investment properties

Is Buying A House A Good Investment?

A cautionary tale to heed…

In trying to answer the age-old question, “is real estate a good investment?” I’d like to submit this little tale of woe about the “professional” property investor who thinks he knows what he’s doing. I recently showed a house an investor had renovated to a young couple I represent as a buyer’s agent. The house was a simple 1915 Cape Cod style home. For the most part, the investor had done a fairly decent rehab job on the property. He claimed to have done all the work himself. This is a rarity. In my experience, most people who invest in homes traditionally create their own crew to work with from project to project. Not this guy.

Self-selling investment properties?

On top of this, he was selling the house himself. Turns out he had listed it with a real estate agent a year earlier, and committed the deadly sin of overpricing from the get-go. So it just sat there. No offers. No nothing. He kept reducing the price several times. Ultimately, after six months, in the dead of Winter, he took it off the market. And in the Spring, he placed it on the market by himself, with a much lower, more realistic asking price. Problem was, he was still over-priced for the market and the work he had done. But I could tell he had boxed himself into a corner. He was trying to price the property based on what his costs were. Not what the market would bear. So, basically, he was sunk.

The finer points of owning an investment property

As he showed us the house, he also proudly showed his Building Permit and final Certificate of Occupancy he received for successful completion of the project. Check…and check. At least the town felt it safe. So why didn’t I? Most times, I can forgive stupid-looking remodeling work. This guy had redone everything. But his upstairs full bathroom offered the tiniest of a vanity, while utilizing a five foot wide shelf for….I have no idea. It was free form…unconnected to anything. Stupid. But you know, investors can be stupid and still make money on their flip projects in spite of themselves – and their lack of understanding of what buyers really want.

This guy was an idiot, however.

We went down into the basement, where he had a brand new boiler, water heater and well tank and pump. All were on raised blocks. The concrete flooring was all newly done. Looked great. New solid support beams on the new concrete. Fantastic. And a huge pond of water on one side of the basement leading to nowhere. Oh – and a lovely sump pit with new sump pump doing nothing, sitting on the other side of the basement floor… “Oh, that – probably coming from the well outside,” he volunteered. WTF????

Learning the hard way…ouch

So what does it take to be a property investor, preferably a good one? Well, not what this guy did. This fool had spent easily over fifty thousand dollars on the renovation, but he allows his support beams to get drenched from some major water problem he did not choose to address? He claimed to have been doing this sort of rehab work for many years on many different projects. I don’t see how. For a few thousand dollars more, he could have installed a French drain in the basement, solving his water problems. (A French drain is a basic interior drainage system.) Now, any buyer’s home inspector is going to send out red alerts about what major water issue could be confounding the property surrounding the house. Could be a high water table. Could be a well leak. Could be any number of things. A French drain would by an easy solution. Instead, he does all this work, and has trouble selling his investment property, due simply to his stupidity.

And he’s still trying to sell it…

Let this tale of woe be an example to any beginner property investor. This particular investor may know how to do renovation work himself (and clearly, not all renovation work). But he knows nothing about marketing a house. Indeed, he also knows nothing about identifying what buyers in his area are truly looking for. If he did, he’d know what to give them. In addition, he’d know his target market, their price range, and the price his renovated house would need to sell for – before he ever acquires the house to flip! In so doing, he can best plan his renovation work, materials needed, and work to be done, so that he can price based on the marketplace – and not on what his overall costs end up being. Certainly in his case, and sadly at that, he will most definitely be taking a substantial loss on all his efforts.

Beware older home rehab projects

As in this example above, older, period houses usually come equipped with renovation costs that can skyrocket out of control very easily. Costs that the average property does not share, and that you may not properly account for when you crunch your numbers, and come up with your overall rehab budget. It would be sad indeed to purchase an older house at a great price, only to discover you’re sinking in red ink as your fix-up costs spiral out of control, and way beyond what you originally planned on.

Do you have the business acumen for older homes?

I have written in prior articles here about purchasing older homes, and their pitfalls. I have noted that any property investor should “consider what an older house brings to the table: sash windows that are thin by today’s standards, and also are quite leaky – producing many drafts, thereby increasing your heating costs. Also think about the costs of rewiring hundred-year-old electrical wires and circuits throughout the house. And how about replacing antiquated plumbing lines and fixtures as well. On the whole, your repair costs could run 25% to 50% higher on an older property than on a newer one.” I have gone on to recommend that the best investment property search results can usually be found through investing in newer houses that need less repair work to begin with, and which will cost less to maintain in the long run.

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Different Loans For Investment Properties

Many options abound…

There are many ways to finance investment properties. If you’re not paying all-cash for a property, and you want to utilize leverage to greatly increase your prospective ROI (return on investment), you’ll find many options available to you. Which one you choose is a matter of personal taste. And deciding among different investment property loans available, that will suit your temperament and pocketbook, will be critical to your bottom line.

The OPM concept

I have always been a big advocate of trying to use OPM, or other people’s money. Certainly, as you search for investment properties, it is always a smart idea to ask each and every time if the seller will carry paper – that is, if they will hold a mortgage note on the property you’d like to purchase. This may be the most advantageous form of investment property loan you can obtain.

A key example of seller financing

As an example, I once purchased a four family house where the seller was willing to offer a first mortgage if I put twenty percent down on the sales price. Now, he wanted to get his price, so at first blush, it looked like a terrible deal. But when I asked if he would take my terms for a mortgage, the deal became a whole lot better. At the time, he was willing to offer a first mortgage with an interest rate almost four points less than any commercial bank would have offered. In addition,

investment property loans from banks traditionally require at least thirty percent down by the buyer. So I was able to leverage an additional ten percent by going with the seller financing. This was a great way to get a business loan for rental property.

On top of this, the seller offered me a thirty year amortization schedule, with a ten year balloon…plenty of time in which to reap the

benefits of an unbelievably low monthly payment, and resultant high cash flow – and even greater net income. This four family house quickly became a huge cash cow for me. And I had plenty of time in which to refinance to a traditional loan. So while I ended up paying about ten percent higher in market value than the property was worth, the difference was more than made up for (while I held the property) in net cash flow income and capital appreciation when it came time to sell. So my advice: if you can find seller financing, take it. And don’t be afraid to give the seller “their” price” in return for “your” financing terms. It could end up being a major financial windfall for you in the end.

Going the hard way

Sometimes it makes sense to go the hard money lender way of financing when looking for a loan for investment property. If you have poor credit, or poor cash reserves, you’ll pay for the privilege of doing business with hard money lenders. Their investment mortgage rates

are usually at least double conventional mortgage loan rates. And their points charged (pre-paid interest) can be triple or quadruple conventional points charged.

I have written in a prior article here how “the average hard money investment property loan is supplied with capital put up by private investors – usually as a pool of money that is used to drive much greater profits for its investors. This private capital is traditionally unregulated, which gives the hard money industry a kind of “Wild, Wild West” feel to it’s practices and reputation. Pejoratively, many consider hard money lenders as sharks feeding off the misery of those in bad financial straits. As a property investor, you will certainly need to approach any hard money investment property loan with a great deal of caution and foresight prior to signing on the dotted line.”

The typical hard money loan

That said, don’t be totally scared off by trying to obtain a hard money loan. You need to know ahead of time that typical hard money loans carry interest rates that can run anywhere between 12 and 18 percent. Balloon payments are de rigeur, and these mortgages usually come

due within 1 to 3 years. In all but rare instances, hard money lenders require being in the first mortgage position, so they can get their money out first if you default.

In addition, typical loan-to-value (LTV) ratios on hard money investment property loans range between 50% to 65%. And this LTV is based upon the “quick sale” market value of the property…that is – what the property will fetch today – not three months from now after you’ve fixed it up. Another potentially scary cost to take into account are points (up front interest charges). Typically, they can run anywhere between 4 to 8 percent of the total mortgage amount.

Going the more conventional route

As I have noted in the past here, “most conventional investment property mortgages are standard income and asset verified loans. They can be conventional 30 year terms, or short-term adjustable rate mortgages (ARMs) with balloon payments. These loans usually require

a minimum of 30% down in most instances. In that case, you’d be obtaining a loan of 70% of the purchase price. Your loan-to-value ratio (LTV) would therefore be 70%. When buying investment property, you’ll usually want to try to obtain the greatest return on investment (ROI). Leverage (also known as cranking) is one of the ways you can purchase multiple properties over time, and thereby maximize your ROI. Depending upon your credit rating, as well as the type of property you’re purchasing, the down payment required may be higher, and could go up to 50% – and therefore your LTV would be a low 50% as well. In addition, the points charged on the loan (pre-paid interest) are roughly twice as high as for a conventional home loan.”

A word about commercial loans

If you’ll be looking to acquire strictly commercial buildings (these include office buildings, retail stores, warehouse buildings, or rental

investment property type - apartment building

homes or apartment buildings with at least five units in them, the you’ll definitely need a commercial loan from a lender. Lenders have separate divisions to evaluate and extend credit on these type properties. Since commercial properties are much more specialized, their inherent risk need to be evaluated as a niche within most banks. Unlike conventional residential mortgages, you can expect that underwriting requirements will be much more stringent by comparison. For example, a commercial lender will be poring over your financial statements with a fine toothcomb, and you can certainly count on much more scrutiny of your assets and income, as well as the existing income statement of the property you’re considering purchasing. Also expect rates and points to be higher than standard residential loans.

Going the personal home equity line route

I have also made note here before how it’s a good idea to utilize a home equity line of credit (HELOC) on your own home as a way to leverage investment property acquisitions. First of all, it’s a very inexpensive

way of financing. Interest rates are usually as low as you can obtain from any lender. Second, the interest is tax-deductible as a business expense. And third, you can choose to make interest-only payments monthly on the outstanding balance, usually for a period of ten years, knowing that you’ll have a balloon payment looming down the road. Most times, the balloon will be incorporated into a second ten year payback period, where you’ll be making monthly principal and interest payments. In this way you can utilize the equity in your home to create a credit line for further property investments. You’ll find this a great way to finance further investment property acquisitions. Also, you can structure the loan as a revolving credit line. So when you sell a property, you can pay off the credit line. Then you can take it out again when you’re ready to purchase the next house.

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The CAP Rate Controversy

The cap rate demystified…

When evaluating several properties to purchase, whether you’re investing in rental property or commercial real estate, experienced property investors use a cap rate formula to help crunch their numbers. Ultimately, the cap rate (more formally known as the capitalization rate) aids the investor in analyzing what property makes the best deal. It is used simply as an indicator – a directional arrow – as to which property SHOULD offer the best yields, and throw off the most profit for you in the future. However, a controversy has brewed of late about how much investors should rely on the cap rate.

What is a cap rate exactly?

A simple cap rate definition would be that the real estate cap rate is a calculation that measures the annual rate of return for any given investment property, or set of investment properties. The cap rate for any geographical area will differ, with the general axiom that the more in demand the area is, the greater the cap rate will be. These hotter markets tend to offer yields with cap rates around ten percent or more. However, low demand areas may throw off cap rates as low as four percent.

How to calculate cap rate

I have previously written about how to calculate the cap rate here. I have noted that the calculation for the CAP rate is easy; simply follow this order: ascertain the annual rent roll from a given investment property (making sure to double check and confirm any seller-given figures). If there are vacant property investor units in the building, you’ll need to ascribe a correct market rent for each unit. Make sure you check out several Realtor’s estimates, Craigslist listings, and have actually visited like units in other buildings to help determine accurate rent roll pro forma numbers. Then add up all the expenses associated with the building, on an annualized basis.

I had also mentioned that you should not forget a vacancy amount (usually between five to ten percent of total rent roll), as well as maintenance, taxes, insurance, electric, heating, and any other utilities the tenant will not be paying directly for. Of course, unless you’re paying all cash for the property, you’ll need to add in your mortgage payment on an annualized basis as well. Once you subtract the total expenses from the pro forma total income, you’ll have your (hopefully) positive cash flow number. This, of course, is your net income.

Cap rate calculation

Now simply divide the net income figure by the amount the seller is asking for the property. (As an example, if a property that throws off $50,000 in net income has an asking price of $500,000, then the CAP rate would be $50,000/$500,000, or 10%.) To reiterate, the greater in demand the area, the greater the CAP rate should be. In addition, you need to set minimum standards for yourself. Some investors won’t buy anything with a CAP rate below 5%. That’s up to you. But be sure to use the CAP rate to help you back into the highest amount you would offer for a property. The CAP rate can represent your rate of return on any given investment property.

At the beginning of your investment property search, a novice may initially want to use pen and paper, however, there are many real estate investment calculator programs readily available online to do the calculations for you. Simply plug in your specific numbers to software programs that act as a cap rate calculator…one of them is right here in the Tools section – and let them do all the numbers crunching for you…

Here’s the crux of the cap rate controversy…

Some real estate investment pros believe the cap rate to be too short-sighted…like looking at a landscape with a telescope. One such critic of cap rates is W. Grayson Powell, a broker and managing partner with Coldwell Banker Sun Coast Partners. In an article he wrote last year ( “Property Investment Cap Rates Aren’t Always Accurate, “ Wilmington Biz.com, September 1, 2014), Mr. Powell noted that “cap rates are solely based on property income performance for the current year. Cap rates don’t take into consideration factors that may affect property values five years or 10 years down the road. Because cap rates only deal with what a property is producing now, it’s a very shortsighted and narrow view of property value and should not be the number on which you ultimately base your purchase price.”

Like buying a used car?

He goes on to compare cap rate analysis with your decision-making process when buying a used car. He adds that “cap rates on income properties are often like the list price of a used car. They can be an indicator of the estimated value of the property and give you a starting point for your search, but there is more information and more work to be done before choosing a property and making an offer.” Mr. Powell then notes that “there are many factors to consider when determining and fine-tuning property valuations. Here are a few of them:

How good are the existing leases? A reputable grocery store with a 20-year lease is low risk; but a restaurant that’s empty most of the time with one year left on its lease is much riskier.
Is there a good tenant mix and do they effectively serve the needs and interests of the surrounding community? The demographics of a community can change, and the types of tenants must evolve to match the needs and demands of the people in the area.
What is the age and condition of the property? How soon will you have to pay for upgrades and repairs?
What is the current housing market and financial environment like? Are rental rates rising or falling?
What are the current interest rates and what are they expected to be in the coming months?
Are operating and management expenses rising or falling? Here’s a hint – they’re usually rising.
What are the historical occupancy, retention and vacancy rates for the property over the last 10 years to 15 years?
What are the tax implications of buying a particular property?”

Finally, he goes on to recommend “analyzing the cap rates and the values of each individual tenant, rather than looking at the property as a single entity. This provides a better picture of the actual risks that exist within a given property.”

The fallacy of his argument

My opinion is that, while all of his assertions are correct, he loses sight of the main reason why a property investor uses the cap rate: namely, to analyze what the investor should be offering to pay for any given investment property. Obviously, this will be highly subjective from investor to investor. However, keep in mind that, when a piece of investment real estate goes on the market for sale, the asking price of that investment property is pegged to a point in time. It’s not the asking price ten years from now. And the asking price usually bears some relationship to the prior year’s income performance of the property….and not to the performance in ten years.

And this is the main fallacy with Mr. Powell’s argument. I think it’s absolutely fair to consider a property’s short term performance utilizing the cap rate in so doing – because the cap rate will reflect the underlying value of the property today – when the asking price is set. After all, the asking price is not set some time down the road. As I mentioned earlier, you’ll be taking into account vacancy rates for the area when you figure your cap rate. And you’ll also be analyzing the future revenue potential of a property based on your expectations of what renovations will be needed to bring in current market rents, or how the rental market in general will perform down the road as well.

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Best Ways To Handle Tenants When Owning Rental Property

Saving on investment property expenses

There are many ways a property investor can save on expenses when owning rental property. A major expense trimming can be had by simply searching for the best investment property mortgage rates. After all, finding excellent terms on any investment loan can save an investor many thousands each year. In addition, locating the optimum prime properties that can be purchased under current market valuation is another huge savings. However, buying a rental property and then knowing how to choose and handle the right tenants can realize the most cost savings of all.

Set your ground rules with your tenants

I always advocate for a written lease when renting out your units. Month to month rentals are fine – however, consider at least placing it in writing. A written document, even for a month to month rental, helps solidify your expectations. It also makes it more difficult for a tenant to negotiate with you down the road. In the lease, you’ll need to include exactly what you require for your rental: the monthly rent, the day payment is due each month, the penalties for late or bounced checks, and all the negative consequences (read: the eviction process) should the tenant break any of the rules.

Stick to the rules you set

Once you break your own rules for one tenant (as a nicety – giving them a break – just this once), you’ll end up getting into a bad, costly pattern with other tenants. This could prove disastrous to your business. Tenants talk. To one another. Never show weakness (that is, being a nice guy). Once you, do they will, by human nature, start taking advantage of your largesse. Always stick to your guns. If you have not received full rent from any given tenant by the fifteenth of the month, send them written notice immediately. Don’t wait a full month (or worse, longer) before getting tough. Impose late payment fees after the fifteenth of the month.

Evictions – the nuclear bomb of owning rental property

If you have not received full payment and late fees by the end of the month, you must start eviction proceedings against a bad tenant in order to protect yourself, and minimize the damage they are doing to you. Expect eviction proceedings to last up to two months, on average, depending on your local municipality’s court schedule. If you are unfamiliar with the eviction process, you’re certainly going to need the services of a local, experienced attorney you can trust to act expeditiously on your behalf to remove the delinquent tenant. It’s always a gut-wrenching, ugly experience. And obviously, quite costly as well.

Unpaid time

Besides paying for the services of an attorney, there’s the issue of lost rent for the time period until you find a new tenant to replace the delinquent one…It’s not simply the time period that the bad tenant has not paid you. Until you get them out of your building, it’s going to be very difficult to even show the unit to prospective tenants. And many times, a bad tenant, just before they are finally evicted, will perform some form of “revenge” destruction inside your unit. A bad tenant can end up costing a property investor a tremendous amount of money.

Finding the “good” tenants

For this reason, it’s best to find only “good” tenants to avoid this scenario. Make sure you’ve properly vetted them – check their references well. Speak to their current and prior landlords, as well as their work references. Check their credit. Make sure they can afford your unit. To this end, their rent should only comprise no more than 33% of their current gross monthly income, as a general rule of thumb. If you follow these simple rules, you’ll be able to save a tremendous amount in unnecessary operating expenses. In this way you can turn each and every one of your rental buildings into a prime property.

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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.

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Best Tenant-Choosing Tips

Maximizing profits

Attracting good tenants is the lifeblood of any successful rental property investment. And there are some essential rules for attracting these tenants to your units. Keep these tips in mind as you continue buying rental property. These tips will also help keep you maximizing your cash flows when investing in real estate. Remember that you can always be learning new and better ways to maximize your profits in investment properties by becoming an even better landlord.

If you want good tenants, be a good landlord

Any landlord worth his salt will ensure he performs proper maintenance on his rental property. As a landlord, you should not only make repairs in a timely manner on all defects you can see – but also on those you can’t. Remember, that when investing in rental property, since you’re not going to want to disturb your tenants constantly, make sure to ask them on a periodic basis what physical property issues are arising in their units. Is there a new small leak in the kitchen drain? Is their toilet working properly? Any gas or oil odors suddenly present? You need to ask to find out.

And you should be asking these questions about your investment properties on a regular basis. When you keep up with repairs to your investment property, you make your tenants feel more secure about you, as well as making them feel good about staying in your unit. This will aid in future retention. Obviously, the more tenants you can retain year to year, the less work you’ll have to do – since you won’t need to look for new tenants to replace them. Proper maintenance also keeps your overall repair costs down over the entire term of your ownership of the rental property.

Hire a good property manager

If you’ll be using the services of a property management company, make sure you are stringent in your due diligence prior to hiring them. Check out their references, talk to their current landlord roster, and obtain referrals from local real estate pros like real estate agents in your area. Good property managers always stay in regular contact with all tenants. They don’t simply collect rent. It’s their job to maintain good relationships with all tenants. They are proactive at performing property inspections, and will take care of maintenance and emergency repairs as needed. And they will screen prospective new tenants for you as well.

Set realistic market rents for your units

If you set a rent that’s too high, you may profit from the incremental amount above market rent for a short time…but you’ll end up paying for it later when that tenant decides to move because his rent is too high. Again, looking for new tenants is always a costly endeavor. Not only time-wise, but also due to the increased vacancy that occurs every time a tenant moves out. On average, expect at least a month of lost rent due to any tenant moving out. Always make sure you know what current market rents for your area are. Check out your competition for like units. Go visit them. Talk to local real estate agents to get more information as to what constitutes market rents for comparable units at any given point in time. Check out Craigslist listings for rentals in your area. Become an expert on market rents. Know what other real estate investors in your area are charging at any given time.

Likewise, setting rent too low does you no good either. While you may get more takers for your unit, you’re not optimizing your cash flow, as you are giving up the differential between market rent and what you’re charging each month. Remember too that tenants that pay rents under market rate tend to not be so careful about keeping up the look of the unit. Ultimately, they may end up doing more harm to the physical space due to increased wear and tear, and lack of care. Basically, they’ll take much less pride in their living environment when they know they are paying a discounted rate for it.

Beware the professional bad tenants

Tenants that know how to work the system are the ones you’ll need to be most careful installing in your units. While tenants that don’t pay their rent on time need to be evicted as quickly as possible, some states allow the eviction process to last for months. All the while you’re losing revenue due to non-payment. And don’t forget the legal fees involved as well for retaining the services of a good eviction attorney. The best advice here for all real estate investors is simple: make sure you carefully check all references for any prospective tenant. This includes speaking with their previous landlords, running credit checks on them, as well as criminal background checks too. Do this, and you should properly protect yourself from those professional tenants who are gaming the system.

photos courtesy of regulatedtenants.com, iresvegas.com, newhomessection.com, lowesforpros.com, landerassociates.wordpress.com

Bricks And Mortar versus REITs

And the survey says…

A recent survey undertaken by overseas lender Homeloans Ltd. finds that real estate investors tend to choose bricks and mortar properties over Real Estate Investment Trusts (REITs) as the primary vehicle for their property investment funds. The singular reason? Most investors buying rental property prefer the “comfort factor” that a physical property affords them. Read: they want the feeling of security that controlling one’s own rental properties affords.

What the findings mean for small property investors

According to this report, the Homeloans Home Buyer Barometer, about half of property investors who took part in the survey preferred investing in rental property over purchasing shares in a REIT, regardless of the type of REIT (residential, commercial, or mixed). The comfort factor means that rental property buyers feel more secure in navigating their own destiny, rather than leaving it up to other real estate investment professionals to do so for them. They also want to realize a greater chance for capital growth returns, as well as higher cash flows from rentals that these real estate investments provide them.

Location is critical

As usual, the survey indicated that most property investors choose bricks and mortar rental houses that are close to transportation, jobs and local amenities. Naturally, this means central cities are the most popular spots for purchasing rental properties, followed closely by suburban bedroom communities. Rural communities rank last in desirability for rental property acquisitions. This is because rental demand is completely predicated on the proximity of services and amenities for prospective tenants. This also plays a major role in the ability for property investors to have an easier time of selling their properties when they deem it necessary to do so.

Additional findings of the report

The report went on to say that most investors would be in the market to purchase a rental property at some point in the next year. In addition, some 34% of the survey takers claimed they will be making their first rental property buy during this time. Some other highlights of the report indicated that close to one quarter of the respondents had bought their first rental property when they were between the ages of eighteen and twenty-nine. In addition, more than 50% had bought a detached house as their very first rental property.

Many prefer to buy close to where they currently live. About one sixth of respondents wanted the ability to drive by their rental properties on a regular basis to keep an eye on them. Also, about two-thirds of survey takers said they use a property manager, while a third self-manage their own rental properties. And finally, the average number of rental houses owned by the respondents was 1.6 properties.

photos courtesy of tenantscreeningblog.com, itimes.com, moneyaftergraduation.com, lawofficewalterjennings.com

The Current State Of REO Properties

Foreclosure dumps and the small property investor

As foreclosed homes for sale continue in a rapid pace, REO (“real estate owned,” by banks who have completed any given foreclosure process) buys from large hedge funds such as the Blackstone Group over the last few years have created a de facto wholesale-retail environment for these formerly bank-owned properties across the U.S. Though not getting as much press in the past year, buying a foreclosed home, thousands of times over, remains a mainstay of hedge fund buy-ups. States like New York that require legal proceedings for each and every foreclosure home, are now working through their years of backlogged homes that banks wanted to foreclose on. As they come out the other end, so to speak, of the legal process, they promptly go on the market for sale. Small property investors thus have to compete head to head with large hedge funds who are well-capitalized, and can easily offer all-cash for any and all properties they purchase. This is not so easily done with smaller investors. And this gives the hedge funds quite a leg up in the buying process. In addition, it also explains why they have been monopolizing the foreclosure buying industry in this country for several years now.

Making it simple for banks

These large hedge companies will purchase a property (or thousands at a time), and take the foreclosure in as is condition. This makes things very simple for any selling bank to make a deal with them. The hedge fund then hires renovation specialists, and they come in to do their thing right after the purchase is completed. These specialists will do the very simplest, most basic repairs to make the home livable – and attractive to a prospective tenant. Fresh paint jobs inside and out, and kitchen cabinet and appliance upgrades are the mainstays of these quickie rehabs. Then the homes are placed on the market as rentals only. In this way, hedge funds are willing to wait out the current tepid pace of the resale estate market until it comes time to unload their holdings. (In fact, some large hedge funds have been slowly beginning to do so to realize quick profits on their poorest performers.)

All-cash deals are preferred

When banks place huge inventories of their foreclosed properties on the market, you can be assured that all-cash deals are there preference. The safety of the all-cash deal, in which hedge funds tend to be the winners in locking up these properties over the small homebuyer who requires some form of mortgage financing, as well as the speed of the transaction, make it much more worthwhile for the banks to unload their property inventory at deep discounts. In addition, all-cash deals usually don’t require the bank to make any repairs…that is, the buyer is purchasing a property in strictly “as is” condition. Thus, the buyer is taking the inherent risk of finding some major defect with a property – and being placed in the position of having to fix it (at possibly at an exorbitant cost). Naturally, all-cash buyers make very lowball offers to protect themselves in case of this occurring.

The newly created wholesale-retail real estate market

As I’ve noted in a prior article here, hedge funds have just recently been starting to unload some of their poorer performing rental properties back onto the market to capitalize on the currently improving state of the real estate market. This creates a de facto wholesale-retail environment. The hedge funds buy up large amounts of bank REO’s for all cash, do the least amount of repairs necessary, and then convert these homes into rentals. In this way they are acting as the wholesalers of the residential real estate industry. After holding them a few years, they now look to take their gains by placing at least some portion of their portfolios back on the market for either single family homebuyers to acquire, or for small mom and pop investors to purchase. In this fashion they are acting as the retail merchants of the real estate business. Either way, they don’t care much about the communities their properties are located in. And this ultimately can have a deleterious effect on many communities around the country that have been plagued with large percentages of their housing stock ending up as foreclosures over the last several years.

photos courtesy of quickenblog.com, newsone.com, auroragov.org, infrawindow.com, newgeography.com

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