Archives for November 2015

Why Millennials Are Betting on Investment Renovation

Some anecdotal notes about millennial investing…

Recently my nephew, a millennial who is soon to be married, asked me for some basic advice when it came to property investing. He and his fiancée were not sure if they should get into the real estate market, and if so, where to start. He was overly concerned with finding a property first, and wanted to know how best to run a search, especially for investment renovation property. I tried to tell him that he was getting way ahead of himself…and here’s why…

Starting with your local lender

As I explained to him, the starting point always begins with an honest assessment of what you can comfortably afford. If you’re looking to rehab a house, it’s best to speak with a lender about a home renovation loan. So your first stop should be with a local mortgage lender – be it a local bank or mortgage broker. Online national outfits are OK (for example, Quicken Loans), however, as I’ve noted in many prior articles here, it’s best to develop a relationship with one local lender. They can get to know you in person, you can actually sit down and talk with them, and they will eventually become part of your team of professionals aiding you in your property investing journey. Try speaking with several lenders first, then see who you feel you can work with the best. In addition, make sure they are good listeners, and can recommend mortgage products that really address your particular situation.

Expect initial mistakes to occur…

If you intend to get your hands dirty, and are looking for home renovation projects, you’ll be numbers crunching all your estimated home renovation costs. Renovating an investment property will become easier over time, the more projects you get under your belt. But initial forays into the world of renovating an investment property can be fraught with many mistakes…especially underestimating your renovating costs. For this reason, it’s best to know how much house you can afford by speaking with your local lender before starting your search. Then, you should get several quotes for the repair work to be done from different local contractors as well. If the numbers seem viable, then, and only then, should you consider actually placing an offer in on the property.

A growing trend

According to a recent article in The New York Times, millennials are becoming one of the fastest groups now investing in rental properties (“Millennials Investing in Rental Properties,” by Lisa Prevost, The New York Times, November 20, 2015). In fact, many millennial property investors don’t even own their own home, preferring to purchase an investment property instead! In the article, the author notes that “for all the talk about the so-called millennial generation — often defined as those between ages 18 and 34 — being slow to move toward homeownership, some young adults are, surprisingly, drawn to real estate as an investment opportunity.”

A millennial’s rationale

Ms. Prevost interviewed several millennial property investors for her article. One summed up his rationale for this form of investing this way: “I’m interested in real estate investment because of all the ways you can make money — from appreciation, leverage, cash flow, tax benefits. I’m not looking to get rich quick. I’m just looking to have long-term income I can rely on.” The author also noted how he liked the concept of control over his investment dollars, relative to other forms of investment, like the stock market, for example.

Another interviewee added his summation, warning “inexperienced investors to proceed cautiously when considering a rental property. “There’s a lot of information out there that makes it sound easier than it is,” especially if you’re managing the property yourself, he said.” This particular investor also noted that “buying a multifamily home that you can live in can be a great way to go. Rent from the other units might cover your mortgage payments. It’s easier to manage the property because you’re right there, and if you want to move sometime down the road, you can then rent out your own apartment.” Many millennials are doing just that indeed. It’s a growing trend that’s seen the market for multifamily houses become quite hot over the past couple of years, with no end in sight.

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Would Terrorists Be Good At Flipping Houses?

The fight for Doctor Evil supremacy

As ISIS and Boko Harum duke it out for taking the world heavyweight title of Doctor Evil (right now the statistics indicate the latter is clearly the world leader in terrorist acts, but the former gets much better press), I mean, it’s only a matter of time before ISIS-controlled oil fields get completely bombed out, and Boko Harum’s kidnapping and extortion endeavors seem so passe, and do not make for a long term business model to continue funding their efforts. It would seem to make sense they should learn some basic house flipping 101 lessons, and create a global real estate empire to help fund their mayhem.

Reading, writing…flipping houses

Clearly they should peruse a couple of my articles I’ve posted here about how to flip a house. Most notably, they should read http://investinginproperties.org/fixing/the-art-of-the-house-flip/ for tips on how to flip houses. They can also glean some more advanced advice on how to start flipping houses by also taking in my article http://investinginproperties.org/locating-property/beware-biggest-house-flipping-danger/. Terrorists could learn a thing or two from the Mafia about converting illegal activities to societally-approved business endeavors. Of course, in doing so, they would fall victim to their own success. As they get bigger, they become bigger targets. Targets to be done in – not by the U.S. or European governments and armies, but rather, by small, upstart terrorist organizations. It’s, alas, the way of the modern-day world. The little fish eat the big fish…one teeny bite at a time.

Geo-politics and property investing

When a non-sociopath watches the incomprehensibility of Paris under attack, as we all did last week, one is filled with feelings of empathy, anger and a solidarity…mostly for some form of retribution and punishment. But when it comes to complex geo-political matters, those knee-jerk reactions, while typical and normal for most, are exactly the response the terrorists are trying to elicit. I like to take a different stance. Interestingly, I’ve advocated this position in a prior article here when it comes to investment property acquisition strategy choices. Namely, sometimes it’s best to do nothing. Yes, do-nothingism may in fact be the best solution to terrorism in general. It signals a nihilistic world view – one that is counter to every effort of the minions who would bring about a perpetual state of fear to the civilized world.

Counter-terrorism through nihilism

If do-nothingism sounds too blasé for your tastes, consider a more overtly nihilistic version of the same theme. Barbarism for the twentieth century, to counter barbarism in the twentieth century. How fitting. To properly counter terrorist acts, the world should consider taking a Masada-like view of existence…or, rather death. Namely, why allow a few to control the many? Better to kill ourselves than live in constant fear of the next terrorist attack. I’d advocate the United Nations take control of the world’s nuclear warheads en masse. (Hey…ain’t gonna happen, but I like to dream…) Then every time there is a terrorist act somewhere in the world, the UN Secretary General should throw a dart onto a map of the world. Where it lands, so goes a nuclear warhead. It’s simple meta meta rational decision making on a global scale. Protect ourselves by destroying ourselves. That way, no country gets to live in a state without fear. In effect, everyone universally can live in total fear all the time of being destroyed. I think it will eventually bring about the end of all terrorism in so doing. What will terrorists have to export if everyone already lives in complete fear for their lives every second of every day? Naturally, building your real estate investment empire would be placed in a precarious position. But then again, it would put everyone on an equal footing of fear. Or, as the French would say, vive l’egalite!

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Is An FHA 203K Loan Right For You?

Alternative financing options…

When you spot a potential investment property being sold below market value, but in need of a great deal of renovation work, always consider a couple of possible financing options available to you. These particular type of mortgage loans will help drastically increase your ability to leverage any given property. If you’re planning on living in at least one of the units of the building, then consider utilizing an FHA 203K loan for your mortgage needs. With the 203K, you can choose from a couple of options, either the regular version or the streamlined version. With either one, you’ll be rolling the costs of the renovation work into the entire mortgage. However, the main caveat with an FHA 203K renovation loan is that you must be an owner-occupier of the property. All other property investors will not qualify for this style of mortgage loan.

Choosing the right lender

If you use the services of a local, trusted mortgage broker, they will recommend banks that offer the FHA 203K style loan. (Not all banks participate in offering this particular lending product.) The Federal Housing Authority allows participating lenders to offer this option. The main difference between the regular FHA 203K and the streamlined versions has to do with the amounts being borrowed for the renovations. Generally, smaller projects (with rehab work under thirty-five thousand dollars) qualify for the streamlined version. And conversely, larger projects naturally qualify for the regular version. With the streamlined type of 203k mortgage, the paperwork and process tend to be shorter and faster. And with the regular version, things will take linger, and are more involved with the paperwork. This tends to be the main drawback of the regular 203K loan – the time to close can be quite long due to the paperwork and bureaucratic red tape involved in closing on the loan. Expect a typical loan to close within sixty to one hundred twenty days from application, or about twice as long as a conventional loan.

Using FHA 203K

If the investment property that you will be making your primary residence needs major repairs, you may be able to handle the purchase transaction and also secure the necessary fix-up monies using one single loan using the 203(K) FHA rehab loan. In many situations where conventional financing is hard to come by (or doesn’t even exist in your area) to finance the renovation work for your primary residence, applying through an approved FHA lender for 203(K) financing can work as the optimal solution to your financing problem.

The FHA (Federal Housing Administration) is the HUD’s (Department of Housing and Urban Development) division that administers various single-family mortgage insurance programs through approved lenders. These programs help offer aid to buyers of residential properties. It is very important to note that the FHA does not directly get involved in the underwriting, processing or actual funding of the residential mortgages it insures. It is only these FHA approved lenders handle that will control aspects of the loan origination process. This all came about when, in 1978, section 203(K) of the National Housing Act was amended (by the Section 10(c) (1) of the Housing and Community Development Amendments). The main reason for this action was to allow HUD to be able to help promulgate the restoration, rehab and preservation of existing housing stock in the U.S.

Some basics about FHA 203K mortgages

The FHA 203k loan is a type of FHA-insured product which lets homeowners finance the cost of repair work to renovate their primary residence into their overall home mortgage. Most of the qualifying criteria are similar to regular FHA loans. However, the way it is administered and the procedure involved is wholly unique to the FHA loan application process. These loan requirements are created by the Department of Housing and Urban Development (HUD). A homeowner/investor can use the 203k loan program would use the program to pay the outlays needed for improvements to their primary dwelling. The paper involved includes essential cost estimates based on written bids from a 203k-approved contractor and appraiser. With these estimates, a lender can then determine the total 203k mortgage amount the lender will be willing to lend the applicant. Renovations that include energy efficient improvements, structural changes and kitchen appliances are just some of the improvements eligible for 203k mortgage loan financing.

Choosing the type of 203K program

With FHA 203K products, as mentioned above, there are two types of renovation programs that fall within their guidelines. The type of loan depends on the type of work and the total cost for each of them. Keep in mind that both sets of loans can be used for either purchase or refinance deals. With the standard program, only properties that need drastic improvements are considered. Major additions and structural changes would come in under this mortgage type. A standard 203k loan program allows a loan amount that is 110% of the after-improved value. This of course would be determined by the use of an FHA-approved appraisal. An FHA 203K – approved contractor is required to perform the building inspection in order to do the complete work write-up and estimates. A minimum of $5,000 must be borrowed for the renovation work. And the maximum loan amount will be dependent upon the proposed appraised value. Meanwhile, all other qualifying guidelines are going to be similar, and in line with, other FHA type loans.

Using the streamline style program

The FHA 203K streamline mortgage is mainly utilized for rehab work costing less than the aforementioned thirty-five thousand dollars in total improvement costs. Items like basic cosmetic improvements (for example, interior and exterior painting), as well as simple non-structural repair work, can be financed with this type of streamline mortgage loan. However, there is a minimum loan amount requirement. The whole 203K streamline guidelines were created to help make the approval process go smoother and faster. The 203K standard program is thus meant for projects that need major renovation work, whilst the 203K streamline type of mortgage loan is primarily used for simple cosmetic repairs that fall below the thirty-five thousand dollar threshold.

What about non-primary home investment?

If you’re not going to be living in your investment property while renting out one or more other units in the building, then consider a different style of renovation financing. There exists a unique wraparound loan that has been around for a few years now. It came about as an outgrowth of the 2008 financial crisis. I have written in a prior article here about this type of product, noting that “for many years now investors have had only one choice when it comes to investment property loans that allowed for renovation cost wraparound financing. These types of loans are used so you can incorporate the fix up costs to renovate the property into the total mortgage for the house. This type of loan is called the FHA 203K renovation loan. The problem in the past with this form of loan is that you had to occupy at least one of the units in the building you were purchasing.”

The Homestyle Renovation mortgage

I went on to say that “for most investors, if you were not going to live in the investment property, this type of loan would not be available to you. In addition even if you were purchasing a multi-family house under five units, and if you were not going to live there, this type of loan would not be for you. It would only work if you’re going to live in one of the units.” I then mentioned how Fannie Mae created the Homestyle Renovation loan. It came into existence as the federal government attempted to help banks lessen their inventory of foreclosed properties. I noted that “as an investor, you can purchase a property and wrap the renovation costs in with the total mortgage. And you don’t have to live there.”

Why buy with all cash?

The name of the game is leverage. It is through leverage that you will be able to grow your rela estate holdings in the future. And the Homestyle Renovation mortgage allows you to greatly increase your leverage on any given property that requires a good deal of repair work. Instead of utilizing your own cash reserves, better to use a lender’s – if they are willing to supply it, that is. I have previously noted how this concept “frees up your other capital for purchasing other properties. This Fannie Mae Homestyle Renovation loan can be used to purchase basically any house, condo or townhome, or multifamily property. And the property can be in any condition, and loans will typically carry loan to value ratios in the 50 to 75% range, depending on the property.”

Some advantages of using the Homestyle Renovation loan

One of the major advantages of the Homestyle loan compared with the FHA 203K is that Homestyle is a conventional Fannie Mae mortgage loan. In most places that means the loan limits in most places are $417,000. Besides allowing for higher loan limit amounts, the Homestyle program (as noted above), is available for property investors. Naturally, FHA mortgages are intended only for owner-occupants, and to be used as a primary residence. Another key advantage of the Homestyle product is the mortgage insurance premium savings. FHA loans have private mortgage insurance (PMI) associated with them, regardless of the amount you put down. Even if you do put 20% down on the property, you still have mortgage insurance on a FHA 203K. Unless your refinance, that insurance will continue to be paid – for at least a minimum of five years. However, with Homestyle, just as with other conventional loans, the mortgage insurance will get reduced over time, and will go bye-bye once you reach the twenty percent down level. Your overall savings will be substantial the longer you hold your property.

Other advantages of the Homestyle loan…

In addition, the Homestyle loan has no restrictions on the type of work performed on the investment property. So, for example, if you feel you can add tremendous value to the property by adding a pool, since the location can take the added value a pool confers (assuming there are many similar properties with pools already there on the same block), you can use the Homestyle to finance this type of improvement. Not so with FHA 203K loans, which do not allow “luxury” items to be financed. For all these reasons, the Homestyle type of loan offers many more advantages than the FHA 203K mortgage program.

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The Current Cap Rate Outlook

The mystical cap rate…

I have written here about the basics of the somewhat mystical ideal of the capitalization rate. I have noted in my article “Cap Rate For Dummies” that the cap rate is “a simple tool to measure the annual rate of return on your property investment. Different geographical areas will have different CAP rates. In general, the more in demand an area, the greater the CAP rate.” For a refresher on these basics, including a cap rate definition and a simplified explanation of what is cap rate, you can check out this article here: http://investinginproperties.org/rental-investments/cap-rate-dummies/.

The current trend

The trend for cap rate real estate over this current year has been somewhat downward however. What I mean is that you should expect a lower cap rate on your investment properties since most investors, including large hedge funds, for example, are buying properties and expecting less returns than in prior years. That is to say, their cash on cash return has been trending slightly downward. (Remember to use our cap rate calculator in the tools section here, or any other online cap rate calculator, to help you crunch your numbers on any given potential property acquisition.)

Predictions holding strong

As noted in an article from Urbanland.uli.org published earlier this year predicting this trend (“Six Trends in Commercial Real Estate to Watch for in 2015,” by Peter Burley and David Lynn, January 5, 2015), the authors guessed correctly that multifamily houses would retain their high popularity with investors. They said that “multifamily transaction volume has reached pre-recession levels, outstripping office transactions for the first time in ten years, as real estate investment trusts (REITs) and pension funds have fed a fierce appetite for the multifamily sector.”

They went on to predict that “the pace is unlikely to slow anytime soon. Apartment demand has been—and is expected to be—robust, supercharged by the shock waves of the recession and by strong demographic trends that are only beginning to manifest. But most interesting is their conclusion about the current state of cap rates. They went on to say that “as values moved ever higher, cap rates fell back toward 6 percent, close to where they stood in 2005 and 2006. Most deals have been concentrated in larger urban markets, such as New York, Washington, Los Angeles, and Chicago, with considerable focus on the echo boomers, who are partial to the amenities of an urban lifestyle, and their parents, who are realigning their housing needs toward walkable surroundings and mass transit.”

The interest rate effect

In their summation, they concluded that property investment would continue to remain robust, even with slightly declining cap rates. This is namely because positive cash flows continue to be impressive with continued high demand from tenants, both in the residential as well as the commercial sectors. Here’s what they predicted about cap rates at the beginning of this year…They concluded that “investors are moving into an array of asset choices in a widening number of markets as they seek ever more attractive yields. Interest rates do not appear ready to rise substantially in the near to medium term (especially in light of the Fed’s ongoing accommodative stance and massive deflationary factors gathering momentum), and cap rates—even in many secondary markets—will continue to compress, creating negative spreads in some larger gateway markets for the first time in many years—a worrisome sign.”

Fundamentals continued to improve

However, for all their fear-mongering, the markets have held up this year despite the cap rate downturn. They ultimately predicted that “while new construction has begun to pick up in a few areas, new product does not appear likely to offset positive absorption trends. The outlook for 2015 is that commercial real estate fundamentals will continue to improve—but will its popularity, as evidenced by ever-increasing investment flows, create the conditions for another pricing bubble?” The answer to date? No. I can foresee that next year pricing bubbles may occur in several major U.S. cities, but not until the Fed raises interest rates. Of course, the Fed has hinted recently that they may do so, possibly as soon as December. Property investors will by and large be taking a wait-and-see, cautious approach and attitude toward their property acquisition strategies for 2016.

Capital appreciation

In addition, make sure you always keep an eye on the capital appreciation rate in any given area you’re searching in moving forward. As I’ve noted in a prior article here, “it’s the holding and growth investment property tips of the marketplace of houses surrounding your building that will add value to your property in the long run. Be very mindful of this fact.” And don’t forget that your year-to-year cash flow is obviously important to paying the bills and allowing yourself a profit on a regular basis. But it’s when you are ready to sell the building that most of your profit should be made.

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Figure Out Your Property Investing ROI

Using simple math to locate the best properties

You think you found an excellent potential rental property to acquire. Now it’s time to crunch your numbers to determine how much you should offer for it. If your return on investment (ROI) looks good on paper, then by all means move ahead and place an offer. (You can also use a basic investment property ROI calculator. The one I supply on this site is quite excellent.) You’ll find with experience, you’ll be making many offers every week in order to arrive at one good deal. By determining your property ROI on each potential investment property acquisition, you’ll find that you’ll be able to compare it with other properties, as well as other assets too.

What’s the ROI of my investment property?

First, start with the rent roll…Let’s examine the income side of the equation, namely, the rent roll. If the rental property you’re considering making an offer on is already fully rented out, then you obviously won’t have to impute a projected amount for any existing vacancy. However, make sure you’ve confirmed the actual rent roll by asking to see copies of the seller’s leases with his tenants. In addition, check to see that they are indeed current market rents. You don’t want to have a seller’s friends or family receiving some lesser rent as a break for their relationship with him. Be sure the gross monthly rent is an actual rent, and not a made-up one, designed to help the seller increase the price for his property. If you feel an actual rent is way under market value, then you can adjust your numbers accordingly, as long as there are no long term leases associated with the property that are currently in place.

Due diligence

Part of your due diligence is to check on what constitutes market rent for each of the units in the building. For example, try checking out ads for other, similar units currently being offered for rent in your area, as well as visiting some of them to make sure they are similar to the property you’re considering making an offer on. Ads can be located in your local papers, Craigslist, or other online classifieds for your area. Also check with local real estate agencies to see what they have listed for current rentals.

Sites like Trulia, Zillow or Realtor.com can also provide you with this invaluable information. You can also obtain prices of actual rentals – what the units actually rented out for, through the same sites and/or your local realty agency. Most multifamily or apartment unit rentals tend to rent for the same amount, or slightly less than their advertised rents. However, in the case of single family home rentals, be sure to check for their actual rental price, since they may have a much larger disparity between advertised and actual rents. Also, if you feel you can make some modest renovations and repairs to bring the units in the building more in line with current market rents, then figure on the higher rent roll as well.

The expense side

When you’ve got your rent roll numbers down, you can next concentrate on the expense side of your pro forma income statement. From the top, you’ll state your total estimated gross monthly income. On the other side of the ledger, you start subtracting all your monthly costs. These include your fixed costs like property insurance, taxes, any property management fee, homeowners association fees, and other maintenance items that you are responsible for. This may include landscaping, snowplowing, or, in some cases, heat or water charges. As with the rent roll, be sure to ascertain the exact expense figures. Double check the seller’s numbers by asking for proof of all his prior expenses. Then, pore over them again as a means of double-checking his numbers.

Don’t forget your vacancy rate

It is critical to never forget to include a rate for vacancies in your particular area. When a tenant’s lease ends, and you begin looking for another replacement tenant, you’re going to have a vacancy. Maybe it’ll only be a couple weeks…Most usually it will be at least a month. In a good area where there are many tenants available (as in an urban area), a standard vacancy rate would be 7%. In a more rural area, where tenants are harder to come by, you may want to bump up this figure. Either way, you’re going to have some vacancy when a tenant leaves, and you need to build this number into your calculations to show an accurate picture of cash flow over the life time of your ownership of the particular investment property you’re analyzing.

Mortgage costs to be added in…

You’ll also need to add in your total monthly mortgage amount, assuming you’re not paying all cash for the rental property. Consider the fact that property investors are charged higher interest rates than homeowners…usually about one to one and a half percent higher on average. Also, expect to make a higher down payment than a conventional home loan. Thus, instead of twenty percent down for a conventional home loan, non-owner occupied rental property can start at twenty-five to thirty percent down in most cases. (With poor credit, it can go up to forty or fifty percent down, depending upon the lending institution and their lending standards.) You’ll then need to subtract your mortgage payment based on what you intend to offer on the property to determine your net cash flow per month. Naturally, if you’re paying all cash, there would be no mortgage payment figure to subtract. The greater the positive cash flow it shows on paper, the more attractive the property will be to make a bid on.

Figuring your return on investment

Now, to determine your return on investment (ROI), you’ll need to divide the annual positive cash flow amount by the expected total amount you’ll be putting into the property when you buy it. This will include your down payment (or, the total amount if you’re paying all cash) plus all closing costs on the purchase. This ROI is also sometimes referred to as your “cash on cash” return on the investment property. It will enable you to compare buying this particular asset with other types – whether they be another property you’re interested in, or other investment choices like REITs, stocks, bonds, etc. Of course, this simple analysis does not take into account the other benefits of property ownership, like market appreciation, tax benefits that include the ability to depreciate your asset, and the overall barrier against inflation that property usually confers on investors.

An example of a cash return ROI

As an example of the cash on cash return method, consider you want to acquire an investment piece of real estate for $500,000. Assume the property will throw off a conservative positive cash flow of $15,000 annually. If you put 30% down on the property, and therefore invested $150,000 of your own money, the return on investment would be 10% ($15,000/150,000). ROI’s above eight percent would make for excellent investment property returns these days…

Unless you’re specifically trying to offset other income by buying negative cash flow property (where the aim is to use investment property as a tax shelter), you shouldn’t be considering wasting your time on investment properties with cash on cash returns below five percent. There’s simply too many things that can go wrong for you to accept a smaller ROI investment property. Always remember to analyze your numbers conservatively, and definitely stay above this five percent ROI level. This simple method will then hold you in good stead as you move forward in making new property acquisitions.

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