The seesaw swings both ways with leverage
The main advantage of leverage
The main drawback of using leverage
One of the fundamentals of real estate investing is quite straightforward and simple – don’t ever sell any of your investment properties. Once you sell, you’ll have to pay capital gains tax, and you’ll lose the cash flow from the investment (assuming it is positive), as well as losing the ability to leverage your equity in the properties for future investment acquisitions. This third feature is probably the most important and financially productive for your ongoing success as a real estate investor. It truly comprises one of the most basic of property investment fundamentals – namely, using other people’s money to grow your real estate investments.
Never selling any of your rental properties also means you’ll pay stricter attention to detail – like ensuring you always run at a positive cash flow for each property you acquire. I once purchased a four-family house with generous owner financing. I paid slightly over market value for the property because of several reasons. First, I knew I’d be holding the property for the long-term. Second, in return for “giving in” to the seller’s price demands, I secured an incredible below-market rate of interest with excellent terms from him directly. I didnt have to apply with a bank, or pay bank fees associated with closing one of their investment property loans.
In addition, the owner-financing was for a first mortgage with no balloon payment in a short period of time. And because of the term and interest rate the monthly payments were ridiculously low. I knew I had a cash cow from day one on this rental property. I was using other people’s money (in this case, the seller), and I had added another rental mortgage to my stable without incurring any hit to my credit rating for taking on more debt. (Private mortgages do not show up on credit reports). So I left my credit rating intact, and could still use this new property for future leveraging of my equity in it when needed for other rental property acquisitions.
So even though I knew I was overpaying in the short run, I knew I was adding a great positve cash flow to my stable of investment properties for the long term. And by holding onto it, I was deriving the benfits of the excellent cash flow it was throwing off, the ability to leverage my equity in it at will, and I did not have to pay capital gains taxes on it as long as I held it. It was truly a triple winning rental property combination. So be sure to analyze the cash flow aspects of any rental property deal when encountering a “stubborn” seller who “must” get his price. You never know when that stubborn seller may turn a dog of a rental property into a cash flow bonanza for you. Always ask for owner financing to obtain your investment mortgage loan, and see what they say. You could end up with a marvelous real estate investment acquisition in the process.
photos courtesy of houstonmortgagetexas.com, anchorloans.com, zillow.com
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.
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.
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.
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.
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.
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.
So make sure you do your research into your geographic area as intensively as possible before looking to buy investment property for flipping. Keep a keen eye on the most important statistic: the average days on the market in your area. If it’s too high, consider purchasing in a more fertile area for flipping…Even if it means you’ll have to travel farther each day to oversee the renovations. Just don’t get stuck holding a flip property in a bad economic environment. Your carrying costs (taxes, insurance and mortgage) will eat up all your potential profits – and then some.
photos courtesy of tmgnorthwest.blogspot.com, cbsnews.com, metrosdrealty.com, foreclosurequestionsguru.com, foreclosuredatabank.com
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.
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.
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.
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.
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
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.
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.
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.
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 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.
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.
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).
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.)
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.
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
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.”
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 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.
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.”
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
When I was just starting out buying rental property, an investment opportunity came on the market that totally captured my fancy. It intrigued me so much, I came very close to acquiring it – and making a major error at a very early stage of my real estate investing career. The property was an eight unit set of townhomes, all attached, and owned by a local bank that had taken them over when the developer defaulted. The project was totally finished – nothing had to be repaired, fixed up, renovated…a truly turn-key operation among investment properties. Of course, new tenants would need to be found for it, which would take several months after a closing to gain full occupancy.
I negotiated directly with the bank, and they were willing to provide the loan, with investment property mortgage rates that were very beneficial for me on the property. And the numbers, which I got into a habit of crunching several times a day, every day for a few weeks, kept making more and more sense. So – why didn’t I acquire the property? Simple – it would have used up every penny I owned in available capital. Any mistake on my part in my numbers crunching meant I could potentially lose money as I was just learning about investing in rental property. And it could happen quickly – without any means to tap a “slush” fund for emergencies…not only for the townhomes, but for myself personally. In effect, I could lose everything I owned on this one set of real estate investments.
I could sense the danger every day I got more and more serious about closing the deal. Ultimately, common sense prevailed. While the upside was also quite large on this grouping of townhome investment properties, and would have set me up, in theory, quite nicely moving forward, the downside, as I evaluated it was equally nerve-racking. I just didn’t have the stomach. So I backed out of the potential deal.
This offers a good lesson – as I taught myself – in the need for diversification in any type of real estate investing. To have put all my eggs in one basket, at the beginning stages of my property investing career, would have been a very risky, and probably fool-hardy thing to do. When I applied reason to my analysis, I came away with other options, like picking and choosing smaller multifamily homes, one at a time, that were much less risky. Again – not as much reward, but no one property would sink me like this townhome project could if I was wrong in my calculations.
Diversifying is such an integral part of investing theory, and yet when confronted directly with the prospect of a “big kill,” the notion of diversification can easily go out the window, especially when dollar signs go up in the sky in big bold letters.
In real estate, this means diversification can have many looks. You can diversify across one class of properties – for example, sticking entirely within residential real estate, and acquiring individual homes as I have done. It can also mean spreading risk out over several classes, or types of real estate investments. Owning a small office building, a retail store property and a multifamily home at one time are a good way to diversify your real estate holdings.
With more diversification comes lessened risk – as a downturn or a financial hit to one segment won’t totally destroy your overall holdings. It’s slow and steady financial gains that are approached as an averaging of all your different real estate holdings in the diversification model. In this way, real estate investors can protect themselves, and can be ready in the event of any downturn…Ready to acquire another, different class of investment property moving forward.
photos courtesy of besthawaiihomes. com, elementcommunity.com, worldpropertychannel.com, chrismercer.net, rifuture.org
Demand for rental units is the key component in current high rental prices for real estate investors. And this demand has been created by several major trends in the world of real estate investing of late. The national trend towards household consolidation, present and increasing since the financial crisis of 2008, means less homebuyers. Less homebuyers, due to their having to sit on the sidelines because of tight credit and a poor labor market, and uncertainty en masse about their job security, means more renters. More renters means higher rents in the marketplace for investment properties.
Also feeding this demand on a more local level, is the growing importance of repairs to current infrastructure, as well as newly built infrastructure. That road crew you passed this morning on the highway – well, those repairs ultimately help keep tenants looking in your area. Without road repairs, for example, your geographic area becomes less attractive as a place to live in – or commutate to and from.
Likewise, any new subdivision, office building project or retail mall that’s about to be built in your area all help to create a greater demand by tenants for your particular neck of the woods. Certainly as each project is built, they also have concurrent infrastructure building going on to support the project. Roads, electric lines, cable, phone, internet, transportation lines and a whole host of other support infrastructure are required with new builds. When investing in real estate, always keep an eye out for potential new projects being approved by your local town boards. The growth afforded your community can only help to increase demand for rental units, and therefore, rent prices. With this new growth also comes ancillary services, as well as demand by renters. Schools, hospitals, shopping centers – they all grow outwards to meet demand as new expansion is created by disparate physical property projects.
Ever notice the type of housing stock in non-vacation, rural areas? Slightly different than a typical suburban housing area, right? Typically, homes are flimsier, poorly constructed, or haphazardly constructed in these rural areas. And so, too, the rental demand and prices in rural communities is much smaller. The main reason? Jobs. In areas with less job creation and sustainability overall, relative to suburban or urban communities, you’ll certainly find much lower rental prices in their rental housing stock. Without a strong job base in any particular geographic area, rental housing will always remain weak. And this translates into very low rents for real estate investors.
So if you see that a new, major employer is coming to town soon – you can bet that demand for housing will jump. Infrastructure will most assuredly be upgraded, or added completely. And real estate investors should always be on the lookout, and become aware of these trends in your local community. Be certain to capitalize on them to maximize your dollars when buying rental property. Let these trends act as directional arrows for areas you should be focusing your real estate investing efforts.
photos courtesy of newsroom.aaa.com, flickr.com, usatoday.com, m8property.com, prospect.co.uk
In my role as a real estate broker, I am occasionally reminded of the bad reputation levied on most landlords by a tiny, select group of unscrupulous property investors. Within this category of horrendous landlords who act so horribly towards their tenants (see my article here entitled “A Tenant’s Nightmare,” May 1, 2013) , there lies a sub-category of human being marked by venality and greed. This sub-category goes way beyond just being “thrifty,” or “cutting corners” in order to increase or create a positive cash flow in their rental property. No, this particular type of landlord is much more dangerous. And they hurt all landlords terribly. This subspecies I call the sociopathic landlord.
As a real estate broker, I was recently representing a seller of property with a rental home on it. The tenant had been renting there for over a year. While the conditions were not what I would call squalid, there was still a great deal of needed repair work that should have been done to the house, but was neglected by the landlord/seller. In the process of negotiating a deal to sell the property, the buyer, after reaching an agreement in principle to purchase the house, had a house inspector perform their engineering inspection.
As part of the routine engineering inspection, since the water system was well water-based, a simple water sample was collected for testing at a local lab by the engineering inspector (and the sample was done quite properly too, since I was standing next to him as he took it). After several days, the testing lab sent in their report to the buyer on the water sample: the water, as it turns out, was not “potable.” It simply had too high a coliform bacteria content in it to be safe to drink.
Now, well water in a vacant house can usually fail water tests, since there is no movement in the well over some period of time, and bacteria can easily form this way. However, I have never encountered a water test failing in a home where people are actually running the water every day. So this was a first for me. I knew the lab that did the testing, and how rigorous their testing procedure can be. And I had seen the inspector do a proper water collection for the sample. So, I really don’t know why it would have failed. The main thing to me, was that the situation be corrected immediately, since the tenant and her family were being placed in some form of physical jeopardy by drinking non-potable water!
And then I called the absentee landlord to inform her that the buyer’s water test failed. Her reaction: “Well…I think the tenant drinks bottled water. She’ll be fine. So, I’m not going to do anything.” Besides being an absolute deal-killer, the landlord was also exhibiting major sociopathic tendencies…that is, a sense of grandiosity about herself, along with a total lack of concern for the health and welfare of her tenants. Unbelievable. I had never seen such callousness on the part of a landlord before.
Over the course of the next couple of days, I was successful in getting her trusted handyman to read her the riot act, and he convinced her to finally remedy the water situation by having him “shock the system,” or add chlorine bleach to the well. But it was her overall lack of concern for the safety of her tenants that scared me silly. (I was prepared to report her to the local building department if she had not remedied the problem.) As of this writing, it is doubtful the sale of her property will go through (what a shock). She is as recalcitrant about the failed water test as she is with all the other inherent problems the buyer’s inspection found with her house.
This story highlights the adage about “one bad apple” truly spoiling the whole batch. Is it any wonder how landlords as a group of property investors, intent on running a successful business while providing a much-needed service for renters, nonetheless get saddled with a less-than-stellar reputation due to the sociopathic tendencies of a very, very select few in our field. It is so important that we try to police ourselves to help rid our industry of these reputation-killers.
What can be done about the problem? Well, when you see a bad landlord, call them out. Make sure they see the error of their ways. Tell their tenants. Have their tenants complain to the landlord. Or report them. And if that doesn’t work, call their local building department to report them yourself. Clearly, our collective reputations as good, decent property investors are at stake. And sociopathic landlords will never “get it.” They’ll never be able to empathize, feel compassion or protect the safety of their tenants. Only when they’re ordered to do so will they ever budge.
photos courtesy of magnoliaforever.wordpress.com, sodahead.com, flatremovalslondon.co.uk, upad.co.uk, holidayapartments101.com, ohmyapt.apartmentratings.com