Archives for October 2014

The Ups And Downs Of Leverage

The seesaw swings both ways with leverage

Unlike other forms of investment, real estate investing affords property investors the innate ability to leverage their assets to obtain much greater returns over time. While this is a tried and true investing fundamental when purchasing real estate, there are also pitfalls one must be aware of before jumping headlong into the property acquisition process and obtaining any investment mortgage loan. To better protect yourself, here are the main pros and cons you’ll need to be very cognizant of when using leverage as you invest in rental property and take out investment property loans.

The main advantage of leverage

When utilizing leverage, the property investor is trying to use as little of their own investment dollars to act as a springboard to greater wealth. Return on investment (ROI) is traditionally much greater utilizing leverage than when only using one’s own

investment dollars to fund your projects. By obtaining a rental mortgage on one or all of your investment properties, you’re able to leverage the most amount of investment dollars while keeping the absolute amount of your own dollars sunk into investing to a minimum.

As an example, if a $100,000 rental property acquisition cost has a down payment of 30%, then you need only put up $30,000 of your own funds to lock up the property. If market appreciation is 4% a year, the property value in this example would increase to $104,000 on the rental real estate. But your ROI on it would be 13.3% ($4,000/30,000). And as you continue to grow your business, slowly adding properties, you can take out mortgages on each one, eventually using the equity in each prior one to help defray your new acquisition down payment costs.

The main drawback of using leverage

Traditionally, home values have remained quite stable over time. However, in periods of great flux or recession, they can decrease in value. And if you need to get out of the market at any given time, this can create a dangerous scenario for real estate investors. If, using the example from above, the $100,000 property decreases in value by the same 4% in a given year, the property would be worth only $96,000. And you, the property investor, still need to make interest and principal payments on the loaned amount (in this case, $70,000), regardless of the current market valuation. If you have leverage multiple properties, and we hit a bad real estate market all of a sudden, well…you can see the potential for financial destruction that could ensue.

Beware the dangerous housing “bubbles”

Luckily, these periods of “correction” or housing bubbles come few and far between.

But nevertheless, it is imperative when buying rental property that any prospective property investor understand the conceptual financial risks inherent when taking on investment property mortgages, thereby increasing their leverage. While leverage is one of the fundamentals of real estate investing, if you’re willing to take moderate risks, you’ll be able to manage using leverage to your advantage. However, always weigh the illiquidity of property investments, as well as the lack of diversification if you only acquire properties in, say, residential real estate and/or in one geographic area.

photos courtesy of leverage-your-resources.com, mathforgrownups.com, mediacenter.dw-world.de, petetheplanner.com

The Changing Nature Of The Investment Property Market

Current effects of the millennial generation

If you haven’t noticed, the entire landscape of the residential property investing marketplace has been going through a seismic shift over the last several years. Coinciding with the financial crisis that begain in 2008, demand for single family homes has plummeted. At the same time, rental prices have skyrocketed, making residential rental properties hot commodities of late.

Millennial characteristics

One of the main reasons for this is the millennial generation. They have come of age, and are taking their place in rapidly increasing numbers into the workforce. However, unlike their predecessors in the Baby Boomer and Gen X demographic models, millennials stay at home with their parents much longer, don’t feel this is a major social negative in doing so, are not fiancially prepared to obtain mortgages for their first home, and are quite scared of losing their jobs. Hence, these reasons effectively keep large numbers of them on the first-time home buying sidelines.

An increasing trend

However, statistics are now showing an increasing trend for millennials to start purchasing investment property to live in as their first home. Buying two to four family homes, and living in one of the units, allows them to offset the normal investment property expenses, pay their mortgage each month, and even create a small positive cash flow in the process. In addition, they are treated to the loophole of being able to utilize FHA and VA style mortgages, since they will be owner-occupants. This makes obtaining a rental mortgage much easier.

Friends with benefits

Many in the millennial generation also are purchasing multifamily homes with friends to offset their costs. The millennial generation (born between 1977 and 1998) share some rather unique characteristics that make then especially suited to do this style of investment property acquisition. Generation Y characteristics include a celebration of diversity, with an overriding sense of optimism about the future. They tend to be rather inventive. And while they may be used to individualism, they consider their friends quite dear – so much so that they may equate their friends as family.

Creating their own rules

In addition they are used to creating new rules, and they are certainly well-versed in the internet and the concommitant communication style that entails, including an easy acceptance of all new technological advances. They’re excellent at multitasking, and are used to feeling nurtured. All of these characteristics make them better suited for the ability to trade off the traditional first time home buying process for the non-traditional role of first time owner-occupant-landlord.

Priced out of the current first-time home buyer market

When coupling these characteristics with the fact that, in today’s real estate market, rental prices are very high, first time home prices are also quite high, and most first time buyers are unable to afford to buy a home in an area that they would like to live in, these millennials are basically priced out of the home real estate market. But not so with the owner-occupant multi-family rental property market.

The entree into the real estate market

The average first time investment property buying millennial has never bought a home before, and sees the rental property as his entree into the home buying world, while at the same time creating an inflationary hedge in real estate. They effectively get in on the ground floor, utilizing their rental units in the process. Again, many millennials may jointly purchase an investment property spreading the costs, while also renting out other units for cash flow. Remember, they hold their friends in high esteem – and aren’t afraid to live with them in the next unit over as co-owners. This is one of the many characteristics that give generation y the ability to make these bold, new, trend-setting investment property moves.

photos courtesy of loyalogy.com, immersiveyouthmarketing.com, screenmediadaily.com

Real Estate Investment Fundamentals

One valuable lesson to learn

One of the fundamentals of real estate investing is quite straightforward and simple – don’t ever sell any of your investment properties. Once you sell, you’ll have to pay capital gains tax, and you’ll lose the cash flow from the investment (assuming it is positive), as well as losing the ability to leverage your equity in the properties for future investment acquisitions. This third feature is probably the most important and financially productive for your ongoing success as a real estate investor. It truly comprises one of the most basic of property investment fundamentals – namely, using other people’s money to grow your real estate investments.

Positive cash flows

Never selling any of your rental properties also means you’ll pay stricter attention to detail – like ensuring you always run at a positive cash flow for each property you acquire. I once purchased a four-family house with generous owner financing. I paid slightly over market value for the property because of several reasons. First, I knew I’d be holding the property for the long-term. Second, in return for “giving in” to the seller’s price demands, I secured an incredible below-market rate of interest with excellent terms from him directly. I didnt have to apply with a bank, or pay bank fees associated with closing one of their investment property loans.

But wait, there’s more…

In addition, the owner-financing was for a first mortgage with no balloon payment in a short period of time. And because of the term and interest rate the monthly payments were ridiculously low. I knew I had a cash cow from day one on this rental property. I was using other people’s money (in this case, the seller), and I had added another rental mortgage to my stable without incurring any hit to my credit rating for taking on more debt. (Private mortgages do not show up on credit reports). So I left my credit rating intact, and could still use this new property for future leveraging of my equity in it when needed for other rental property acquisitions.

Overpaying for a property as a positive move

So even though I knew I was overpaying in the short run, I knew I was adding a great positve cash flow to my stable of investment properties for the long term. And by holding onto it, I was deriving the benfits of the excellent cash flow it was throwing off, the ability to leverage my equity in it at will, and I did not have to pay capital gains taxes on it as long as I held it. It was truly a triple winning rental property combination. So be sure to analyze the cash flow aspects of any rental property deal when encountering a “stubborn” seller who “must” get his price. You never know when that stubborn seller may turn a dog of a rental property into a cash flow bonanza for you. Always ask for owner financing to obtain your investment mortgage loan, and see what they say. You could end up with a marvelous real estate investment acquisition in the process.

photos courtesy of houstonmortgagetexas.com, anchorloans.com, zillow.com

The VA Rental Mortgage Loophole

The inside scoop on this legal trick

Of all the tricks and investment property financing tips I point out in my real estate investing articles, the VA mortgage loophole is one of the better ones. Veterans Administration (VA) mortgage loans, traditionally offering financing of 100% of the purchase price on a home for veterans, are designed specifically for homes – that is, owner–occupied houses. However, VA loans, like most FHA loans, allow for financing of 1-4 family homes as long as the purchaser will be an owner-occupant. So if you qualify for a VA loan, you would be able to purchase a two, three, or four family investment property, live in one unit, and rent out the other units in the building. All the while taking advantage of 100% financing provided by the VA, in a de facto rental mortgage loophole.

Qualifying veterans

As long as you are the owner-occupant at the time of the loan, you could qualify and take advantage of low rental home mortgage rates. But let’s say you do this, then decide to move after a period of time. The loan would stay in place, and in theory, you could look to repeat the procedure. Keep in mind that any veteran has an amount that he would be qualified to borrow without having to make a down payment on the property. If all of a veteran’s allowance is not used up on one property, he could utilize the remainder to obtain 100% financing on another property. In this way, you could start building up investment properties utilizing strictly VA loans.

Another investment mortgage loan possibility

The VA also offers another excellent choice of financing for veterans. It’s called the Interest Rate Reduction Refinance Loan (IRRRL). This program would allow a veteran to refinance a property that had been formerly bought with a mortgage from the VA. This would be done, ostensibly, to obtain a lower rate of interest on the loan. This Interest Rate Reduction Refinance Loan also has some unique provisions regarding owner-occupancy. For example, it does not require the owner to live at the property – only that he once lived at the property. This would offer a veteran the ability to buy a multi-family property, live in it, and then eventually obtain this IRRRL mortgage at some point in the future. In this scenario, one could then move out and purchase yet another multi-family under four units, live in one of them – and obtain yet another VA first mortgage with no money down. You can see how much leverage these types of investment mortgage loans can produce…and they’re not really investment mortgage loans per se.

Using your equity as leverage

Finally, a veteran would be able to utilize his equity in each succeeding investment property he acquires in order to leverage the acquisition of even more rental properties. He could use the IRRRL route of mortgage financing, or decide to utilize other forms of non-VA, traditional rental mortgage loans from banks or other lenders. Either way, he’d be substantially increasing his investment property acquisitions by wisely using leverage to its optimum advantage, simply by taking the accrued equity from each of his properties and plowing it back into other property investment purchases.

photos courtesy of albanyhomes411.com, salending.com, americanhousingbuilders.com

Beware The Biggest House Flipping Danger

Perfecting your house flipping business model

I’ve found through all the house flips I’ve done that the biggest danger is going in with a flipping business model that is destined to fail. Just know that when you are learning how to flip a house, you may execute a business plan poorly, but if it’s a good model, you still have a chance of succeeding financially, and pulling out a profit. It’s when you have a poor house flipping business plan, even when executed well, that can’t possibly achieve success.

The budgetary process

From the outset, you’ll need to create a pro forma budget for your real estate investing project. This is the easy part. Acquisition costs, tentative rehab costs, and carrying costs until you sell it need to tallied up. Be sure to be conservative in all areas, and don’t forget to add 10% as a overage factor when investing in real estate. Then, figure on a realistic market value for the property once it’s all fixed up to determine your net income projection.

Doing your due diligence

Make sure you use a local contractor to obtain accurate quotes on the work you need to have done for your renovations. Also, once you have a very good idea of the total work to be done, write it up! You can then bid out the work to several contractors (or, to disparate tradespeople responsible for their own individual parts of the whole rehab). And you’ll at least be comparing quotes with exactly the same work to be done.

Buying and selling at the right time of year

House flippers know that seasonality is extremely important in any flipping business model. Look to acquire properties in the late Fall and dead of Winter. You’ll find sellers tend to drop their prices right after Thanksgiving and Christmas…Likewise, try to have your renovations completed by the Spring to take advantage of the best time of year for any seller to place a house on the market. This is because most homebuyers come out of the woodwork in Spring, having stayed on the buying sidelines during the middle of Winter.

Knowing your local marketplace

This is the largest component to your house flipping business model. With research done online (for example, web sites such as Realty Trac, Zillow – http://www.zillow.com/ – or Trulia supply excellent data for your area) you should be well acquainted with the average sales price of like properties. In addition, you should know off the top of your head how many houses for sale there are in your town this month, how many there were last year, and what the overall change was. Likewise, you need to be very familiar with the most important statistic of all to a house flipper: the average number of days houses stay on the market in your area.

The greatest danger

Any experienced real estate investor will tell you that the greater the average number of days average that a house remains on the market in your area, the less of a proper chance for your flipping business model to succeed. House flipping requires as short a time as possible between your acquisition of the property to the date you actually have it sold. In my business model, I won’t even consider purchasing an investment property to flip if the average number of days on the market for house sales in my area runs over one year. I would prefer six months or under. And I would take a very long look at my net income projection numbers on any given project for each month over six as an average time on the market in a given area.

Always do your research before you buy

So make sure you do your research into your geographic area as intensively as possible before looking to buy investment property for flipping. Keep a keen eye on the most important statistic: the average days on the market in your area. If it’s too high, consider purchasing in a more fertile area for flipping…Even if it means you’ll have to travel farther each day to oversee the renovations. Just don’t get stuck holding a flip property in a bad economic environment. Your carrying costs (taxes, insurance and mortgage) will eat up all your potential profits – and then some.

photos courtesy of tmgnorthwest.blogspot.com, cbsnews.com, metrosdrealty.com, foreclosurequestionsguru.com, foreclosuredatabank.com