3-into-4 bedroom conversion success in Montgomery, Alabama

Hi folks,

Thought I’d do a deal walk-through of my latest property acquisition. This is a long one, but if you stick around reading you’ll be rewarded by what I think are some good insights and strategy ideas. For those who don’t know, I started investing in USA residential property almost 2.5 years ago now.

I did a deal write-up a while back (found here) of my most cost-efficient deal which was in Detroit, Michigan. Quick update on that one: I still hold it and it remains to be cash-flowing very very well. Detroit is a difficult market and much higher risk than the deal/market I’m about to take you through. I’m also now into my second tax-return-year in the US/AU and have a solid understanding of how it works + a robust spreadsheet process/system built out with both my US accountant and then my AU one. Of course I’m no tax agent so I cannot give any advice etc.; but the tax process each year is easy if you are organized and live your life in spreadsheets like I do!

Anyway, on to this latest deal which is easily my most lucrative to date, thanks to a strategy I’ve deployed once in Australia, but for the first time in the USA; being: spotting the opportunity to add an additional bedroom within the EXISTING footprint of the house (I.e. no DA required; no construction/extension). The very modest rehab (renovation in AU-speak) cost up front to convert what was a utilities/store room with its own door and window and legal minimum-bedroom-size dimensions for that state’s code added tremendous yield to this deal.

Upfront note on currency/Forex: Ok all of the numbers presented below are (to simplify it), all post-conversion to AUD currency. Everything was done in USD. Of course, Forex rates change by the minute. The way I manage this is to ‘lock in’ the upfront hard purchase costs (because these are frozen in time as they are 1-time transactions). Thereafter, for monthly rental incomes, I adjust my spreadsheet to track the monthly-average forex rate, just so I have the data over time. In reality though, it’s a misconception that people have where they think that you are “at the mercy” of Forex rates monthly, when your rents get paid. That’s not necessarily true. In my case, I have a TransferWise Australian bank account that features a USD-receiving ‘stream’. This stream is not a Bank account owned in my own name (as a foreigner, to get one of those, you need to physically present at a US bank to open it, under KYC laws…). Instead, the USD-stream is held in TransferWise’s US-entity name – but is for my own exclusive use only. So it serves the purpose I need. Critically though, I CHOOSE when I move funds from my TransferWise USD-stream, over to my TransferWise AUD account. This means I can back months of USD rental incomes and then ‘pounce’ in real-time when the Forex favors me to do so. Tax-wise, seek your own advice but my learning from AU accountant is that ATO has a table of Forex rates for every day of the fiscal year so their rate of FX is what is used to determine for tax purposes; on the day/date you bring USD funds of taxable income back to AU into AUD currency. So, for simplicity in this deal overview, I’ll outline all costs as AUD currency, fixed at the same Forex/Inverse-Forex rate that I purchased the property in.

Note on finance: those who know me know I only purchase cash-outright in the USA. Never take out mortgages neither in AU nor in US, for buying USA properties. I simply take a ‘loan from myself’ at dirt-cheap AU Bank mortgage rates, take that cash to the USA and buy/renovate cash-outright. What I mean by this is… On the AU properties I have mortgages, some fixed, some variable. On the cheapest-rate variable mortgage (that is entitled to an Offset account), which is currently ~ 2.2%-ish interest rate; I simply take the money out of this offset account that I’ve saved up, to purchase the property outright in the USA. This means that the remaining property in AU now has a higher ‘interest-payable’ mortgage due to me removing funds from its’ associated offset account. Meaning (e.g. if I take $100K AUD out), that property’s mortgage each month then charges interest on $100K more of its mortgage amount, than it did before. So, essentially I’m financing my own deals in the US, paying only AU’s cheap mortgage rates on the finance that remains on the AU property. I do not refinance/equity-release/increase my actual loan amount, to do this. All my AU properties are ~ 70% LVR or lower. The high cash flow from the US helps to pay down debt exponentially on the remaining AU properties that have mortgages on them.

Cash-flow note: Naysayers on my Detroit deal were critical of the low “Net-Net” cash flow it offered (Net-net being post-running-expenses, then post-tax-outcome each year), arguing that with only AUD ~ $3-$4K per year of Net-Net actual cash income, you’d need a lot of these deals to replace a Median AUD salary (being $80K Gross which is about what AUD $60K after tax?). Note on myself: since my PPOR is effectively fully paid out, my Financial Independence ‘number’ of net salary is not outrageous. It is very modest. I have no desire to drive a Maserati, live in Vaucluse, holiday in the south of France or Monserrat bi-annually etc. etc. That ain’t me. I don’t need AUD $100K+, POST-TAX. My comfortable FIRE number with a fully paid out PPOR is AUD $40-$50K POST-TAX each year. That’s it. That’s the number I’m chasing and this strategy is rapidly getting me there! This below deal is so exciting because it does something new for me and is also my largest cash-flow deal yet (not by % yield which is a bit meaningless a metric!); I mean actual hard $$$ Net-Net cash-flow each year, based on all-in purchase/rehab cost upfront. That’s the number I care about.

With all that preamble said, let’s get stuck into the deal:

The deal:

- No I won’t supply the actual address due to privacy etc. But this is a 3 bed / 2 bath house in a good street about 5-10km from Montgomery CBD, ~ 1500 square feet house (about 140sqm internal) on a 0.28 acre lot/block (about 1133 square meter block). I’ll show you some before/after photos in this post

- Single level mid 1950’s brick house on concrete slab (no basement). No large trees in yard. Reasonably good condition driveway, and shingle-roof has a good 5-7 years of life in it

- As soon as the Facilitator shared the deal which she sourced below original list-price, I looked at the photos (there was no floor plan; less common in older US house-listings); and immediately saw something opportunte. It was large square footage with two living areas; the master-bed having an ensuite, and a hallway bath (both with bathtubs). At the back of one living area was a storage/utilities room with its own door and window. This wasn’t even mentioned in the sales listing. I had the rehab estimator visit to quote the usual upfront rehab I’d do on any US purchase; and ensure he measured the dimensions of this room. It was just a touch larger than Alabama’s state property code for minimium dimensions/rules for a ‘habitable bedroom’. This included measurement for ceiling height, natural/own source of light (window), closable door etc. It met code for this (though didn’t have a wardrobe/closet)

- I then researched what a 4 bed/2 bath house rents for in similar suburb streets in Montgomery, compared to a 3/2, of a similar age, condition, square footage. It was substantially more than a 3/2. As in, USD $200-$300 more per month ($2400 - $3600 per year more), than a 3-bed. Meaning, as-is it might rent for USD $700pm, but with cosmetic rehab of house and 4th-bed conversion, it could fetch $950-$1000 per month in rent. Gold. Exponential gain, right there.

- The rehab estimator’s quote came in around $2.5K to do the conversion to a bedroom. Including gyprock walls, ceiling, paint, install new wardrobe, carpet the room. Meaning, the 4th bed pays for itself by the end of year #1; then from year #2 of holding onwards, it continues to compound along, year in year out

- The rest of the rehab estimate was cost-effective too. House was in good shape, just needed updated paint, carpets, bit of yard work and pressure washing, and some new vanities and deep clean in the bathrooms

- The result? Achieved a USD $970pm rental income, instead of $700-$750pm I would have got as an unrenovated 3/2

So, here’s the numbers and how it all shook out (AUD):

Purchase Costs/Data:

- Purchase date: 20.11.20

- Total all-in purchase cost: AUD $130,531.62, broken out by: house itself ($108.5K) Facilitation ($8.2K), Rehab upfront ($11,090 of which about $3.3K was 4th bed, the rest was items as mentioned above), Legals/closing costs ($2,100 – note I already have my Alabama LLC setup from previous purchases so no LLC setup cost for this one), Apportioned/Adjusted rates/taxes at closing ($700)

- NO STAMP DUTY UP FRONT! When purchasing in this state J = more of my $$$ working harder for that cash flow

Income/Expense Costs/Data:

- First date of income producing status (tenancy lease start date): 21.01.21. Tenants: high income earning same-sex couple, both work at local universities in Montgomery with great rental history/checks etc.

- Annual Gross incoming rent: AUD $16,279.74 (that’s a 12.47% gross yield, but a large ‘$$$’ amount yield – my largest on any one deal)

- Annual totality of all running expenses: AUD $4,424.96 (remember: no mortgage cost because I now pay 2.1% interest on $130K of mortgage on an existing AU property instead..); broken out by: Rainy day/contingency ($313.07), MGMT fees (1,302.36), Accountancy Cost (AU/US total) per fiscal year filing portion for just this property within my wider filing ($292.08), County Taxes ($559.44 – yes Alabama really is one of the CHEAPEST county tax states in the US), Alabama annual LLC legal/filing fee ($160.00), Allocation for random maintenance repairs annual ($839.16 – note some years this could be $0, other years higher. ~ $800 is where it shakes out to), Insurance $1111.18 (includes dwelling and landlord cover)

- Annual ‘Net’ return (defined as: post-expenses, but pre-tax): AUD $11,854.78 (still representing a 9.08% Net-yield)

- Annual Taxes Paid: *based on my FIRE tax status which based on total AU-fiscal-year income incl. Medicare levy, likely shakes out to ~ 25% actual tax-rate paid*: ~ AUD $4,069.94

- Annual ‘Net-Net’ return (defined as: post-expenses, post-tax-outcome): AUD 7,784.84 (which is 5.96% Net-Net Yield), but more important than any %; it is still a huge $$$ amount of money.

- Circling back to my stated FIRE goal above of AUD $50K Net-Net income replacement/salary to leave full time work… $7787.84 represents 15.5% of that goal. In one property. In theory and indeed in practice, I only need about 6.7 of deals of this size/shape, to reach my FIRE goal. I also mentioned that this is my 7th US property purchase. Whilst this is the largest of them all; you can see how quickly this can compound. Whilst the ‘source’ funds for some purchases were realized by selling AU properties; paying out their mortgages, then taking the equity cash-outright to the US; others were acquired simply by frugally saving my hard-earned from my salary day job. I’m in my 30’s. This is possible. I’m doing it. And it can compound quickly.


Things learned:

- Have an eye for such opportunities for additional bedroom (or even bathroom if the plumbing and space allows for it); or other adjustment/installation that can ramp up the rent; up front; when working with a facilitator or buyers agent

- Know your market. Be sure to research what the realistic rent would be if you do the above addition or expansion

- Continue to (where possible) avoid houses in the US with basements (harder to do in cold-climate states); or large trees in the yards; due to the ongoing maintenance costs associated with these things that eat away your yield through recurring costs to either chop the trees when they overgrow into the roof etc.; or in the basement which come with their own challenges

- This is my 7th US property and I continue to use Facilitators/buyer’s agents (though a Facilitator’s scope of work in the US is greater than an AU BA’s scope of work) and will continue to do so. They are invaluable for so many reasons and worth every cent. Even though I’ve some experience now; I am not on the ground in the US and likely won’t be until Covid is but a distant memory; using a BA is invaluable. Don’t think you can do it all yourself when starting in the US, you’ll get lost, ripped off, or worse (getting yourself into incorrect legal/LLC structures) if you don’t use a Facilitator

- Via the Facilitator I’ve learned how invaluable my USA teams are. Just like my AU ones. Accountant, lawyer/legal, Property Manager, Rehab/consulting crew, Maintenance folks etc.

- Finally… that this strategy is indeed scalable. I see no reason to stop. In fact, with the AUD being quite high at the moment, it might make it easier for me to push into property #8, #9 etc.

- That a FIRE strategy can be built on residential property! (Just… not in AU; well; not until traditional retirement age, not a FIRE-ambition retirement/transition to “CHOOSING to work, or not” age! I.e. 40’s not 60’s). The FIRE community are obsessed with shares/stocks as their ride to FIRE status. I guess I’m an outlier but I’m proof that it can be done in the property asset class

I’m sure in the comments there’ll be more naysayers on this deal. I don’t really care. I don’t need to prove anything to them; as I’m already living it/succeeding in it for my own little race. Because... in life and in investment, we should always run our own race; never anyone else’s. And I can tell you, on my own little racetrack in an Olympics featuring only me as the participant/athlete, I’m winning J

And to the naysayers I guess I’ll repeat my motto that has appeared in my PChat profile’s tagline since day #1 on this platform: “Those who say it can’t be done, should not interrupt those already doing it”.


(Attached photos indicate whether they are 'before' or 'after' via file name )

 

^^^^ Update: The above is a screenshot of my closing (settlement) docs from my conveyancer. I just had to include it. Yes, that's right; total stamp duty cost for the purchase was... USD $77.50 (about AUD $100.00).

That's it.

By comparison; for the same purchase-amount here's how much of your working capital isn't actually working hard for you, because its going away to state revenue-raising, in say the 5 biggest states in Australia...:

(spoiler-alert: SA is an absolute shocker!?!)

NSW:



VIC:



QLD:



WA:



SA:

 

I always wonder though, why would people still renting at that price if it is so much cheaper to buy... is it remote, hence land value almost worthless? How about tenants quality?

I read the journey by MTR, tempting...

 

Hey Mulianto, I used to wonder about this question a lot, too. My perspective on it is this: "in general", the working population of the USA is much more mobile and more frequently move in/out of cities around the country as and when they change jobs; or when their job transfers them; or when new opportunities come up; compared to the working population of Australia (again, 'in general'...).

This segment or 'cohort' of the population become a valuable and desired prospective tenant; often they may only be in town for a few years for work and don't wish to lay down roots and purchase a property in that place. But these potential tenants also want to rent a house that's got space and has been looked after well enough, in a decent street/suburb; whilst they do their 2-3 years in that town or city. These prospective tenants are great because they have the income and job stability to afford a nice B or C+ street or suburb within that city, and usually make for good quality tenants.

Outside of these people though; my other opinion/perspective to answer your question; ties back to FICO ratings (credit scores). Its in a different ballpark in the US compared to AU. Your FICO score is EVERYTHING. Even though you may present well to a bank and have great income; many Americans have MORE 'ancillary' debt-types than Aussies do. Meaning, they are likely to have more Personal Loans, Car Loans, and (especially!) Student Loan debt (this is a huge one!). These debt-types hammer down their FICO scores to say sub-700, or even sub-600. (The Score is from 0-1000 in scope...). Anything below a 600 FICO score and a decent/reputable bank is unlikely to give you a home loan, even for a modest $100K house and even with a 10% or 20% deposit down. Or, there are tier #3 or tier #4 lenders who 'will' take on such applicants; but offer mortgage interest rates so terribly high; that people don't see the value and just choose to rent instead of paying extortion-rates on a mortgage.

There are a couple of other minor reasons too. Also, its not like this EVERYWHERE in the US; just in particular markets and sectors of markets/demographics.

When you find the sweet spot though (being the nexus of affordable purchase-prices; good quality reliable tenants; and high rental yields/rent-rates achievable if you are willing to do some up front rehab/reno on the property to attract such tenant-types); it is really quite lucrative.

Montgomery as a city isn't rural. Its greater-metro population is around half a million people; it is also the State Capital and is also the 3rd largest city in the state.

Re: tenant quality; per my post above; these particular tenants are a high income same sex couple who are professors at local universities (Auburn Uni, and Alabama State Uni). Beyond this property... others in my portfolio are also median-to-above-median income earners for their state; typically full-time employed and with good rental background checks/references prior to placement.

In Detroit however.. understandably.. tenant quality there can be VERY sketchy.

 

thought to bump this thread

any update c-mac on this property? wondering if you spent any huge maintenance bill within the past year or any other issues?

Really keen with this market

 

Thanks for bumping this thread - incredible story - thanks OP for sharing!

 

Hi Redjane, thanks for responding on this thread! Since this post, I have continued to grow and expand in Alabama, but only adding one more property. Covid has seen for property markets around the world (including ours, but also markets in the US that were more affordable pre-Covid!) continue to skyrocket in prices. Montgomery, Alabama appears to be no exception; meaning that affordable deals seem to have dried up and buyers are paying overs for these houses. However, rental growth has occurred for several of my properties in Alabama and Georgia, over this same period of time so... perhaps deals can still stack up even if the purchase price is higher (so long as the rental income is also higher in line with that price).

But I digress; to answer your question; on this particular house; there has not been any major maintenance over the last 15 months since I posted this 3-into-4 bedroom property/strategy. I did have to get the arborist out to remove a couple of trees that had completely overgrown the fences. Easier to pay once to have them removed than pay repeatedly every couple of years to trim them back each and every time they overgrow...

On another house I have in Montgomery though... it has been a bit of a maintenance nightmare this last year and my cashflow suffered a bit (the electrics in the house were too old and kept blowing/destroying the tenant's appliances due to circuits issues). My amazing property manager had Alabama Power out three times to firstly check if its an Electricity Company/Grid responsibility (it wasn't). We then upgraded some electrical panels and some wiring which seems to have solved it, but it was a bit of a hit in the budget. However, with this resolved, hopefully that's the only major expense for some time, for that property.

If I can find more affordable houses in good streets that are low-maintenance and easy-rehab; I'll likely continue with this strategy. It is serving me well.

 

Thanks for updating us C-mac!

How much roughly was the bill on the other house with circuits issues?

Just trying to see if this does happens how much would that normally cost...

 

Hi Redjane, no problem. So the electrics/circuits upgrade was about USD $3K all up, so maybe $4.5K AUD. Not cheap. I have all the paperwork and receipts/specifics of what was required, but didn't read through it in great detail.

Other things to be mindful of (And I've mentioned this many times on threads re: USA houses); shingle roofs. They aren't designed to last the decades that Australian Tile roofs tend to last. Shingle roofs tend to have a life of about 7-12 years depending on the shingle type, the joists and supports, and whether there has been successive/'lazy' "shingle over shingle" over the decades (as opposed to spending the money and time removing all the shingle and starting over). Something to be mindful of.

In general, the renter expectation is also quite high in terms of fresh/clean carpets and walls/doors; meaning that if I have a tenant I get say 2-3 years out of and they vacate, I'll usually need to do a paint and re-carpet rehab to easily and quickly attract a tenant again.

 

Lol yes, I call out that definition/language in my original essay post, I think!

I built an entire glossary at some point for US speak versus AU speak. They have all of the exact same stuff as us.. just different words and names. E.g. in insurance we call it an 'excess' they call it a 'deductable'. In Aus we call it 'Strata' they call it HOA (Home owner's association) etc.

Actually, US is better because they do distinguish between rehab and reno as being different things... Often a 'rehab' is referred to merely bringing a property up to bare-minimum standards or back to original condition etc. Whereas in the US when they say 'renovation' they usually mean improving the property substantially. E.g. adding rooms/levels; ripping out the entire kitchen/bath and replace with brand new build kitchen bath and so forth. Here, we just lop it all under the word 'renovation'.

 

Maybe one day I will. It's a pretty long list actually.

I've been busy with other projects and a new small business these last 6 months, and with deals being a bit unaffordable in Alabama I've paused my progress there.

As a sidenote though I've been busy refinancing the debt on the few remaining AU properties and created some extra cash-flow via the reduced IO repayments on those as a result. Also a couple of cashbacks gave some nice liquidity injection too.