By Dr. Colin Gage
A few years ago, a good friend of mine talked to me about a severely run down 24 two bedroom apartment building in my small town of Merritt, BC. After doing some homework on this property, I found out that only about three or four of a possible 24 units in the building were occupied. Even worse was the fact that one half of the building was condemned by the City of Merritt and the local fire department.
The building was built in the 1970’s and all of the 24 two bedroom 800 square foot units were identical. The owner was an elderly absentee landlord. The existing manager was a nice lady but was desperate for someone new to take over the building and finally address the neglected repairs. Therefore, she was happy to let me look around a bit and start doing some due diligence. I have renovated numerous houses in the past so I had a decent understanding of the red flags to look for. I spent weeks crawling around in that building!
Surprisingly, the owner was not enthused about letting me do my due diligence and eventually told the building manager that I was not allowed to do it anymore. To me, the biggest issue with the building was that one of the ground floor units had a long standing water leak in a vacant corner unit. It leaked long enough to cause a serious mold issue in that unit and some of the floor joists were so rotten that they had simply fallen away into the crawlspace gravel floor. In addition, each unit had a small deck and many of them were rotten and structurally unsafe. Prior to the end of my due diligence period, I did manage to have an engineer and a hazardous materials contractor inspect the water and mold damage. Their conclusion was that they could fix it, but it wasn’t going to be cheap.
Since the owner wasn’t going to allow me to continue further with my due diligence, I decided to play it safe and make him an offer that was based on the assessed value of the rather large multifamily zoned lot ($400K), minus potential demolition costs of the building ($125K) if it wasn’t salvageable. Since the building was basically vacant, other than three or four units, there was no way a bank was going to finance the purchase of it. Therefore, the $275K offer I wrote for the entire building included a ninety percent VTB ($247,500) at 5% for five years and a 10% down payment ($27,500, borrowed from my personal LOC). Since the building had become much more of problem than the owner wanted to deal with, he accepted. I was well aware that there was definitely some risk involved in this project. Therefore, I created a new corporation and appropriately named it “GrewSome Investments Incorporated”. To clarify, the incorporation name was based on the fact that I had to “grow some balls” in order to take this project on. I always like to add some humour to my corporation names.
Once I had purchased the property, I commenced the renovations immediately. To generate the funds to do this, I approached my local Community Futures Development Corporation for a private loan of $100K at an interest rate of 10% for a term of one year. I combined this money with another $160K that was borrowed from my personal LOC, which allowed me to hire an engineer and other qualified contractors to fix all the mold and structural issues. I was also able to renovate and rent out six units. This was a lengthy and stressful process. The fire department and the City of Merritt were then able to remove the “condemned” status of the east half of the building.
Once I had six units renovated and rented, and another eighteen units that were ready to be renovated next, I was able to demonstrate to a bank that there was revenue coming in and lots of future potential in the building. It was at this point that I had an appraisal done that was based on me renovating all twenty four units. This appraisal came back with a value of $1.5 million. I was then able to get an $860K mortgage from the commercial branch of the Interior Savings Credit Union. The credit union was willing to give me a mortgage that was based on the “equity” in the building. Other lenders, such as RBC, would not give me financing because their policies are strictly based on the “cash flow” of the property, and not the “equity”. With only the cash flow from six units available at the time of the loan application, RBC turned me down. The Interior Savings Credit Union was excellent to work with. They even allowed me to make interest-only payments for the first six months. I simply asked for this and they said yes. My motto is that “If you don’t ask, you don’t get!”
With the $860K, I paid off the 90% VTB loan ($247,500), the Community Futures Development Corporation loan ($100,000), my 10% downpayment loan from my LOC ($27,500), and my $160,000 renovation loan also from my LOC. This left me with $485,000 to renovate the remaining eighteen units.
After completing the renovations to these remaining 18 units, painting and updating the exterior of the building, and running into more labour and plumbing costs than expected, I ended up having to once again use $100,000 of my LOC to get it all done. However, as you recall, the appraisal of the property once completed was $1.5 million. Thus, I went back to the Interior Savings Credit Union and asked to have the $860K mortgage increased to $980K so I could pay back my LOC the last remaining $100K. In the end, I had a fully renovated and fully occupied building appraised at $1.5 million with a mortgage of $980K. The part I loved most about it was that I no longer had any of my personal LOC money or cash in the project. It was basically 100% financed and the rent collected paid for all operating expenses and mortgage costs. The left over monthly cash flow was left in the corporation to cover an unforeseen capital expenses.
The process I just explained in detail may sound quite simple to some seasoned investors. However, there were many sleepless nights that were created by: ongoing tenant issues, some of the contractors, WCB, water leaks, and many other things that I have purposely blocked out of my memory. During this time, I was fortunate to have a supportive spouse and two daughters who constantly reminded me of what was really important and that this apartment building was just a physical entity. This kept me from getting too stressed.
In the early summer of 2014, after more than two years of renovating and renting all of the units, I determined that the building was at its highest value and best utilization. Therefore, I decided to see if I could sell it to an investor who was searching for a fully renovated, fully occupied, turnkey property.
In November 2014, a pair of investors came to town and wanted to see the property. I had it listed with a realtor in Kelowna but he was unavailable to be there on such short notice to provide the necessary details about the building and property to the potential buyers. Since I knew more about the building and its renovation than anyone, I offered to show it to the potential buyers during my lunch break. After showing them four of the units and answering all of their questions, they asked if I would join them for lunch. I happily agreed and after a bowl of soup and some small talk at a local bakery, they just asked me what my “number” would be to make a deal. I simply told them that if they made a clean offer of $1.8M with minimal subjects and a reasonable closing date, that I would accept it. Once lunch was finished, we shook hands and they said that they would be in touch. Surprisingly, they called me back that afternoon and said they would accept my offer. The deal closed in January 2015. We still go for lunch at the same bakery every few months when they come to Merritt to check on their properties.
In regards to the net profit from the project, the initial $980K mortgage was paid down to $890K by the time the deal closed. Therefore, once the $890K mortgage was paid off (I made sure the mortgage was initially set up as “open/variable” so there would be no penalty if I sold the property), I was left with a net profit of $910K.
I have been investing in real estate since the late 1990’s but this project was the biggest one I have ever taken on by far. Knowing what I know now about renovating a big building like this, I would surely do it again if an opportunity like this came up again.
With some of the profits, I recently purchased five one bed and one two bed apartments in a neighboring apartment building of similar age that have a cap rate of 7%. Once again, I am renovating each one and then renting them. Merritt is still a hidden jewel for reasonably priced rental properties if you know where to look and who to ask. Other than moving away for eight years for university, I have lived in Merritt for all of my life. Therefore, I feel it is important to let other REIN members know how they can also invest in Merritt, be successful, and at the same time create positive spin offs for the community.
Colin Gage purchased his first rental property 16 years ago and has continued to invest in real estate on a part time basis ever since. He has learned a lot about real estate investing over the years by reading, attending quality seminars, and the hands on experience of investing in as many different avenues of real estate as possible. In addition to his passion for real estate investing, he has been working full time as a chiropractor in Merritt for almost 20 years. You can contact Colin at firstname.lastname@example.org.