers and managers which were employed by the company but assigned to the property. They were paid for by the property with no mark up. They were paid strictly by a percentage of gross income.
 

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Rental cash flow from decent houses sucks. I have about 15. The play on houses has to be for equity / resale. For example, I bought a house about 15 months ago for $42,000. This was a decent house at a good price. I spent about $8000 to get it cleaned up and rented for $900/mo. I figure about 50% expenses so it was making $450/mo, less mortgage = $275/mo or $3,300/yr. A month ago the property manager sent me an email and said the tenant just walked in and turned in the keys, they have to move out of state. I said great, get it cleaned up and listed for sale. I spent less than $1000 getting it ready for sale, listed it at $109900 and got a full price offer in a few hours. I should net about $50,000 after commissions and closing costs. I hope to 1031 the proceeds into an small multi-unit building that should at least double the cash flow I was getting from the house. If I would have re-rented the house it would take 15 years to make the $50,000 at $3300/yr. Plus, at some point I would have to put on a roof or furnace or fix tenant damage, etc which could cost a whole year or more in cash flow.
 

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All of my rentals are in individual LLC's so that one lawsuit or loan default can't take down the whole operation, only that individual business. Each loan is secured by the property it finances and is not in my name, only the LLC's name.

So I've heard about this before but I still have a question, do you set up the LLC then purchase the property under that LLC?
 
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So I've heard about this before but I still have a question, do you set up the LLC then purchase the property under that LLC?
That's the easiest way. You can also purchase the property and then deed it into the LLC. In PA, you'll have to pay transfer tax (2% of the fair market value of the property), and the quitclaim process that is espoused is beyond my risk tolerance, although others have successfully used it.
Keep in mind that purchasing it in an LLC generally limits your loan options to commercial loans.
 

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Rental cash flow from decent houses sucks. I have about 15. The play on houses has to be for equity / resale. For example, I bought a house about 15 months ago for $42,000. This was a decent house at a good price. I spent about $8000 to get it cleaned up and rented for $900/mo. I figure about 50% expenses so it was making $450/mo, less mortgage = $275/mo or $3,300/yr. A month ago the property manager sent me an email and said the tenant just walked in and turned in the keys, they have to move out of state. I said great, get it cleaned up and listed for sale. I spent less than $1000 getting it ready for sale, listed it at $109900 and got a full price offer in a few hours. I should net about $50,000 after commissions and closing costs. I hope to 1031 the proceeds into an small multi-unit building that should at least double the cash flow I was getting from the house. If I would have re-rented the house it would take 15 years to make the $50,000 at $3300/yr. Plus, at some point I would have to put on a roof or furnace or fix tenant damage, etc which could cost a whole year or more in cash flow.
This is the ideal situation. Having positive cash flow monthly but possibly appreciation which allows you to exit if necessary. But a lot of cash flow positive properties in the midwest or the midwest flat cities do not appreciate much. they also dont tank as much either in a crash. But definitely this seems like the way to go.

Was this a distressed property? What rating neighborhood? If you want to say the city, that'd be interesting too. $42k to 110k appreciation in 15 months is a good deal and not easy to find in my limited experience. Do you invest in town or out of state?
 

ljean

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This is the ideal situation. Having positive cash flow monthly but possibly appreciation which allows you to exit if necessary. But a lot of cash flow positive properties in the midwest or the midwest flat cities do not appreciate much. they also dont tank as much either in a crash. But definitely this seems like the way to go.

Was this a distressed property? What rating neighborhood? If you want to say the city, that'd be interesting too. $42k to 110k appreciation in 15 months is a good deal and not easy to find in my limited experience. Do you invest in town or out of state?

Yes it was a distressed situation when I bought it. There was some "appreciation" per-say but most of the profit was simply from making a good buy. Last year I was lucky to be able to pick up about one deal like this a month. Its been slower this year unfortunately.
 
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Denim Chicken

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Yes it was a distressed situation when I bought it. There was some "appreciation" per-say but most of the profit was simply from making a good buy. Last year I was lucky to be able to pick up about one deal like this a month. Its been slower this year unfortunately.
So a flip that's also cash flow positive. That's a good scenario. Most of the turnkeys or rental ready homes are priced at market or over so there's no equity there.
 

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