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So you want to build a real estate empire?

So you’d like to be the next Donald Trump. And maybe you think buying investment property will be a nice, secure way of achieving some kind of financial “freedom.” Well, the reality is that beginner property investors tend to get overwhelmed very easily at the prospect of where to start their investing adventures. Like any field with an overload of information available online, especially with the best way to do something as nuanced as property investing, it is easy to stop before you even get started.

How best to start the process? Simple. Treat it like a process, of course! Take step one, complete a few simple tasks, then move to step two. And repeat. Here are the most important steps to follow. Just know you don’t have to become an expert overnight at any one of these steps. Just accomplish a few tasks in each step, and then move on. Do them in order, and you will most assuredly become a property investor!

Is property investing right for you?

The first step is actually the most difficult. It requires you to be honest with yourself. Not an easy task in the least. In order to become a property investor, you’ll need the right temperament. Will you have the patience to deal with tenants? With emergencies? Do you analyze data well? Are you comfortable with numbers? Does risking a large portion of your savings in something new make you queasy? Be honest now. You’ll need a great deal of inner fortitude to whether the storms that most assuredly will arise as a property investor. Are you calm and level-headed? Or flighty? Property investors need to be unemotional about their property purchases, separating business decisions from personal whims. Can you do this? Again being truthful about yourself, with yourself, is crucial here.

Depending on your current financial situation, family status, and existing job security, are you still ready to move forward into unchartered waters? Do you have a good idea of your borrowing abilities at this point in time? Do you even know your credit score? Taking a deep inventory of your current financial health (not simply your assets) will lead you to a decision as well.

Setting realistic goals for yourself

This next step is another imperative. Ask yourself what you want to achieve as a property investor. Some common goals for investors include capital growth (when the property increases in value over time), cash flow (or the amount the property will throw off as net income from rentals), tax advantages (including offsetting gains from other sources), and diversification (to even out your overall portfolio of investments from other asset classes, that may also include stocks and bonds). Deciding which objectives are most important to you will help you move on confidently to the next step in the process, and will help to hone your expectations from property investing in general.

Doing your homework

Learning more about the process from sites such as this one is a good way to get yourself plugged in, and thinking of the intricacies required in each phase of the property investing process. You should also have easy access to your local Multiple Listing Service data, or at the very least, use the data from sites such as Realtor.com or Zillow.com to help you analyze existing trends in the neighborhoods you’re considering buying in. There’s a wealth of information on these sites. Enough to have you numbers crunching for quite some time…

Assembling your crew

Due to the relative areas of specialization within each phase of property investing, and their respective complexities, you’ll want to assemble your own personal “crew.” A crew of professionals that you’ll go back and use with each succeeding project you undertake. A crew you will implicitly learn to trust to offer you their expert advice. They will save you many times in your professional property investing career.

This crew will feature, but not be limited by, the following professionals: a real estate agent (preferably acting as a buyer’s agent), mortgage broker/banker, accountant, attorney and licensed house inspector. Eventually, you’ll also learn to gather your other “crew.” Your workers who will help do any repairs or rehab work on any property you invest in. This crew will consist of a contractor, and trades people like plumber, electrician, mason, painter, floor specialist and landscaper.

Searching for properties

Before you hit the pavement looking at properties, you’ll want to do your research to winnow down only the best property investment prospects available in your area. For this, you’ll need to have a good idea of the price range you’re looking in, the kind of property you want (multi-family, single family, residential, commercial?), as well as the exact geographic area you decide to be looking in. You’ll also want to crunch estimated numbers to determine if the net cash flow justifies even making an offer on the building. Too high an asking price means the seller is not being realistic, and that’s not someone you traditionally want to deal with in a negotiation. Read: don’t waste your valuable time.

Managing the property

Finally, once you’ve acquired a property, you’ll need to decide if you’ll be managing it or if you’ll be hiring a property manager to do so. Obviously, hiring a manager comes with costs (usually, ten to fifteen percent of total rent roll). Most beginners tend to cut corners, and feel they’ll be able to “learn as they go.” And they end up acting as their own property managers. I say: try it. Maybe you’ll have the aptitude for it. And if not, you’ll know that a property manager is in your future…or your very near future. Acting as your own manager means finding your own tenants. Be sure to read my articles here on tenant selection. This will prove very helpful and informative when doing it yourself. This is especially true because choosing a bad tenant can bring down your whole business. And we wouldn’t want that, now, would we?

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Commercial versus residential loans

So you’re considering the big move up to some form of commercial property investment. This could mean retail – a single store or small strip mall, for example,

or office building or warehouse or light manufacturing building as well. It could also mean any residential multi-family housing that contains five units or more. Since commercial space is traditionally a much greater leap in pricing than single or small multi-family residential housing, how best do you finance the potential investment?

Most individuals don’t have the deep pockets required for such serious cash outlays relative to simple residential buildings. And I have advocated in previous articles here for the concept of partnerships as a way to pool investor money for larger and more lucrative investments. But at some point, if you’re going commercial, you’re going to require a commercial mortgage to handle the ability to make the deal happen. So where is the best place to look, and how are commercial loans evaluated?

Commercial lending departments

Most banks offer commercial loans, but they are traditionally processed in a separate department from residential lending within each bank. Rules tend to be

more stringent than residential loans, and a common axiom is that interest rates associated with commercial mortgages will definitely be higher than for residential loans. In addition, while amortization times may compare favorably with residential loans, expect much shorter time limits on when the mortgage will come due, and so balloon payments should be expected within five to seven years on most commercial loans. Thus, you can expect your monthly payments to be comparable to residential loans due to longer amortization schedules, but you will have to prepare for that short term balloon pay-off of the loan.

Debt to income ratios

Another key difference that commercial loan evaluations require relative to

residential lending, include a greater weight placed on debt to income ratios. For residential mortgages, one’s personal income is paramount in determining whether you may qualify for a loan. In commercial lending, the building’s ability to throw off cash flow through its net operating income is paramount. So all your income statement documentation (or pro formas if the building is new) must support this positive net cash flow. A lender will look at the building’s debt service coverage ratio (DSCR) as a key determinant. This ratio is a simple measure that looks at the projected net operating income, then divides it by the mortgage payment amount. Most DSCR’s need to come in at a minimum ratio of 1.2 as a general rule of thumb in commercial lending.

Loan to value ratios and credit scores

In addition, lenders will look at the loan to value ratio you’re applying for, and in most cases, 70% LTV would be the maximum ay bank will allow. Of course, the

lower the LTV, the greater the likelihood of your obtaining the loan – simply because the bank’s risk is reduced when you have more equity at stake in the property. The lender will also look at your credit score to get a good idea of how you’ve handled credit through your lifetime. Obviously, the higher, the better. Minimum commercial credit scores need to be in the 720 range…but your chances for obtaining a commercial loan increase greatly as your approach the upper end, or 850.

Landlord experience

Another key ingredient in a lender’s commercial loan department deciding on your

loan approval, will be your previous landlord experience. General business experience (if you have already run a successful business) will also be taken into account in a very positive way too. You’ll want to show proof through examples and documentation of your past landlord/business experience. Showing that you’ve been successful in the past will be a boon to any attempt to obtain a commercial loan. It also helps to write up a separate business plan for your potential new investment building to help sway a lender’s commercial loan officer. The more professional and business-like you come off, the greater your likelihood that a lender’s loan officer will see that you’re treating this mortgage seriously, and that will afford you a greater opportunity and chance to be rewarded with the mortgage loan.

Hard money lenders as last resort

If all else fails, and you are unable to obtain a commercial loan from a bank, there of

course, hard money lenders out there in droves. I have previously written several articles here on where to find them and how to apply with them. But – they are only to be used as a last resort. Their rates and terms tend to be ridiculously onerous – especially since they know they represent your last ditch attempt to make a commercial deal happen. Only utilize them if the deal still makes sense after being initially turned down by a bank.

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Property Investing Advice For The Minimalist