Archives for August 2014

Investment Property Loan Financing Tips

Understanding the psychology of lender risk

The reason investment property loans are more expensive, harder to obtain, and more restrictive than loans on personal homes, is that investment property mortgages are inherently riskier than home lending. Fannie Mae and Freddie Mac charge higher rates for investor property loans, much more than for primary home loans because of these higher risk factors. It’s a simple axiom – the greater the risk, the higher the cost. Of course, the opposite axiom is likewise the same – the lower the risk, the smaller the cost. For lenders, real estate investors are inherently more dangerous as a group to make loans to than are homeowners.

Thinking like a bank thinks…

Banks have to look objectively, and ruthlessly so, at their bottom line. What’s their worst case scenario in any lending situation? Naturally, a foreclosure. And in the case of those investing in rental property who are unable to make their monthly loan payments, since they have no emotional stake in the property, they will be more likely to walk away from their loan obligations in any worst-case scenario. Much more so than any homeowner would, since homeowners are emotionally grounded to their home – which is most probably their single greatest asset. This helps explain why total mortgage costs run higher for real estate investments, as well as why investment property mortgage rates are higher than homeowner rates.

Real estate investors understand that buying a rental property is simply a game of numbers. A homebuyer views their purchase decision in much more emotional ways – deciding what emotional benefits will accrue him if he buys a particular home. Conversely, this makes it much more difficult for the homebuyer to give up “his baby” so to speak. And this single reason is what makes lenders value the homebuyer as much less risk than anyone buying rental property.

Mortgage rate differentials

Regardless of the specific area of the U.S. you may look to buy in, real estate investments will have mortgages that will generally run about half a point greater than home loans on average. In addition, many fees tend to be added to loans on investment properties – many more than home mortgages. Thus, the overall cost of any rental property mortgage will be greater as well. Some of the factors involved in the overall costs associated with an investment property loan include the borrower’s current credit score, the loan-to-value ratio for the loan, the property character (ie. – single family, duplex, multi-family, multifamily with owner-occupying one unit) and the specific mortgage program being applied (FHA, Fannie Mae, Freddie Mac or no government-insured program).

LTV’s

In many instances, when in investing in real estate, lenders set up loan-to-value (LTV) ratios at higher overall amounts than home loans. The greater the amount you put down on the rental property you’re trying to finance, the less overall risk to the lender. Most lender these days have maximum loan-to-value ratios of 70% of the purchase price, where you, the buyer, must put down at least 30%. But if you put down 40%, or even 50%, you’ll find your interest rate and overall costs of the mortgage loan will come down substantially. This is also because you are helping to substantially lessen the lenders overall risk. (After all, it’s much harder to walk away from a property you have 50% down in equity than it is if you had only 30% down.)

Using rents as income qualifiers

Traditionally, banks will allow 75% of gross rents currently in place on units in any property you’re thinking of acquiring to help offset the monthly carrying cost of the loan. Keep in mind that this applies only to actual rentals…not hypothetical “market” rents. In addition, the tenants need to already be in place. Typically, the same 75% figure can be used to offset monthly loan costs in any refinance situation for your rental property.

Credit scores

You should also remember that lenders usually require those buying rental property to have better credit scores than their homebuyer counterparts. Lenders like to see scores of at least the low to mid-700’s before extending any rental property mortgage. (That’s not to say that it’s impossible to obtain a loan if your score is in the 600’s – but it will be more difficult, and certainly, it will come with a much higher interest rate. The bank, after all, is always looking to defray their risk.)

photos courtesy of thelastembassy.blogspot.com, answers.yourdictionary.com, ehow.com, ocdwellings.com, chicagoagentmagazine.com, infinitecredit.com

Real Estate Investing Trade-offs

Analyzing risk versus reward…versus stupidity

How far would you go to get a great deal when investing in real estate? This story ripped from today’s headlines shows that most property investors (OK – no property investors to date) want to risk everything (and by everything, I mean their lives) to obtain a “killer” of a deal when buying rental property.

As reported in Forbes.com (“Investment Opportunity: Possibly Booby-Trapped Property Remains Unsold,” by Kelly Phillips Erb, 8/15/14), the following investment property recently came on the market, and was advertised as such: “For Sale: Home on 110 acres in Plainfield, New Hampshire. As is.* Minimum bid: $250,000. * Property may be booby-trapped.”

No winning bid?

As Ms. Erb wrote: “surprisingly, when this property went up for auction recently, it didn’t attract a winning bid. Crazy, right? I mean, who wouldn’t be interested in purchasing a “fortress-like” home on more than 100 potentially life-threatening acres?” She goes on to tell the story of self-professed tax protestors Ed and Elaine Brown, who were recently found guilty of defrauding the U.S. government, as well as tax evasion, among other numerous counts.

Apparently, the Browns had a unique defense involving self-jurisdiction. As Ms. Erb went on to explain: “at trial, the Browns argued that they were not required to pay taxes. They firmly believe that the federal government does not have jurisdiction to tax money that they earn and used the courtroom to explain, claiming, “We will once and for all show beyond the shadow of a doubt – not reasonable doubt, beyond the shadow of a doubt – that the federal income tax system is a fraud.””

The bottom line?

The Browns eventually decided not to attend the rest of their trial, and fled to their property, where they proceeded to booby-trap it. When federal authorities eventually caught them and subsequently placed the property on the auction block for property investors to snatch up, no assurances could be given any potential investor that all the booby-traps had been found and removed. Hence – a bit of a sticky wicket for any property investor. Make a potentially lovely deal while investing in real estate, or die trying.

Fixer-upper to the max

Quite frankly, I don’t understand why some real estate investor didn’t decide to buy the property as is, and then throw in as part of their “fix-up” costs a team of well-trained security bomb experts to locate any potential booby-traps. As Ms. Erb reported about the marketing of the site: “at auction, there were no winning bids. And by “no winning bids,” I really mean, “no bids.” And by “no bids,” I really mean no bidders. Despite the fact that the property was listed for auction, not one potential bidder showed up in the courtroom in Concord, New Hampshire, just an hour and half away from the property.”

Second chances abound…

But not to worry…a second auction is being planned. So if you missed out on the first one, and your appetite for risk is at hunger level, gung-ho property investors may certainly like to consider fully analyzing the potential risk versus rewards of this particular secluded New Hampshire retreat. Of course, like with any real estate investment – you could make a killing in the process…

photos courtesy of upscaleluxuryhomes.com, aaii.com, blog.guidantfinancial.com, realtybiznews.com

Best Renovations For House Flipping

Learning from other’s mistakes

As a licensed real estate broker, I recently had to offer my opinion to a client as to a current market value for a home that had recently been renovated. On the surface, and from the photos and listing data, it appeared a professional flipper who knew how to flip houses had purchased this unique lakefront home in order to rehab and then place back on the market for a quick sale. It had been purchased only two years ago from an estate, the house needed work, and now after renovations were done, the house was back on the market – for more than double what the seller bought it for. However, upon going to inspect the house as a preview for my client, I instantly could see that the seller was no flipper. Rather, they were simply stupid, short-sighted sellers, who bought the run-down home in a good location, but then proceeded to over improve the house to their own personal likes. In property investor parlance, this was a “vanity project.”

Avoid personal taste decisions

In the first place, the entire renovation and materials used were highly personalized to the owner’s tastes. The granite countertops in the kitchen were not a style a flipper would choose. When buying property flips, you should always consider selection of materials that will appeal to the largest segment of buyers – not a small niche who might also happen to coincide with your own design sense. In the case of the kitchen counters, a highly stylized granite top was used – and a whole lot of it to boot – meaning, if a buyer didn’t like it, it would cost a ton simply to re[lace it. Otherwise, any buyer is going to learn to have to like it. Or pass on the house. Which, sadly in this case, most will do.

Adding insult to injury…

Creating further turmoil in this particular rehab, was adding a new radiant heating system to the entire house. While very energy efficient, this kind of upgrade is certainly far above the style of most homes in the area. Unless many other homes on an area of the property you’re considering flipping already have this upgrade – your investment in something so expensive is downright foolhardy. Especially if the house can’t take the extra cost, relative to the neighborhood it sits in.

What not to do

Another example of over spending in this particular rehab that screams “vanity project” is that the owners removed the former floor to ceiling massive stone fireplace to allow for their large, 100K plus kitchen redo, then added steel interior exposed girders for extra support afterwards. This smacks of an overzealous owner who is simply not in touch with the real estate market next door to them. This also told me they weren’t professionals when it came to flipping houses.

Ultimately, the seller must have run into financial issues, since they are trying to sell it, and also trying to recoup their renovation cost (in this case, probably close to 300K). Of course, this seller now owns the most expensive home on the block. And one of the basic tenets of property investing is to never get stuck buying or owning the most expensive home on the block.

To make matters even worse, this particular house is a Contemporary – which also negatively affects market value, since most buyers prefer Colonials. From the granite countertops to cherry cabinets and top of the line appliances, radiant heating, new floors throughput and new high end bathrooms added as well, the seller went seriously overboard in the renovations.

Setting the asking price

Another important point to remember when learning how to flip houses, is to never let your own vanity come into play when setting your asking price. The market always dictates the price. And most certainly not the cost of your renovation. In fact, the cost of your rehab should have no bearing whatsoever on the final asking price you set for the property come time to place it on the market. It is the comparable properties in the neighborhood that will ultimately help to set your asking price. As well as the final market value, once it is sold. Never go into a project with your own blank check for renovations. You must make the most tasteful design decisions at the right price. Rehabbing an upscale home with top flight materials makes a lot of sense. But doing so in an area of lesser priced homes would be foolhardy. The rehab would dictate a lesser grade of materials.

Pricing correctly

Remember too, that when it comes time to put your flipper on the market for sale, pricing it too high can have disastrous results. When a property is priced unrealistically high (for example, more than 10% over market value), most buyers don’t want to even make offers, for fear they are too “insulting.” Thus potential buyers may stream in to view your property, but you’ll end up with no offers on it. This is because you’ll have scared them off with too high an initial asking price.

The best renovations

Keep in mind the basic rehab areas listed below when trying to flip houses. These are the simplest ways of adding value to any rundown home. But always remember you’ve got to improve to the level of the next door neighbors – and not way above them. This is the safest way to keep your renovation costs in check.

The kitchen rehab

Keep things simple if possible. If you can get away with sanding and painting the existing cabinets, and then replacing the old appliances, do so. If not, keep your kitchen redo budget in line with like homes’ kitchens. Don’t forget that new track lighting, a new sink and new faucet can really spruce things up inexpensively. Laminate countertops are OK, unless everyone else on the block has granite. Then you must spring for the granite. Avail yourself of planning and design help from local home improvement centers.

Bathroom remodeling

Again, try to keep things simple. If you can just change out existing toilets, sinks and towel bars, you’re lucky. But sometimes old tile walls look terribly dated, and/or you’ve got to spring for a total gut renovation. Keep the material costs down by using Lowes or Home Depot materials. Some of their cabinetry can look as good as designer cabinets at half the cost.

Plumbing upgrades

If a house hasn’t had any plumbing upgrades in the past 20 years, you really need to consider changing out all lead pipes to the more recent plastic tube piping of today. While the labor cost is high, the materials cost is low. In addition, any dated plumbing fixture should be upgraded as well – from dishwashers to washing machines, and everything in between.

Flooring changes

Carpeting is still the cheapest way to go – but it has no “wow” factor to it. Refinishing old wood floors is a great way to go – if the existing floors are hardwood to begin with. If not, consider using some of the new engineered hardwood flooring available on the market today. Or, one can simply upgrade with the “look” of wood, using laminate hardwood flooring. This is what most buyers today expect. Naturally, if you do go with any carpeting, keep it very neutral colors – beiges or grays, to appeal the largest group of buyers.

New interior paint

Like carpeting, stick with lighter, neutral, off-white colors. The more extreme the color you choose, the narrower the range of buyers who may fancy it. Also keep in mind that light equals bright. And bright is a flipper’s moneymaker. Remember too, that keeping the whole house the same shade of color keeps an evenness to the potential buyer’s eyes as they move from room to room. This makes for another positive impression on any house you’ll be flipping.

Putting it all together

If you utilize all these suggestions for the best property flipping renovations, you will invariably be playing it safe. I can’t overemphasize the need to keep your vanity out of your design decisions. Especially when it comes time to place your investment property on the market for sale, and setting a realistic asking price. A price that will absolutely invite many offers. If you can get buyers into a bidding war, you’ll have done your house flipping renovation job properly.

photos courtesy of brokersbestmtg.com, tmgnorthwest.blogspot.com, realestate.msn.com, cbsnews.com, ocregister.com, article.wn.com, vimeopro.com, foreclosuredatabank.com

The Diversification Model

Safety versus reward…

When I was just starting out buying rental property, an investment opportunity came on the market that totally captured my fancy. It intrigued me so much, I came very close to acquiring it – and making a major error at a very early stage of my real estate investing career. The property was an eight unit set of townhomes, all attached, and owned by a local bank that had taken them over when the developer defaulted. The project was totally finished – nothing had to be repaired, fixed up, renovated…a truly turn-key operation among investment properties. Of course, new tenants would need to be found for it, which would take several months after a closing to gain full occupancy.

Thinking pragmatically

I negotiated directly with the bank, and they were willing to provide the loan, with investment property mortgage rates that were very beneficial for me on the property. And the numbers, which I got into a habit of crunching several times a day, every day for a few weeks, kept making more and more sense. So – why didn’t I acquire the property? Simple – it would have used up every penny I owned in available capital. Any mistake on my part in my numbers crunching meant I could potentially lose money as I was just learning about investing in rental property. And it could happen quickly – without any means to tap a “slush” fund for emergencies…not only for the townhomes, but for myself personally. In effect, I could lose everything I owned on this one set of real estate investments.

Listen to your inner self for the danger signs

I could sense the danger every day I got more and more serious about closing the deal. Ultimately, common sense prevailed. While the upside was also quite large on this grouping of townhome investment properties, and would have set me up, in theory, quite nicely moving forward, the downside, as I evaluated it was equally nerve-racking. I just didn’t have the stomach. So I backed out of the potential deal.

A self-taught lesson in fiscal restraint

This offers a good lesson – as I taught myself – in the need for diversification in any type of real estate investing. To have put all my eggs in one basket, at the beginning stages of my property investing career, would have been a very risky, and probably fool-hardy thing to do. When I applied reason to my analysis, I came away with other options, like picking and choosing smaller multifamily homes, one at a time, that were much less risky. Again – not as much reward, but no one property would sink me like this townhome project could if I was wrong in my calculations.

Basic property investment theory

Diversifying is such an integral part of investing theory, and yet when confronted directly with the prospect of a “big kill,” the notion of diversification can easily go out the window, especially when dollar signs go up in the sky in big bold letters.

In real estate, this means diversification can have many looks. You can diversify across one class of properties – for example, sticking entirely within residential real estate, and acquiring individual homes as I have done. It can also mean spreading risk out over several classes, or types of real estate investments. Owning a small office building, a retail store property and a multifamily home at one time are a good way to diversify your real estate holdings.

Eschewing the big kill mentality…

With more diversification comes lessened risk – as a downturn or a financial hit to one segment won’t totally destroy your overall holdings. It’s slow and steady financial gains that are approached as an averaging of all your different real estate holdings in the diversification model. In this way, real estate investors can protect themselves, and can be ready in the event of any downturn…Ready to acquire another, different class of investment property moving forward.

photos courtesy of besthawaiihomes. com, elementcommunity.com, worldpropertychannel.com, chrismercer.net, rifuture.org