Sell Half the Property to Increase Your Income

There are some very worthwhile advantages to fixing up real estate
First, then finding an investment partner to help bail you out of debt. One advantage is that you can sell your “sweat equity” for a premium price or a very high markup. The following is an actual case I became involved with. The names have been changed.

Allen, a student of mine, recently came to Redding for counseling and a tour of my fixer houses. He wanted to see for himself exactly what kind of properties I recommend for most investors. He also wanted advice about how to generate more cash flow without selling the properties he’d worked so hard to develop.

Over the past several years, Allen has managed to acquire several prop­erties with low down payments. Today, he owns two single-family houses, a five-unit “leper property” (a property no one else wanted to touch), and a seven-unit apartment building. He’s done very well with low down pay­ments; however, he suffers from the affliction common to most all low-cash-down buyers—elephant-size mortgage payments every month Allen has managed to fix up the properties himself as he goes along, but he’s in a cash bind now, because his fix-up expenses have basically been paid from his personal bank account, which is running on fumes. Nothing stops a good investment plan faster than running out of money. Allen has reached the point where he fully understands the flip side of no-down- or small-down-payment buying. It generally means no cash flow or very little.

The Best Computer in the World Doesn’t Help Broke Investors

Allen came to Redding well prepared to discuss his financial dilemma. He brought along six sets of computer spreadsheets to show me why he was losing money every month. None, however, offered a solution for how he might stop losing money. Allen saved that problem for me to solve.
My seminar students understand I’m not a computer person when it comes to earning money. I use a rather simple technique—what I call the “MLO (money left over) formula.” It works like this.

Every month I deposit all my rents and other income from carryback notes in my bank account. During the month I write checks to pay my employees, property expenses, and mortgage payments. Finally, when the last day rolls around, I check the balance in my account. If there’s some­thing left for me, that’s MLO! See how simple accounting can be? I might add, there’s an extra $10,000 in my account today, which I’ve saved over the years by not buying a computer to figure out whether I’m making money or not.

50% Sales Can Greatly Improve Cash Flow
One of my favorite methods for generating income quickly, which of course is what Allen wanted to hear about, is to purchase a rundown prop­erty with good upgrade potential—fix it up, then sell 50% of the owner­ship to a passive investor. You might be wondering, Why sell only 50%? Why not sell the whole property?
First of all, if I can relieve my cash flow problem by selling only 50%, I’m more than happy to keep the other half for myself. As you shall soon learn, there’s extra money to be made by the 50% owner who manages the property in addition to the profits from the sale itself. Let me show you how a typical transaction might look. We’ll call this property “El Dumpo Villa.”
El Dumpo Villa—Two Duplexes and Three Single-Family Houses Seven rental units on a large city lot (older, shabby, and rundown):
Financial Data
Monthly income ($375 rent per unit x seven units) $2,625
Annual income ($2,625 x 12 months) $31,500
Purchase price (offer) (6.5 x gross rents) ($31,500) $204,750
Purchase price (accepted) $205,000
Terms
$15,000 cash down. (6% to 10% is average for rundown properties.) $190,000 unpaid balance. Seller agrees to carry back the mortgage at 9%
interest amortized over 20 years. Monthly payments (principal and interest) are $1,709.49.

Typical Property Income and Expense Setup at Beginning

The Task Is to Quickly Fix Up the Property and Add Value

Let’s assume the fix-up costs (labor and material) will be 10% of the pur­chase price, or $20,000. On average, the cost breakdown between labor and material, as mentioned earlier in this book, is 70% for labor ($14,000) and 30% for material ($6,000). The buyer will provide the labor for this project. Therefore, the buyer’s out-of-pocket costs for material will be $6,000.

Depending on how fast the buyer can accomplish the fix-up task (I always estimate 12 to 18 months), he’ll probably lose a few tenants who don’t see any need for improvements. They also see the handwriting on the wall, which tells them that in the very near future, when things are cleaned up, rents will likely increase. Tenants of junky properties who are paying under-market rents understand the reason rents are low—and they know very well that rents won’t stay low for long once the property gets fixed up.

Rents and Gross Multipliers Go up Together
Finally, the big day arrives and the property is all fixed up and looks great. Along the way, we had some tenants come and go. The new ones moving in should naturally be paying higher rents. A fixer property of this size, purchased at 6.5 times gross rents, with $20,000 worth of fix-up work completed, should easily command 25% higher rents. That means total rents of $2,625 per month can be increased to $3,285 when the fix-up work is done. A 25% increase is very modest, in my experience. More often, I’m able to achieve 40% to 60% or even higher increases, especially if my fix-up job takes longer than a year. New tenants will see the big improve­ment and are willing to pay higher rents.

With new looks and a higher income, the property is now worth much more than the lowly 6.5 GRM. For example, in my area, a 6.5 GRM is what you will most likely pay for ugly, rundown properties. After they’ve been fixed up, however, they will generally sell for about 8 times the gross rents.

How to Market a Fixed-Up, Fixer Property

The secret to selling 50% ownership in a fixed-up property for the highest price is to make an offer the buyer can’t refuse. My suggestion is to offer a no-down deal to a qualified buyer. Naturally, if you need to retrieve your fix-up costs in order to keep buying groceries, a no-down sale may not work for you. However, folks with good jobs (the kind of buyer you want) are always eager to purchase investment real estate for no down payment, especially if you’ll manage it, and they are happy to pay you monthly installments. Most of them will not even question your selling price. From a personal income tax standpoint, most buyers can generally offset a good portion of their monthly payments with tax write-offs (savings) from their regular wages or salary.

No, I haven’t forgotten about the $21,000 cash that’s tied up in this deal ($15,000 down payment, plus $6,000 materials). However, the income we can generate from a 50% sale will quickly pay that back. Let’s take a look at a marketing strategy for the fixed-up property. You should under­stand that no-down buyers are willing to pay top retail prices in exchange for an easy buy-in (no cash). In this example, selling for 8.5 times gross rents should work. Here’s how the numbers would look:

New annual rents: $3,285 per month x 12 months $39,420
Selling price: 8.5 x gross rents (rounded) $335,000
Existing mortgage balance: $189,000
Total equity: $146,000
Notice that the selling price of $335,000 represents more than a 63% markup, which is pretty good when you’re calculating profits.
Obviously, a 50% buyer will be entitled to half of the income. He or she will also assume half the existing debt and share expenses 50-50. The buyer will be paying you for 50% of the equity with monthly installments. In this case, his share is $73,000 (50% of $146,000). I generally draw up a promissory note amortized over 10 years at 10% interest. That works out to 120 monthly payments of $964.71. Certainly, 15 years would be accept­able to me if my buyer insisted on smaller payments.
The sale gets reported like this for setting up the buyer’s 50% pur­chase:
Total sale price: $167,500
Buyer to assume existing mortgage: $94,500
Buyer to execute new promissory note in favor of seller: $73,000
The transaction can be done with a deed transferring title or a land contract without a title change, which is often done with no-down trans­actions. Either way it’s OK, strictly a choice.
When the 50% sale is completed, here’s how the new operating num­bers will look. They show who gets what and who pays for what.
Income and Expense Setup—After 50% Sale

As you can see from the after-sale setup, the seller’s negative cash flow— originally -$184.51—has been eliminated. Instead, the seller now has a $35.26 positive cash flow. That’s not much, but we’re just beginning. Each month for the next 10 years, the seller will receive $964.71 from the buyer until the $73,000 equity purchase is paid off.

It’s starting to get more interesting, wouldn’t you say? So far the sell­er is earning $35.26 positive cash flow from operations and $964.71 from his note receivable. That increases the seller’s monthly income to $999.97. But we’re still not done yet. You’ll notice the $165 management fee on the investor’s side of the after-sale setup. The law says that owners can’t pay themselves a fee for managing properties they own, but they certainly can receive management fees for the portion they don’t own. If the co-owner is managing the 50% he doesn’t own, then he is entitled to the $165 man­agement fee. Now, his monthly earnings are up to $1,164.97. It’s getting better, wouldn’t you say?
Do you recall the 70%-30% labor/material cost breakdown? Once again, if the co-owner performs labor on the 50% share of the property he doesn’t own, he’s entitled to earn the labor fees. In this case, the investor’s setup shows $164 for repairs and $82 for maintenance—a total of $246. 70% of $246 equals $172, which goes to pay the co-owner for the labor associated with repairs and maintenance.

Now, let’s review exactly what we’ve accomplished in terms of improv­ing our cash flow. When the El Dumpo Villa property was acquired, the income and expense setup showed a bottom line loss of $184.51 per month. Now, after selling 50% of the property, you’ll see the seller’s monthly cash flow has improved dramatically. Take a look at what the co-owner will now receive each month if he manages the property and does repairs and maintenance.
Cash flow from operations: $35.26
Mortgage payment from investor: 964.71
Management fee from investor: 165.00
Payment (repairs and maintenance) from investor: 172.00
Total MLO (money left over), after expenses: $1,336.97
You’ll notice the seller’s cash flow is a whole lot better after selling 50% of the property. Two millennia ago, Julius Caesar said, “Divisa et impera”—“If you can divide them, you can conquer them.” That same strategy works just as well dividing real estate as it did for the ancient Romans.

Read next, Fixer-Uppers part 17

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