Summary: How can the purchase of a fourplex turn into a large apartment building? In this post, we show you how our real-life $389,000 purchase could be converted into a $2 million apartment building less than two years after we bought it. Ready to achieve financial freedom? Let us show you how it’s not just possible, but achievable by anybody with this real-life example.
If you’re considering dipping your toes into real estate investing, but can’t quite see how buying a few small duplexes can turn into a real estate empire, this post is for you.
That’s because, in this post, we tackle the issue of how you can increase your net worth quickly with cashflowing rentals. Kenji likes to call this taking large “step-ups” in wealth.
Step-ups are part of our Fast FIRE system and, more specifically, are part of the component we call “Expand the Money.”
If you use this strategy to guide your decision-making it will get you to financial freedom quickly.
So fast, in fact, you might even be able to cut back or quit your job in five years or less.
How can I possibly make that kind of statement? Let’s look at an example property to show you how you too can take a huge step-up in wealth in less than two years.
Note, the numbers shared in this post are taken directly from one of our own properties. So they are real, not theoretical.
Introduction to the Fourplex
In 2016, we bought a fourplex about an hour north of Seattle for $389,000. Because the current owner was living in one of the units at the time of purchase, it was only renting for $2,575 per month. Assuming that the owner’s unit could rent for slightly more than the unit next door (more because it had a bonus room and much nicer finishes), we estimated the gross rental income would be $3,725. This was very close to the 1% rule, so we immediately knew this property was worth investigating further using our cash-on-cash (COC) calculator. Here are the results of our COC calculations:
The COC return on this property is only 5.3%. Meaning, if our down payment and closing costs are $100,840, we only make 5.3% of that amount or $5,363 in cashflow per year. Not too great.
But what if we made one simple change and billed back utilities to our tenants? Because we know our market so well and had billed back utilities at other properties we own in the area, we knew this was easily achievable. If you bill back utilities, that means you get back the $546 per month you were paying out of pocket or $6,552 per year added to your bottom line! When you run the numbers without the utility expense, your COC return jumps to 11.8% and your cashflow jumps from $5,363 to $11,915 per year!
So do we stop here? No way!
As some of you know, after Kenji and I purchase a property, we really get to work trying to increase rents and optimize expenses.
Note, I use the word optimize here because, though we’re trying to decrease expenses, we don’t want to decrease them to the point that we are making our property less appealing. We aren’t slumlords.
In this case, the property didn’t “need” a whole lot of renovating. It could have just been rented as-is and we would be making 11.8% COC return.
But, Kenji and I wanted to significantly upgrade the property for several reasons:
1. Achieve significantly higher rents and cashflow
What if your property is the nicest on the block? Do you think it would rent for more than other units that are otherwise comparable in terms of size, number of bedrooms, and bathrooms? It doesn’t work in every market, but for this particular property and the neighborhood, we knew that a quality upgrade would result in higher-than-market rents. You wouldn’t want to do this if the market doesn’t support the upgrade. But if it does, you might want to consider investing a little more to really make them shine.
2. Force appreciation
Whenever you increase revenue and decrease expenses, your property appreciates in value since the value of multifamily properties is closely tied to the net operating income. This is called forced appreciation. With small multifamily, there is a slight wrinkle in this formula because market appreciation can also play a role in the value of these assets on top of forced appreciation. As you’ll see below, in the few years since we’ve bought this property, the value has increased incredibly. This is in part because of forced appreciation, but also in part because of market appreciation.
3. Shelter clinical income and achieve significant tax savings
Whenever we spend money on a renovation, we get that money back in taxes. Keep in mind that Kenji has Real Estate Professional Status, so when we rehab a property, we are also able to write the cost of the rehab off as a loss and shelter clinical income. I’ll show you how this works in practice below, but roughly this comes out to the government paying for about one-third of the cost of each rehab we do. So we increase rents disproportionately and only pay a portion of the cost of the rehab. What’s not to like?
4. Tap into hidden value
This property didn’t have as much hidden value as many of our other properties. However, it did have a studio that we were able to convert into a one-bedroom. By doing so, we could raise the rent for this unit much higher than if we had just renovated the studio apartment. The result was that the rent for the studio went from $725 at the time of purchase to $1,100 after rehab or a 50% increase in rent!
5. Lower maintenance costs
By rehabbing this property, we knew we’d save ourselves in maintenance down the road. When we do a major rehab, we usually replace floors with luxury vinyl planking and granite tile countertops, for example. These are durable products that will lower our maintenance costs over time. Moreover, when we do a fairly large rehab as we did in this case, we find problems upfront (leaks, mold, etc), so we can tackle the problems then instead of finding them years later when the damage is more extensive.
6. Improve tenant base
Another reason to rehab upfront is to attract a higher quality tenant. Because our property is newly remodeled with quality finishes, we knew that we would have our pick of tenants. Better tenants generally mean they take better care of your units.
7. Make our apartments recession-resistant
Whenever you have the nicest unit on the block, it’s less likely your properties will stay vacant. This becomes even more important during a downturn when vacancy rates can go up for certain classes of properties or properties in certain locations.
8. Reduce our liability
Several of the units had fireplaces. Fireplaces are really nice to have as tenants. but they are a huge liability for landlords. Whenever we renovate a property with a fireplace, we cover it up to remove that as a liability.
What was the outcome?
Whew! Now all of that rehab might seem like a lot of work to some people, but here’s a secret: this is where the real money is made. It’s the reason turnkey companies exist. It’s the reason people buy and flip houses.
If you’re buying a property just for the 11.8% COC return, then you’re missing out on a ton of value.
So let’s show you what we mean by looking at what happened to the numbers as a result.
We ended up spending $125,000 into the rehab so so that’s noted in the “repairs” section of the cash-on-cash calculator.
After renovations, gross rents went from $3,725 to $5,400 or a 45% increase.
Cashflow improved from $11,915 to $28,539 per year.
How does this property now turn into an apartment building?
Remember the part about forced appreciation?
When we raise the rents as much as we did and eliminate utility expenses, the value of the property goes up significantly.
In this case, we estimate that we’ve raised the value of this property from $389,000 to around $825,000. It’s likely even higher than that because of market appreciation, but we’ll ignore that for this example.
Let’s say that we sold this property for $825,000. With a loan of about $280,000 and selling costs, we would have $500,000 left to put down for another property. We would avoid any taxes on this sale by using a 1031 exchange.
If we put down 25%, we could buy a $2 million apartment building! Imagine doing this in less than two years!
And that, readers, is how a fourplex turns into an apartment building. That’s how you earn your freedom.
Pretty exciting, right?
Can you see how this is doable for even if you are relatively new to real estate investing?
All you need is to buy a property right (i.e. buy a value-add property that is already cashflowing decently or will do so after you rehab it), be willing to invest some money upfront and have the right team to help you do the project (contractor), and then rent it out after (property manager).
Of course, it also helps to have a good education and mentorship (like you get in our introductory course, Zero To Freedom through Cashflowing Rentals).
So what’s stopping you? And, more importantly, can you break through those barriers and start your journey towards financial freedom today?
“Everyone of us have a story of I can or I can’t. Either one, they’re right.” -Henry Ford
