Seasoned real estate investors always say that you never forget your first deal. I hope this will be no different for us.
You’ll hope you have done everything right, didn’t overlook a small yet critical flaw or if you have used the right calculations. The practical side of things in real estate is not a mere waiting game. Getting in touch with a party to finalize a mortgage or another type of loan to fund the property. Finding a tenant that will move in as quick as possible and in doing so, reduce the time of vacancy. Make all the contracts in order. And if you want to, finding a trusting partner that manages everything for you. It’s this, and much more than you’ll face within real estate investing. Which is all part of the fun of course.
In the past few weeks, months even, you have all been reading along on the journey we took buying our very first rental property, also known as unit #1.
We’ve dropping some progress here and there in our monthly reports, and promising a full detailed report later on. Well, here it is. Today is the day I’m letting you in on how this deal has taken form. With all facts and figures, going the full monty.
Rental property #1 – the strategy
We had a pretty clear vision of our strategy, and on what segment of the market we had to focus on. We would focus on the gap that has occurred on the rental market between the social and private sectors. Which are the people with a middle income, earning too much to live in a home aided by social benefits but also earning too little to afford a high rent in the private sector (which is pretty common in the Netherlands).
We chose a specific and large city, where the demand of living is high and the housing prices haven’t (really) caught up to the national growth trend that much. And we would work with a property manager with lots of experience in that specific area. Working together with a property manager helped us find the right property.
Related post: Our First Steps of Investing in the Real Estate Market
Finding a property
From the start, we had already set up a target price. Our rental property had to cost between 100.000 and 120.000 euro. Why? Well, very simply put, the types of houses we were looking for, we’re listed for around these prices. And it would leave us enough wiggle room to finance a possible second rental property later on.
We worked closely with a local property manager in the search for the right opportunity. Her extensive knowledge of the area helped us by searching in the right neighborhood (down to street level). Because within real estate, location is everything.
Our goal was to find a property which didn’t need any renovation except for some painting. And was big enough to house a small family. We reviewed a few properties. To eventually finalize a deal on unit #1.
A few weeks after we made that deal, we had an opportunity in lowering our operating costs of the property. Through an acquaintance, we came into contact with someone looking for a new home in that area and he became our first tenant. This resulted in the decision to do the management of the property ourselves and canceling the need for a property manager.
The need for a property manager does affect the tax rates, or so we thought. When a rental property falls in box 3, you will not have to pay any income tax on the rental income. Instead, you pay taxes based on wealth, which is close to nothing in our case considering the mortgage debt. However, the only way to do this is to outsource the management, because otherwise the tax authorities will view your investment as labor, and you will have to pay income tax.
As it turns out, we can manage the property ourselves, and still hold the asset in box 3. With the disclaimer, that we aren’t pro-actively adding services that increase the value or spend more than x amount of time on the management.
The real estate business is a rather small one, and knowing the right people can lift you up a level higher. For example, a lot of the properties that are interesting for renting out are hard to find. Knowing the right people, those who are dealing within that circuit (realtors for example), can help you get closer to those kinds of opportunities.
Financing the property
In the meantime, we also contacted several institutions that would be able to lend us the money. This way we could compare the different price points and conditions per mortgage/loan. The best part for us is that we got the mortgage approval very fast after we signed the purchasing contract of the property. For a first property, this largely took away some of the tension around it.
At the end of July, we signed the papers on a three bedroom apartment located in one of the Dutch big cities.
The purchase price of unit #1 came down to 110.000 euro. If we include the closing costs and some small renovations it comes at a total of 116.000 euro. Which is the cost of the total acquisition. The closing costs include costs such as taxes, cost of the notary and mortgage costs. The property doesn’t need any renovation in the coming years because the property is well maintained.
Purchase price € 110.000,-
Closing costs + renovation € 6.000,-
Total acquisition costs € 116.000,-
We negotiated a 30-year mortgage, with a 2.65% fixed interest rate for the first year. We chose to fix the interest on a yearly basis because this gives us the flexibility to refinance the property with other banks that offer more favorable interest rates or terms and conditions when possible (without paying a fine for breaking up the contract). Additionally, we expect that interest rates remain low for the coming years.
We have a mortgage on this property of 79.050 euro. The monthly cost of this mortgage is €318,54 which includes the principal payment as well as the interest.
To supplement the deal further we also closed a home equity loan (HELOC) on our own home. We’ll use 10.000 euro from this facility to finance the property. We only have to pay interest on this part of the loan. Because the interest rate is variable we’ll use this as a working capital loan (short-term). The monthly costs will be around 35 euro. Obviously, this amount can change per month, because of the variable interest rate.
Loan Amount Montly costs Interest Principal Payment
Mortgage 79.050,- 318,54 173,00 145,00
HELOC 10.000,- 35,00 35,00
Total 89.050,- 353,54 208,00 145,00
The financing costs related to this property comes at total 353,54 euro per month.
Our investment comes down to €27.000 for this property:
Total acquisition = €116.000 minus total loan of €89.050 = €27.000
In order to calculate our returns and the financial overview, we take a few metrics into account. Like the gross rent, operating costs, net operating income, cash flow after financing, the cash on cash yield (CoC) and the return on investment (ROI). It’s going to get a bit more technical, but we do want to give full insight in order to review this deal and to take lessons from (if you wanted to).
Gross rental income
Our tenant will be paying us 850 euro every month, which is the gross rental income. The contract is already signed off for a one year period, and the tenant will be moving in there only a few days after we get delivered the keys on the 30th of November. The vacancy period is thereby reduced to a minimum, and will not be taken into account in the financial overview for the first year. Normally we would take 2 weeks per year into account for vacancy.
Gross rent per month € 850,-
Gross rent per year € 10.200,-
The costs to operate the property for the first year comes down at €128,91 per month or €1.546,89 per year. Operating costs are including the Home Owners Association fees (VVE), taxes related to the property and maintenance costs. Because we manage the property ourselves we don’t have to pay for any management fees. The costs for electricity, water and heating are for the account of the tenant.
Net operating income
In consequence, the net operating income (gross rent minus operating costs) comes at €721,09 per month or €8.653,11 for the first year.
€850 (gross rent) minus €128,91 (operating costs) = €721,09 (net operating income)
Cashflow after financing
The cash flow after financing will be €367,55,- for the first year.
Namely: €721,09 (net operating income) minus €353,54 (financing costs) = €367.55
This amount will be coming into our bank accounts for every single month and will be used to stack up some money for other RE deals in the near future.
Calculated over the first year this comes down to a total of 4410,60 euro.
Cash on Cash yield on investment (CoC yield)
The CoC yield gives an indication of how much of your own money (the investment) went in the property and how much cash you can put in your pocket at the end of every month. In our view, having a positive cash flow is important to have while investing in real estate. Which is why the CoC yield is a good metric to compare investments.
The cash on cash yield (CoC yield) on this property for the first year is:
€4410,60 (cash flow after financing) divided by €27.000 (our investment) = 16,3%
Total return on investment (ROI)
The difference between COC and Total ROI, is that COC only considers the financial impact of Cash Flow on your return, while Total ROI considers all the factors that affect your bottom line. Total ROI is calculated as follows: Total ROI = Total Return / Investment Basis, where “Total Return” is made up of the components (Cash Flow, Principal Payments, Capital Appreciation).
To keep it simple we don’t take capital appreciation (the icing) into account in the ROI.
Calculating our ROI like this gives us the following numbers:
(€4410,60 (net cash flow) + €145 (principal payment) *12) divided by our investment of €27.000 equals an ROI of 22,78%.
We won’t make additional payments on the mortgage for now. While we are still situated in the build-up phase of our real estate venture. The short-term loan – the HELOC – however, we will try to pay it off sooner.
In this scenario, we can to add more units to our portfolio in the short term and generate even more passive income for the long term. After we believe we can slow it down a bit on the acquisition part of the business, we will start paying off our debts a bit more aggressively.
We are well on our way to build up a real estate portfolio, and hopefully, it gave you some insight into how this works and the steps we’ve made so far. We’re curious if you are investing in RE yourself, have plans to do so or are just not interested at all (and why).
I’ve noticed while I was writing this, I’ve been using a few terms that are very common in real estate investing. But may not be that familiar to you. If there is anything you want to know more about or have a specific question, just let us know via a comment or connect with us via our contact page.