Why (And How) I Bought More Real Estate In A Pandemic

Ever since starting this blog, I haven’t been shy about sharing my views on real estate investing.

On one hand, it is one of the most effective ways to build wealth for retail investors. The first property we bought generated an  over a decade.

You simply don’t get to those levels in the stock market.

On the other hand, and very much unlike buying index funds, real estate investing can be a highly frustrating exercise. I would strongly encourage you to read up on some of the challenges you can expect along the way.

That being said, I promised myself not to give up – and we didn’t.

As of yesterday, the Banker on FIRE household added another property to its real estate portfolio. It’s a five-unit, mixed-use commercial and residential property.

In today’s post, I am going to cover both the logic and the journey involved in buying real estate during Covid.

If you are even remotely considering getting into the real estate game, I encourage you to read it carefully. Then, ask yourself: “Is this a process I would find enjoyable?”

If the answer is not, please do yourself a favour and stay out of real estate as an asset class (other than perhaps buying your own place).

You don’t want your investment strategy to make you miserable. Life is too short.

But if you find the process of finding, pricing, and negotiating deals exciting in its own right, then it may well be that real estate is for you.

The Juicy Details

A couple of things to lay out up front.

First of all, the property is not located in the UK. While we have been living here for almost a decade, for a variety of reasons we actually rent our place in London.

Our existing property investments stem from the time we lived stateside. Because there’s a reasonably high chance we may end up moving back at some point, we’ve decided to add to our real estate portfolio across the pond.

Regardless, the fundamentals of real estate investment are universal across the board, so I would expect this post to be helpful to anyone contemplating a commercial property purchase.

Our new property is located in a satellite town about 2 hours away from one of the largest (think one of the top 5) cities in North America. The town itself has a population of roughly 300k residents and it’s one we know well, having visited multiple times over the years.

The local economy is dominated by technology, financial services, healthcare, educational, and government institutions. For obvious reasons, we were very focused on picking a location that isn’t reliant on manufacturing.

The property itself has five units. On the ground floor, there is a restaurant (you read that right – more on this below). Above the restaurant, there are four one-bedroom residential flats.

The Numbers

The existing owners have bought the place four years ago for about $400k. They’ve spent about $300k on renovations and have refreshed the entire tenant base along the way.

We ended up buying the place from them for $855k. Our bank has extended a commercial mortgage at a 31% LTV and a 2.45% interest rate.

All in, the place nets about $60k in rental revenues per year and runs $11k in annual expenses. This implies a cap rate of 5.7% (i.e. $49k in net operating income divided by the $855k purchase price).

I expect the cap rate to go well north of 6% over the next few years given the anticipated growth in commercial and residential rents.

The Story

The one thing you’ve got to remember about real estate investing is that sourcing good deals is 80% of the battle.

As it happens, this is a property I was familiar with because I actually made an unsolicited offer on it last year. Back then, the seller wouldn’t sell for anything less than $900k. I wasn’t willing to pay more than $850k, so we parted ways.

At the time, I hadn’t yet seen the place. However, a few months later I happened to be visiting family in the area.  My agent and I hopped in a car and drove down to check out the town and look at some properties, including this one.

Having seen it in person, I was impressed with the quality of the renovations (which usually isn’t the case with flipped properties) as well as the location.

The building is located in the very centre of the town, and the local administration has just spent $16m to renovate the entire area and turn the street into a “flex” street, which means it can be closed to traffic and made pedestrian-only.

In addition, there are at least 10 high-rise condo developments nearby, which will further gentrify the area and significantly increase foot traffic for the restaurant.

Having paid my way through college by working in restaurants, I know that location can make or break a restaurant. I also knew that the rate the existing tenant was paying is about 50% under market, on account for all the construction that was happening on the street.

More broadly, the town itself has seen rapid population growth in the past few years given how unaffordable the nearest metropolis has become. As a result, residential vacancy rates are less than 2% and rents are going up 5%+ a year.

Having considered all the above, I reached out to the seller in February and said I was happy to pay $900k for the place. Unsurprisingly, she now wanted $950k.

After some back and forth, we settled on $910k and signed a purchase agreement. Just one week later, the Covid pandemic came to the fore.

Dealmaking In Crisis

From a deal perspective, I wasn’t too fussed about Covid.

I still had a financing condition in the purchase agreement. It allowed me to get my deposit back and walk if I didn’t secure financing on terms that I liked. The ball was in my court.

The challenge, of course, was that I still liked the property. Given the excellent location, I could see owning it for decades. In the meantime, it would cash flow nicely, even at $910k.

Most importantly, I still had a motivated seller who had near-term cash needs.

The real question was pricing in the impact of Covid.  This is when the M&A banker in me went to town.

First, I used a clause in the purchase agreement to extend the closing date to July. Back in March, the stock market was plummeting, and no one had a clue as to what was going on.

I knew that we might not have full visibility to what is happening come July, but we will surely know more (which is kind of how it played out). Extending the closing date meant the seller still had the obligation to sell to me for $910k.

Secondly, I took another hard look at the numbers and made some severe cuts to my projections to create a “downside case” of sorts:

  • Assumed the commercial tenant will go out of business and it will take me a year to find a new one. This reduced both the commercial rent as well as the share of expenses covered by the commercial tenant to zero for an entire year
  • Assumed that when I do rent the commercial unit out, I will take a 20% haircut on an already below-market price
  • Added a $20k one-off remodeling cost in the event restaurants don’t exist in the post-Covid world and the place needs to be turned into a different retail location
  • Increased my operating expenses by 50%
  • Doubled the interest rate on the bank loan to 5%. Unlikely to happen, but I wanted to cover all bases

Are these some draconian assumptions to be making? Sure. Equally, the number one rule to making money is not losing money.  In other words, take care of the downside and the upside will take care of itself.

Clearly, the numbers didn’t look nearly as good as before. If everything played out in the manner above, I would take a $45k cash hit in year 1.

But the property would start breaking even (on a cash basis) the following year and even at the initial purchase price of $910k, my ten-year returns worked out to 5.4% on account of mortgage paydown and some modest price appreciation.

I’ll spare you the long negotiations over the past three months. In the end, we settled on $855k, which I consider to be a fair price to everyone involved.

Could we have pushed the seller a bit more? Perhaps. That being said, I’m not the only one looking to add to my real estate portfolio.

Towards the end of June, multiple properties came up for sale in the vicinity. Having run the numbers on them, I knew I was getting a solid deal.

The last thing I wanted was for the property go back on the market, in which case it could well sell for a higher price.

Restaurant… Are You Crazy?

Yes, I know. In the post-Covid world, restaurants might not exist! So why would I take the risk?

A few reasons, other than the fact that I don’t subscribe to the apocalyptical view above.

First of all, the restaurant accounts for just a third of the total rents. This is still primarily a residential property in an area with strong population growth, low vacancy rates, and an upward trajectory in rents.

Second, the location. Having spent time in the industry, I know that being in a prime spot can make or break a restaurant. In this case, the location is as good as it gets.

Third, it was the restaurant owner. It takes a special kind of person to succeed in the restaurant industry and the owner of the place has a highly successful track record and multiple other establishments.

That being said, I still fully expect him to request a rent holiday now that I have taken ownership. I’d be surprised if he didn’t. But it’s something I have baked into my numbers.

I always have the option of finding another tenant, but for the time being, I’d rather hold on to this one.

Our Plan For The Property

Just like with any property purchase, the first year tends to be a transitional one. It takes some time to get things up and running, sort out all the operational issues, and file all the paperwork.

Given we are abroad, we’ve hired a property management company to help us with the day-to-day stuff. That being said, leaving your property manager to it is a fast and easy way to lose money. You have to keep tabs on things to make sure you are getting a fair shake.

Our investment horizon here is at least a decade, likely much longer. I expect to refinance the mortgage a few times along the way, which will release capital in addition to the annual cash flows. The money will likely be used to purchase additional real estate.

My “base case” projections imply an annualized return of 10%. Worst case, the return declines to ~5% (see the “downside case” above). Equally, it could go up to about 15% assuming rent growth in line with recent trends.

On a ten-year basis, this distribution of returns works for me. And as much as I like the stock market, I am happy to have allocated a greater portion of my portfolio to real estate.

The Un-Glamourous Life

Today’s post is a detailed one. The blow-by-blow commentary is 100% intentional and I intend to elaborate on a few aspects in future articles.

When it comes to personal finance, I simply don’t believe you can tell others what to do. It just doesn’t make sense.

Everyone has a unique set of preferences and circumstances that dictate their approach to building wealth.

Thus, what I prefer to focus on in this blog is describing what I do to build wealth.

And in that, I try to be as transparent and detailed as possible with the hope that others can learn from my experience and apply it in the context of their own investments.

Somewhat unhelpfully, the mental picture conjured by the words “real estate investing” tends to be along the following lines:

Stroll into a luxury development. Buy a condo (or two). Have a property management company do all the heavy lifting for you. Proceed to cool your heels while collecting cash every month.

Perhaps that’s what it looks like for some people. It certainly hasn’t been my experience. More often than not, it’s messy and complicated.

But for returns that exceed the stock market by a wide margin, I am happy to take complexity over glamour any day of the week.

Happy (real estate) investing!

About Banker On FIRE

Enjoyed this post? Then you may want to sign up to our exclusive updates, delivered straight to your inbox.

You can also follow me on Twitter or Facebook, or share the post using the buttons above.

Banker On FIRE is a London-based M&A (mergers and acquisitions) investment banker.  I am passionate about capital markets, behavioural economics, financial independence and living the best life possible.

Find out more about me and this blog here.

If you are new to investing, this is a good place to start.

26 Comments

  1. Nice to see you write this up. Good luck with it, I like the economics of this deal much more than my UK BTL! two of which we’ve put on the market this week.

    • Thank you. I count being better placed to do deals abroad as one of the few advantages to being an immigrant in the UK!

      To be fair, I’ve seen some really mispriced deals stateside as well, but there are good opportunities too. Sounds like they are much tougher to come by here these days.

  2. Interesting read. I am intrigued to understand how the taxes differ between the UK and US. I have a single BTL in the UK and the tax reforms have made it unviable. So like Finumus I am looking at selling mine.

    • The only difference I am familiar with is the tax deductibility of the mortgage interest which obviously has a sizeable impact on cash flows.

      However, I was under the impression that here in the UK, mortgage interest is still deductible provided you hold the property in a corporation. As there are multiple other advantages to incorporating, I am a bit surprised more people don’t take the incorporation route?

      I am probably missing something here as the answer cannot be that simple…

      • Hi mr B,
        Some comments below re incorporating.
        In addition if you already have the property there is nothing you can can. You can’t transfer it into a Ltd company without triggering cgt, legal costs and stamp duty (currently reduced) so this might now make a difference.

        plus for small portfolios accounting fees start to be disproportionately high in a Ltd company.

  3. Good look with the property. Having read the kyosaki books years ago US taxes make property more attractive in the us. Especially regards to CGT.

    From a British point of view it’s a whole different can or worms.
    If you buy (personally) here, now you can not offset the full mortgage costs. You will pay income tax on the gross rent!
    Increasing regulations from national and local government have deliberately targeted landlords. Renters are generally seen as poor potential voters (not financial banker bloggers 😉) and landlords are a perfect target.

    Gov definition of an hmo, is different to council (ever changing) definition and this is a mine field.
    Also the council then want landlords to a) be licensed (fees) b) in some places attend yearly “courses” how to be a landlord (more fees) c) recent electrical regs can mean a £2k to £3k retire for most residential rental homes. Increasing complex and onerous an regs for mixed multi units. Some cases council deciding individual rooms are individual dwellings and charging council tax on each room! Just google “landlord court hmo council” and weep at the landlord onslaught.

    If you have a property like the one you bought in the US (Mixed) then buying it in a Ltd Co or LLP ( ability to offset montage costs) means the gov charge you a “annual tax on enveloped building” STARTING at £3500 tax per year.

    Buy a property in a Ltd company or LLP and all those “cheap” BTL mortgages vanish. You get 2.5-3% teaser rates with a 1.5% fee then after 2 yrs it jumps back to 5%+. A 5% cap rate will not cut the mustard here. Then they try to make you sign personal guarantees for the “commercial mortgage”.

    With the current madness, nonsense ongoing, it has been estimated that it could take 2 years to clear the Section 21 backlog so your tenants can refuse to pay rent and there is nothing you can do for 2 years. We just sold 5 properties last year. The buyer is currently getting some of these very problems.

    Property here is faaaaaar too risky to make it worth while for a few %. I think I might take a punt on the commercial property trusts first that are trading at a discount before buying an actual property just now.

    • Thanks Steve, this is the most helpful commentary I’ve seen on the topic (and will check out the link below).

      While you will always have to deal with some regulatory issues as a commercial landlord, at some point it becomes far too onerous and costly to bother unless you are running a scaled enterprise, which most private landlords aren’t.

      Quite amazed at the BTL mortgage rates considering where the interest rates are – and the personal guarantee required.

      Good thing all these regs will ultimately lead to an increase in supply of residential homes… oh wait

      • “Increase in the supply of residential homes”…..this is the political goal.

        As you say unless you have a huge portfolio….This is the goal of governments to appease the renters. I read a stat 90% of landlords in the uk own 1 house, people get married, move in together and rent out the other house.

        They are an easy target. Most working full time so the house rent gets added to their top line tax rate. It’s simply not worth it. In most cases transferring to a Ltd company isn’t worth it. As soon as you sell, you have to pay cgt to pay so you can’t afford to buy it back. I think in the US you can roll over the cgt and not pay it till later.

        We were running approx 11% on money actually invested in the properties, but only about 6.5% when you consider the released capital value of the property.
        Add in the hassle factor and it wasn’t worth it.

        dividend income is only taxed at 7.5% up to 50k basic rate band top. Vs full tax on rental income!

        Hence Sell properties and invest in funds. Bit more diversity and liquid.

        They only reason BTL made sense was when interest rates were dropping from 14% to current levels. House prices went up. At best they will flat line from now on. They cream is gone.

        Redeveloping, yes… office conversions….. no planning permission require 😉

        • Makes total sense. No point being in property just to “be” in property if you are getting equivalent or better returns elsewhere with zero hassle.

          Think development / conversions are very interesting but v. tough to pull it off alongside a full time job!

    • And yep – this is exactly why we started selling out 6 years ago! Last one to go this year, all being well.

      We had a couple of multiple btl’s and you are spot on – the council regs were beyond stupid. I totally get they want to protect renters but it was way more than we’d do for own home – which was always the standard we ran places by. And then they’re surprised when there’s a shortage of people who want to rent to them…..crazy!

      • Yes stupid rules. One property was a mix of Very big double bedrooms with one small single bedroom and huge sitting areas. Tenants (students in this case) We’re happy. We set a total figure for the flat.

        The tenants were happy, 3 paid more Money as they had bigger rooms and en-suite bathroom. Single bedroom paid less for a smaller room. They were happy. In effect they also had the en-suite as the single stand alone bathroom was effectively theirs anyway.

        Anyway along come the morons at the council.
        Government rules for HMO “5 different families names..” is an HMO. Council. Oh we can’t have that. It’s now 3 people. They reclassify the place as an hmo and the 3rd bed is now illegal and they threaten to fine you unless you kick out the person in the single room.

        Also they want you to install another bathroom so you have to butcher up the property to cut a corner out of the larger bedrooms to install another shower room.

        • Yeah – a couple of ours fell under HMO – and a whole new level of weird rules. Especially as one of them was a 4-story building too.

          They made great returns but I’m still glad to be out of them now.

  4. Congrats on your new investment, it sounds like a really good deal.
    I don’t have any of my own properties (yet) but my close family is heavily invested in the Swiss property market, so I have been able to observe this for a long time. It does sound fascinating and I look forward to getting more involved.

    • Thanks Kat. It takes some time to get comfortable with and it’s helpful to be an observer before you dip your toes in.

      Kind of like with the stock market – if you grow up around people comfortable with equity investing, you will likely be very comfortable with it also.

  5. Hey BoF. I (perhaps unsurprisingly ) entirely agree with the approach of describing the how/why of property investing instead of the easier but less helpful “do what I did”. No situation is ever the same and in property even more so you need to be able to understand how to break down the investment and run the scenarios. Love it and doubtlessly it will – or should – help others be able to walk through their own potential investments.
    On the actual deal, I like it’s a mix of retail/rental, another layer of diversification is not a bad thing at all. The numbers these days never fail to amaze me though – we bought our first flat for £12k, all be it 20 years ago!

    • Interesting post bof what are the tax implications of investing in the US or are you a US taxpayer anyway?

      Its posts like the above that still keep me on the fence on btl though I am leaning towards buying at least a couple as my partner is a brt payer and I think the numbers work better there

      • The tax point is easy – property is held in a corporation, the corporation pays taxes. I as the shareholder pay taxes when I get a dividend from the corporation. Ideally this happens in a year when I’m in a lower tax bracket.

        Alternatively, the corporation can use the cash to buy additional properties.

        Completely understand why you are on the fence. Tough to find something where the numbers work out (even with appropriate haircuts) to something meaningfully more attractive than stock market (especially through a workplace pension plan). If you do find a gem, it may well be worth it!

    • I think what most people don’t realize is just how complex things can get. We’ve spent days staring at the spreadsheet on this one – and that’s before we even get to the operational nitty-gritty. The stock market is so much easier.

      £12k (rubbing eyes)… us millennials really did get the short end of the stick! 🙂

      • Yeah……upside of rural Suffolk and all but even so, it was still an obvious one-way bet. Not many of those left these days for sure, sorry about that!

  6. This sounds like a great deal – congrats on finding it! I’d be interested in the logistics of having a property in another country, with all the maintenance of a rental property (dealing with tenants, etc.) it seems like a huge feat – though in the US property is more attractive.

    How do you find it managing tenants in another country – or do you outsource that?

    • Thank you. The answer is it depends on the circumstances.

      We’ve always self-managed our tenants in the past. Day to day isn’t so hard, you just need to have a couple of reliable handymen who can do the repairs if / when they come up.

      Filling a vacant unit is a bit tougher but still doable. You just need someone to repaint it and then an agent can let it out on your behalf. The cost is usually a months’ rent.

      However, with this particular property, we hired a property manager to handle the four residential units. With two kids and a five-hour time zone difference, I just cannot be bothered.

      Property management will run you about 10% of gross rent, so you need to bake this into your numbers when evaluating a potential investment.

      That being said, we will still be actively involved, especially when it comes to tenant selection. Running a credit and a criminal check and calling up previous landlords is a must. Too many people don’t do it – and then complain when they end up with evil tenants they cannot evict.

  7. New visitor. Really informative blog and I’ll be reading your other posts with interest over the next few weeks.

    There seems to an assumption the property in question is in the US and subject to US laws. I’d probably look further north. If so (and I don’t want to know) I’m sure there will be some major difference in law, taxation, etc.

    • Thank you. I have some experience “further north” as well and my assessment is that while rules differ, they are much more consistent than between North America and the UK.

      In particular, mortgage interest on commercial properties is deductible in both countries.

      The big difference is the tax rates themselves, which are much lower in the US than in Canada.

  8. I’ve spent the last 3-4 months on educating myself on RE investing – reading books (incl. ‘What every real investors needs to know…’ recommended by you), podcasts (BiggerPockets), blogs etc. There’s still lot to learn, but I feel like I’ve managed to obtain a great amount of knowledge, partly thanks to you!

    Given this, I started looking at some properties in Eastern Europe (where my home country is) as well as in the Netherlands where I currently live. I am not planning on buying yet, I’m just kind of assessing what’s out there.

    I came to realize that most (educational) information on the internet is tailored to the U.S. market and there’s not much for the EU. Many rules of thumb in the aforementioned books/blogs (such as the 1% rule) do not apply for the European market (no matter which country we are talking about). I literally read all the forums out there and most people share the same view – it’s very rare that you can make the numbers work. From others’ experiences, pursuing a BRRR (buy-rehab-refi-rent) strategy also seems difficult (if not impossible) due to banks not being keen on doing the refi.

    Then, I saw the comments under this post which even though are mostly UK specific, I feel like apply to the whole European market. Specifically, it seems that in contrast to the U.S., the EU is very “tenant-pro” (political reasons), making RE investing unattractive for retail investors.

    Could you share your opinion on this? Do you think rental property investing attractive for small investors in the EU (meaning that I’m missing sth)? Does a different set of rules (in terms of analyzing properties) apply here?

    Many thanks and I appreciate the effort you put into these articles – they are a goldmine!

    • Thanks for the kind words Jon!

      My sense is that the UK rules are evolving in a way that will marginalize the smaller players who do not have the time, expertise, and capital to run a proper operation. The ones who are left will benefit as the retail investors leave the country.

      Tough to comment on Europe. Real estate is a very localized market so what works in London is unlikely to work in Paris and vice versa.

      My broader comment would be that I don’t use the headline rules to evaluate properties and instead focus on the IRR (btw, the cash flow book has the best possible explanation of IRR I have ever seen).

      If I’m able to get an IRR of 10-12%, I dive in. If not, I move on. By the sounds of it, it sounds like those numbers may be tougher to achieve in Europe but I am sure there are bargains. By the way, I screened 100+ properties, did a deep dive on 40 properties and bid on at least 5 before I scored our latest purchase. It took me 18 months and I’ve restarted the process again.

      So don’t despair if your initial search hasn’t turned anything up, finding good deals takes a long time.

Leave a Reply