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Property Investing Safe Haven

Commercial property alternatives

It’s sometimes easy to get too staid as a property investor. If you’re used to residential investing, you tend to stick with it, thus placing most all of your real estate eggs in one basket. If you’ve been doing this for a while, you might want to consider a safer haven for part of your nest egg….commercial property. And by commercial property, it can run the gamut from office and retail space to more niche-oriented, but relatively safe property investments, such as medical office space, hospitals and nursing homes. The entire medical care industry is a safe bet for tenancy in the mid to long term periods.

Building your safety net

You’ll soon discover that locking up tenants for long term leases is a whole lot safer and more predictable, let alone less expensive to administer, than finding tenants each year for every one of your residential rental units. The time factor of not having to constantly be advertising, screening, doing financial and background checks, and dealing with a multitude of residential tenant emergency issues makes renting to commercial tenants a great boon as an alternative.

Office buildings, for example

Consider the benefits of office buildings, where many leases with a wide range of tenants over multiple lease terms helps to increase their overall return on investment, relative to residential property. When one tenant in an office park leaves, the effect will be minimized on the overall performance of the building, compared with residential rental unit buildings, especially smaller multi-family dwellings with less units than apartment houses.

In addition, if you own commercial property, you’ll certainly be negotiating for longer-term leases than only one year. Typical commercial leases will range between three to five years on average. Some, a lot longer, depending upon how much remodeling work a business has to do prior to moving in. The more upfront costs they have to incur to get their store ready, the longer the lease they’ll be looking for, in order to help them amortize the total cost of their renovation in your building. On the other hand, a two year lease in residential property would be considered long. And then you have to spend the time replacing any tenant when they leave.

The upshot of the longer term leases in commercial property? Simple…you’ll be able to plan better, as well as realize a greater degree of security and consistency of cash flow by having longer-term tenants. The steadiness of the income stream is one of the chief advantages of commercial property over residential investments.

Other benefits of commercial property

There are several other key benefits of investing in commercial property relative to residential investing. Consider that commercial real estate offers a wonderful buffer against inflation. This is because most tenant leases, since they are mid-to-long term in nature, have bump-up increases in yearly rents. This acts as a hedge against inflation. This helps build in increased valuation for your commercial property over time. In addition, there tends to be less market volatility amongst commercial buildings. Especially ones that are at or near capacity for rentals. Relative to residential buildings, commercial property will show a much flatter growth line, with fewer sharp spikes or dips.

Lastly, commercial real estate offers the ability for certain tax breaks that may not be available for residential property. For example, if building or renovating in a central city a municipality may be offering commercial property owners certain tax-deferred tax breaks to spur construction in their city. This is just one type of tax benefit that may be available to commercial property owners relative to residential investors.

photos courtesy of miamire.com, businessfinancespecialist.com, barryspringerlaw.com, luxist.com, browninsuranceservices.com

Property Investment Legal Issues

Illegal activities in your building

I have written here before about zealous prosecutors going after and prosecuting landlords for illegal activities of their tenants. As a property investor, if you are not aware of illegal activity going on in your leased building or apartment, you should have certain basic legal protections. That said, if a potential for illegal activity exists in your building and you (or your property manager, since you have vicarious liability through them) turn a blind eye, you certainly can be held responsible.

Stay focused and reasonable

It really is a matter of reasonableness and logic. The latest news out of Houston today is of a “stash” house, where illegal immigrants have been smuggled in and kept. In this scenario, it is basically impossible for a reasonable property owner not to know that something quite illegal was occurring.

According to the Houston Chronicle (“Five Will Face Federal Charges in Pearland Stash House,” by Anita Hassan, St. John Barned-Smith, Dane Schiller and Dale Lezon, 3/20/14), “federal authorities plan to charge at least five people in connection with the Wednesday discovery of dozens of imprisoned people living in a Pearland-area stash house, officials said.” The article went on to say “115 people were discovered in the packed, rancid stash house. Literally living on top of one another.”

Squalid conditions

This intense amount of squalid conditions were also described: “federal agents, along with police, sheriff’s deputies and constables, found a “sea of people” packed into the home, sitting on each others’ laps, hungry, thirsty, and exhausted.” It went on to describe the living conditions as “rooms littered with plastic trash bags and clothes, a single toilet, no hot water, and a terrible stench.” Clearly, no landlord in his right mind would allow such a scene to exist if they knew about it….or, more to the point, weren’t engaging in the illegal activity themselves.

Landlords and the law

Let this story be a shining example of the other extreme in landlord behavior and the law. You can, and should be, held responsible for obvious illegal activity in any investment property you own. Would it be reasonable for you (or your agent, a property manager) to complete regular inspections of your building? Absolutely. In this case of human smuggling, it would be terribly obvious. However, in the case of illegal activities that are not readily apparent (for example, a tenant setting up a meth lab in their apartment that you lease to them), good common sense needs to dictate. If something looks suspicious (or, smells so), you have the right to investigate. And you would be held responsible if you did not. But if there is nothing so obvious as to arouse suspicions, you should be in the clear.

Protect your asset at all times

Nevertheless, you still have your investment property as an asset to protect at all times. Even if you’re not liable for any illegal activity, you still get stuck with the clean up bill after law enforcement gets through with your tenants, and they leave. And that clean up could be a major source of headaches, not to mention a huge drain on your cash flow. Make sure you keep your eyes, ears and nose open to all possibilities when selecting and installing tenants, as well as when you do your regular check-ins with them.

photos courtesy of tv.graffitiwithpunctuation.net, barnettassociates.net, thegreatestrealestateblog.com, buildingmoxie.com, tenantscreeningblog.com, hdwallpaperart.com

Investment Property Dangers: Your Tenants

Heed the warning signs

Here are some basic no-no’s to be aware of and avoid when acquiring investment property. These are related to strictly tenant issues here for brevity’s sake. When you understand how you can get burned, you tend to steer clear of these pitfalls more easily, and heed the warning signs that are associated with these particular set of investment property dangers.

The Tenant Slide

The slippery slope of leasing to tenants is a definite learning curve. Hopefully, you can scope these common dangers out before they hurt you financially. Tops among tenant problem areas is that, by and large, renters have a bundle of legal rights that protect them. So, for example, you can’t simply throw a tenant out if they don’t want to leave, without first going through an eviction proceeding. They didn’t pay you rent last month? They won’t allow you n to inspect their unit? You’re getting complaints from other tenants in the building about them? Tough. You still can’t legally throw them out until you go through the formal eviction.

You’ll still have to pay an attorney to take you through the eviction process – and win. And this not only costs in terms of their fees, but the time spent could be several months – of lost rent. Not to mention the clean-up and repairs after the tenants trash your place. How to prevent this? Always find good tenants. And that’s not always so easy to do…

Vacancy issues

And speaking of lost rent, vacancies are another lurking property investment danger. Even in a tight rental market, when one renter leaves, you still have to show the unit and usually clean it up, or even simply paint it, before the next one can move in. That’s a month of lost income right there. Naturally, you build in a vacancy rate for all your units when figuring out your cash flow – but don’t think you’ll escape unscathed in softer rental markets, or areas with stiff competition for apartments. Don’t be surprised if you’re losing several months’ rent when you lose a tenant.

The “bad” tenant

Of course, another key investment property danger is the Tenant from Hell. And yes, there are a few of them out there. Most landlords can relate their “Tenant From Hell” story. It ain’t pretty. A seemingly “normal” renter can become a bad tenant almost overnight. Your unit will suffer the most. Bad tenants have a nasty reputation for tending to destroy units. It’s usually not willful…think of it as more “playful” destruction of your property. It’s just in their genes. And it will cost big bucks to repair said unit after you successfully remove the tenant through the aforementioned eviction process.

Lawsuits and you

And also don’t forget this fun investment property danger: when your tenant sues you. They could slip and fall on a patch of ice in your parking area, or fall on a cracked walkway, or trip on a poorly lit stairwell in the building. Whatever the reason, if the tenant is determined to see some cash from your misery – they will be relentless. This is mainly due to our legal system, as well as how our insurance companies work. Naturally, as any smart landlord, you have adequate liability insurance on your building. (Remember my article on you and your insurance agent, right? The one where the agent tells you his recommendation for how much liability insurance would make sense for your size building?)

Well, even with the right amount of liability insurance, a suing tenant will traditionally have hired a personal injury attorney who only gets paid if there is an award of cash damages. They traditionally receive a third of the award. Then they sue you, your insurance company’s attorney reviews the case, and in long order (yes, it takes months if not years in some cases), the insurance company authorizes a settlement amount to pay out to your tenants and their attorney in order to avoid a lengthy and potentially devastating court case and heftier damages if they lose in court. This is our judicial system. Welcome to it. Yet another potential investment property danger just waiting to snag you.

photos courtesy of investors.housez.ca, kristinandcory.com, mcclurepropertymgmt.com, tenantchecker.com, clickpropertymanagement.co.nz, tenantscreeningblog.com, thegreatestrealestateblog.com

Quick Property Investment Tips

Advice for the beginner investor

Novice property investors should be cognizant of these quick and simple property investment tips. They will keep you pointed in the right direction. Always refer back to them when you hit a snag in the process… (It also makes sense to try to memorize them, and recall them as you begin searching for new investments to acquire.) In this way, you too, can become a savvy, experienced property investor.

Purchase for retention

Make sure you always purchase rental properties for retention purposes. The longer you hold, the better equipped you’ll be to take advantage of long term appreciation in the property. You’ll also concurrently be writing down any mortgage note you’re paying off, thus increasing your equity valuation in the property. If you make a plan for purchasing a property at set intervals (for example, every couple of years – or yearly, even better), then you’ll be able to slowly accumulate a portfolio of properties (your “stable”) that will continue to throw off ever-increasing amounts of cash flow, as well as capital appreciation.

The power of leverage

Make sure you take advantage of leverage, when possible. While making all cash offers on properties may be advantageous to netting the best price on any one property, it is not advantageous to utilizing other people’s money to grow your investments through the concept of leverage. If you can obtain a mortgage, by all means do so. The greater the loan to value ratio the lender will allow, the better. Just make sure you don’t overextend yourself, and that you’ve double-checked your expense numbers properly. You want to ensure you have a comfortable positive cash flow on any property you’re thinking of acquiring.

Beware the bargain basement

While the concept of “stealing” a house in an auction or other competitive bid situation sounds really appealing, always be wary of the cost of a “steal.” Finding a great bargain in a poor location is like finding fool’s gold: you’ll end up paying for it down the road. Long term difficulties with obtaining market rent, high vacancy rates, and terrible capital appreciation tend to make that “steal” a steal for the seller! So be very, very careful when a deal feels too god to be true. It probably is.

The location axiom

Naturally, more desirable neighborhoods will yield greater upside potential in terms of capital appreciation. This does not mean buying a property in a rundown area is bad. Just be aware that a cheaper price for a lesser neighborhood will require you to understand the vagaries of dealing with the neighborhood…which will probably be run down in five or ten years, or whenever you will be selling the property. Keep your sights set realistically. If a bad neighborhood is all you can afford, make sure you don’t expect much from the property n terms of its capital appreciation over time. Or, at the very least, buy in a changing neighborhood – one that’s experiencing the start of some gentrification. (Hint: let the changing face of local stores be your guide here.)

Cash flow is great, but…

Make sure you always keep an eye on the capital appreciation rate in any given area you’re searching in. It’s the holding and growth of the marketplace of houses surrounding your building that will add value to your property in the long run. Be very mindful of this fact. Your year-to-year cash flow is obviously important to paying the bills and allowing yourself a profit on a regular basis. But it’s when you are ready to sell the building that most of your profit should be made…

Create an individualized investment strategy, and stick to it

Critical to this concept is that you’ll need discipline. In addition, you’ll need a plan. And most importantly, you can’t have discipline and a plan without also being scrupulously devoted to research and numbers-crunching for any potential property you are looking at. Simple math errors, not doing total due diligence on a property, accepting seller information only – these are like death to a property investor. You cannot tolerate mathematical mistakes. If you know this is not your strong point, then enlist the aid of a partner – or at the very least, seek the outside help of a trusted, math-oriented friend. Either way, this is the simplest way to mess up. So don’t.

photos courtesy of worldpropertychannel.com, images.cisdata.netmlsNY, pooboy.com, dminotes.com

More Investment Property Buying Tips

The savvy investor

I’ve always advocated for self-understanding before leaping into any investment property acquisition. Coming up with the reasons why you want to utilize this class of investment over others is key to ultimately being successful in the business. You need to be self-aware of your own temperament and abilities before jumping in headfirst to the arena of property investing.

You’ll also need to ask yourself what you want to accomplish. Are you interested in creating a steady income stream from your investments, or are you trying to flip a property for quick cash flow profits? In other words, are you in it for the short or long term? Knowing the answers will help you determine your overall investing direction.

Use the seller for owner-financing

The ever-popular “other people’s money” is usually attributed to family members or friends. However, it can also be a desperate seller that wants to move his property sale along that can offer some amount of financing. It may be in the form of a large first mortgage, usually at slightly higher than going bank rates, and for a shorter period of time, with a balloon payment built in. However, owner-financing is a great way to keep your initial costs of borrowing low. (An owner will not charge you points on his loan, for example…)

Using the seller in other ways

Along the same lines as owner financing, you can sometimes find a seller willing to pay for some of your closing costs. If they won’t make a first mortgage loan to you directly, you should always ask if they can pay for part of the closing costs your bank will be charging you. Sometimes these costs can be folded into the total mortgage amount – so you’ll be able to bump up the purchase price slightly to have the seller recoup these closing costs he’ll be affording you at closing. You end up financing the closing costs as part of your mortgage, paying for them over time.

The real estate agent route

If you’ve worked with a real estate agent, you probably have already figured out that Realtors have the inside track on most deals. They can see when new properties come on the market each day, and are privvy to a great deal of “inside” data most buyers are not aware of. If you plan on making regular property acquisitions, getting your real estate license makes a great deal of sense. With each transaction for your own property (be it buying or selling) you get to partake in some of the commission. This can save you thousands of dollars each year. In addition, as mentioned above, you’ll have access to more info about any given property, including when a hot property may come on the market. In addition, there are many tax breaks you can take advantage of by being a real estate agent.

Getting your feet wet

One great way to get started in property investing is to become an owner-occupant. You simply purchase a two (or more) family home that you will rent the other units out while you live there. You’ll get tax breaks, as well as the ability to finance the mortgage with an FHA, HUD or VA type loan. You would not be able to do so if you did not live there. In addition, it’s a good way to learn to manage your property – with your tenants on site, you’ll get very accustomed to hearing about any complaints with their units. And you can stay on top of any maintenance issues when they arise.

Pulling it all together

Make sure you do proper due diligence , and research any potential acquisition first. You’ll also have to be sure your own finances are in order, you have excellent credit, and can obtain the financing needed for any given project. Also take into account all the expenses that will gobble up your cash flow monthly (including taxes and insurance), and don’t forget your total financing and closing costs as part of your overall nut on the property. If you decide you have the finances, temperament and spirit to undertake an acquisition in real estate, then jump in like there’s no tomorrow.

photos courtesy of prw.net.au, davidcares.com, realtor.co, allmandlaw.com

The Lamentations Of The Landlord

The sad tale of the sociopathic landlord

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.

The tale begins…

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.

The water sample

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!

Confronting the landlord

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.

Enlisting the aid of others…

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.

The moral of the story…

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.

How to clean up the bad apples

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

Reading The Rental Property Tea Leaves

Turn Back, O’ Man?

So the residential housing market is hot. Mortgage rates are on the rise (we’ve known this for a couple months now, haven’t we?). It’s now more affordable to buy than to rent. A lot of stories littering the national headlines both in and out of print of late give any property investor pause for concern. And what concern would that be? Well, check out some of the latest stories – here’s a brief sampling – and we’ll discuss the important ramifications for property investors later in this article. Consider these latest stories all part of a change in direction about to hit the residential property marketplace in the coming months…

The so-called “hot” housing market. Really?

A report from CNBC on August 26th, 2013 entitled “Home prices across the US defy gravity,” by John W. Schoen notes that “home prices are going up, up, up, but it’s not a bubble just yet. The surge in home prices over the past year may have some home buyers wondering if the market has gotten ahead of itself. Rising interest rates aside, housing prices in most parts of the country appear to have plenty of room to move higher if the wider economic recovery remains intact.” He goes on to say that “home prices have room to rise. A recent rise in mortgage rates is also spurring buyers to lock in rates before they climb further. “When start you see interest rates rise, people are going to want to jump in,” said Beth Ann Bovino, deputy chief economist at Standard & Poor’s. “All those people on the fence come back into the market. But that’s a good thing.”

Mr. Schoen also goes on to note that “higher borrowing costs could eventually price some buyers out of the market and slow the pace of home sales. Sales of new single-family homes dropped sharply in July to their lowest level in nine months, the Commerce Department reported Friday. Sales dropped 13.4 percent to an annual rate of 394,000 units, and the government also revised sharply lower its estimate for home sales in June.”

Summing up…

So what was the conclusion of this particular article? Mr. Schoen summed it up by saying “the continued pickup in the pace of home sales and prices will depend heavily on whether the job market continues its slow recovery and incomes continue to rise. That disposable income represents the buying power required to fuel the housing market’s continued recovery. And despite the recent jump in prices, homes in most local markets remain affordable by historical standards.” He goes on to note that “the cost of buying a house is still cheap in relation to the cost of renting, suggesting prices haven’t yet reached a point where they will cool demand, according to housing Capital Economics housing economist Paul Diggle. “The most reliable measure still suggests that housing is undervalued,” he said. Even if rising prices and rates don’t scare away potential home buyers, the continued housing recovery will depend on the availability of credit, which tightened considerably following the wave of rogue lending that fueled the mid-2000s housing bubble. Lenders are much choosier than they were six years ago, but there are signs they’ve begun to ease up a bit on credit standards as they compete for new borrowers. And after paring down a large pile of debt accumulated during the credit boom, those potential buyers are better able to take on a new mortgage payment.”

A hedge fund hedges its bets

Another headline in the Bloomberg News from August 23^rd, 2013, blares out the following headline: “American Homes 4 Rent Said to Fire Workers After Reporting Loss.” This tale of future woes for the residential property market goes on to report about the recent misfortune to befall the property investing company American Homes 4 Rent. The article notes that “American Homes 4 Rent fired a group of workers, with a focus on acquisition and construction staff, after the housing landlord reported a fiscal second-quarter loss, according to a person with knowledge of the terminations. The company, owner of almost 20,000 single-family homes, has cut about 15 percent of its workforce this year, including an earlier round of terminations before its initial public offering last month, said the person, who asked not to be identified because the information is private…Single-family landlords have struggled to turn a profit while acquiring homes faster than they can fill them with tenants. Hedge funds, private-equity firms and real estate investment trusts have raised more than $18 billion to purchase more than 100,000 rental houses in the past two years.” The article goes on to report that “single-family landlords are seeking to take advantage of prices that fell as much as 35 percent from their 2006 peak and increased demand for rentals. The U.S. homeownership rate is at its lowest level in 18 years, and more than 7 million homes have been sold for a loss or lost to foreclosure since 2007, according to RealtyTrac.”

Slowing things down…

The upshot from this report is made very clear in the last part of the article, where it is noted that American Homes 4 Rent “ is slowing its property purchases, with plans to spend as much as $100 million a month on 800 to 1,000 additional homes…the company’s chief operating officer, said on an Aug. 21 earnings conference call. “As far as being able to put money to work, I mean we could easily ramp back up to $300 million-a-month pace if we have clarity that we would have that capital available,” he said. “But we don’t want to get too far out over our skis.” I think that euphemism for being cautious should be used by all property investors…I mean, you’d hate to fall face first down a steep, snowy cliff of rental property negative cash flow, would you?

The writing’s on the proverbial wall

And yet another sobering story comes from the article “Signs This Real Estate Class is Set to Roll … Over” by Steve Mauzy’s blog of June 14, 2013. In it he notes “Axiometrics – an apartment data and research firm – reports rent growth slowed to a 3.1% rate in April, the slowest pace of the past 32 months. Falling rent growth is nothing new, though. Axiometrics reports rent growth has been moderating since July 2011. Rising property prices coupled with falling rent growth is hardly a recipe for real-estate investing success. Unfortunately, any fallout in the investment market won’t be contained to investors. Innocents are at risk as well. In many markets, investors are involved in up to 30% of residential real estate transactions, thus helping to elevate home prices – rental and owner-occupied alike. If the latter buys into an unsustainable trend, he could find himself underwater a few years later should investors start exiting en masse if the numbers no longer work.” This is quite the splash in the face of the average property investor in the U.S. But a cautionary tale nevertheless. It is time to take heed of all of these warning signs.

Hold ’em or fold ’em?

And lastly, a recent article entitled “Why I Sold My Rental Property” by Wyatt Investment Research, in their blog of August 23, 2013 notes that the current “hot market can offer both opportunity for profit and opportunity to get burned. The opportunity to profit arises when there are lots of buyers who think prices will continue soaring. And the opportunity to get burned happens by following the crowd, and assuming that the bubble will never burst. Once again, residential rental real estate is a hot market. Vacancies are low and rents are high. What’s more, vacancies have been falling and rents have been rising for some time. According to data from Reis Inc., a property-research firm, unrelenting rental-price increases have pushed national apartment rents to their highest level since 2007. Concurrently, national vacancy rates are now at a 12-year low of 4.3%.” They go on to say that “the residential rental market includes both apartments and single-family homes. Investors – landlords and property flippers – have been a driving force behind the housing rebound. Today they account for up to 25% of purchases. And their buying spree has helped lift the national median existing-home price 13.7% in the last year. Single-family homes have also been swamped with institutional money.” Get the picture? The tell-tale signs of impending problems for the residential rental market are becoming clearer by the day now. In this particular article, the author also tells how “property developers are following the money, and new construction has surged. Apartment building completions in the top 30 metropolitan areas of the country more than doubled. And more apartments are on the way, with new permits to build multi-family homes reaching a new high.”

A smart choice – or stupidity?

He also then goes on to describe his recent investment decision: “Of course, all real estate markets are local markets. Until recently, I owned a single-family rental property just north of metropolitan Denver, where vacancies are at a 13-year low. Rents are also at a multi-year high. I bought the property since 2003, and it’s been a solid income investment. It’s consistently provided monthly rental income of 15% to 20% above my costs. When my last tenants moved out, I could have negotiated a 12-month lease with new tenants willing to pay 20% more than what the previous tenants paid. But instead of finding new tenants, I decided to sell the property. The reason was simple: I don’t expect real estate to stay hot much longer.” He then goes on to explain his rationale why he would sell out now, when his cash flow was so excellent – “there are a few obvious reasons. Multi-year trends in both vacancies and rents are unsustainable. I expect more multi-family units will mean lower rents. That aside, the market simply looks and feels like it’s approaching a melting point. For evidence, look no further than bidding wars for homes that hit the market.” So he cashed out, rather than riding his cash cow.

A wise choice, or a huge mistake? Well, let’s take a look at the meaning all these articles in the news of late have been saying. Clearly, the upshot of so much national attention on the apparent rise in residential house values while rents have also been zooming upwards – until very recently that is, points to an indication that the residential rental boom is about to go bust. With homes being more affordable than rental rates nationally now, coupled with the slow rise in mortgage rates this Summer, it would appear that property investors should be wary about their calculations for the short term in increased cash flows due to yearly rental bumps. And if institutional investors, like hedge funds that specialize in residential single family homes, find their bottom lines dropping due to this rental rate bust starting to happen, then look out for these large funds to unload their worst-performing homes – en masse. This, of course, will create a glut of single family homes on the market, which will naturally depress home values in the short-to-mid-term range of the next few months through the end of next year at least.

Be wary, but remain calm and in control

What’s a small property investor to do? Well, for one, revise your cash flow projections, to make sure your property will remain comfortably cash-positive in the short run. In addition, since unlike a large hedge fund, you only have to appease yourself and not thousands of investors, determine at what level you are willing to ride out the coming storm that’s about to adversely hit the rental marketplace, as well as home values in general. If you’re OK with your current projections, then by all means, stick. Selling your property only produces more costs as you convert it to another asset class. You may stick with real estate – commercial is hot and steady right now –making for an excellent choice in real estate conversion possibilities. Again, be wary of the costs to do so. It just may be simpler to revise your market value and cash flow projections downward, ride out the short term, and continue to milk your investment property cash cow – but just not at its current level. ‘Cause it certainly ain’t sustainable…

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Insanity

A tale of WHOA!!!

Let’s say you purchase a piece of commercial property. You then find a tenant for it, sign your lease, and start collecting rental income that will produce the intended positive cash flow on your commercial building.

Sometime down the road, you then find out that there is suspected criminal activity going on in your building by your tenant. You find this out by criminal charges being filed against you by the local district attorney. Now you have to fight – not simply for your right to make an income on your investment property – but to stay out of jail.

Sound impossible here in the U.S.? Think again.

A chilling story…

Recently, this story about a local commercial landlord was reported in the Burlington (Vermont) Free Press:

“Chittenden County’s top prosecutor said filing criminal charges against landlords that host spas that mask as prostitution sites is the latest effort by the state in helping local communities combat the problem. State’s Attorney T.J. Donovan admitted state and federal investigators have had little luck in the past 10 years pursuing prostitution at the spas. “We can do better in this community than what we’ve done. And frankly our approach to this problem in the past hasn’t worked. We need a new approach.” Donovan made the comments minutes after a Burlington man pleaded not guilty to a charge permitting his building in Williston to be used for prostitution.

Lunacy? You bet!

But wait – there’s more:

Once the landlord “received a warning letter last week from Donovan, the property owner took action to get the tenants to leave. He said they vacated the building, and the business is closed and in search of a new tenant…Donovan is trying to send a message to the community so landlords are on notice. Donovan said going after the landlord is a new philosophy in trying to battle prostitution.”

Kind of makes you want to see if Mr. Donovan owns any rental property, then rent it out, set up an illegal lemonade stand in front of it, then get him to charge himself with illegal activity….Oh, that’s right – that would be a conflict of interest…

Goose stepping ramifications

Imagine the ramifications of this particular case for property investors. Any landlord leasing out rental office space would be liable for the actions of their tenant. Let’s say you’re renting to a hedge fund company that absconds with their investors’ money, a la Bernie Madoff, for example. You get arrested. Let’s say your tenant leases warehouse space from you. To store their ( place your preferred name of contraband here). You get arrested. Let’s say you’re renting out an apartment – maybe it’s your vacant apartment upstairs in a building you happen to also live in. The tenant sets up a meth lab. You get arrested. Or puts in more unrelated “tenants” than your lease allows. Again, you’re on the hook to be arrested.

To paraphrase Mel Brooks, “what in the wide world of sports is going on here?”

Simple. Zealous prosecutors in a judicial system that is by definition political, and requires district attorneys to be elected to their office, create an environment of absolute insanity in a free market capitalist system for property investors.

A simple solution

What can be done? Again, simple solution. Vote against these zealots. Get them out of office. If you have one in your area, and they are clearly taking a broad stroke approach to fighting crime by going after landlords, then fight back! Get your friends and family to vote them out of office. Spread the word, write letters to the editor of your local paper…voice your opposition to Gestapo-like tactics by overzealous local prosecutors.

Besides our basic capitalist system being threatened, it’s your investment property dollars that are at stake. And that’s the bottom line.

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The Riskiest Property Investments

Caveat Emptor, baby

There are so many ways to earn positive cash flows in the real estate investment world. So why entertain the notion of taking on huge property investment risks with non-performing, no-cash flow or negative cash flow investments? If you are wealthy enough, and a negative cash flow or extremely risky speculative property investment makes financial sense for you – strictly due to potential tax savings – then this article is not for you.

For all other property investors, then absolutely be aware of several real estate pitfalls that you should steer clear of in order to protect yourself. Again, always do your homework to ascertain the positive cash flow potential of any piece of rental property before moving forward to the actual acquisition phase.

Be wary of these investments

There are several real estate investments the basic or novice investor should be wary of, and stay away from like the plague. Chief among them are any rental property that throws of a negative cash flow. Certainly avoid second homes and investments in strictly land for speculative development. Unless you have totally concrete plans for a parcel of land, have gotten your feet wet developing a piece of land before, and know all the intricacies and local laws entailed in local land development, just steer clear of this form of property investing.

Likewise, investing in negative cash flow properties, as mentioned above, should only be done by those wealthy enough to yield a net positive return on their investment, by offsetting other earned income (and a lot of it at that) to make the losses worthwhile.

Avoiding time shares

Also to be avoided are vacation time shares as investments. They have some of the greatest property investment risks assigned to them.. They’re simply too risky because it’s so difficult to accurately predict what, if any, value will accrue as you continue to hold them. They are highly sensitive to overall market fluctuations, and can drop in value precipitously when you least expect it. They are also extremely difficult to predict future cash flows and rental income based on past performance. In addition, they ultimately can be very hard to unload should you need to resell them quickly. You could end up taking a really large haircut on them.

Foreign real estate dangers

Finally, be aware of the inherent risks involved in buying foreign real estate for investment purposes. As I have advocated in numerous articles here, try to stay close to home in your investing. You’ll get to know your local area a whole lot better than property bought farther away, or as an absentee property owner. This concept becomes heightened (as do the risks) when you consider buying foreign properties to rent out.

Risks inherent in foreign purchases include fluctuating currencies, wildly varying real estate laws from country to country, as well as the kind of real estate protection laws afforded here in the U.S. relative to other countries. So be very wary of all these property investment risks when evaluating your next set of real estate rental properties.

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Walking Through The House Of Mirrors

Be very wary…

Just like a fanciful walk through the twisting, colorful and dizzying amusement park attraction, the House of Mirrors, that bend your shape and leave you rubbing your eyes for better perception, so too is the effect on real estate investors trying to read the current state of the U.S. housing market. My singular property investment advice: be wary of what you see in the current housing recovery.

All factors and new data suggest a rapidly improving housing arena. But, like the House of Mirrors, everything’s bent totally out of proportion and recognition. And, we’re left with the main issue I’ve preached in two previous articles here this year: all investor’s eyes need to remain squarely fixed on the unemployment rate – not how the housing market is doing. For it is that unemployment rate that should dictate how you invest in these current economic times.

Here’s what others are saying…

In an article from this week’s Time magazine (“The Housing Mirage,” by Rana Foroohar, Time, May 20, 2013), she notes that in regards to the present housing market conditions, “prices are up, but the market is far from healthy. We’re missing key elements of a true recovery.” She goes on to ask, “if housing is back, why is the percentage of people who own homes lower now than it was over a decade ago.” Of course, it’s because property investors have been gobbling up most of the foreclosure market over the last few years. And this is especially true with institutional investing firms.

She goes on to note “that a relatively small group or rich investors…is driving the real estate market. That includes private-equity titans like Blackstone (which owns a portfolio of 20,000 rental properties) as well as high-wealth individuals who can pay cash up front for property for themselves or to rent out. “Investors remain the dominant force behind the house-price bounce back,” says Capital Economics property economist Paul Diggle. That’s reflected not only in the lower rate of homeownership but also in the swelling ranks of renters. Not since 2002 have fewer rental properties been empty in the U.S., and rents are rising sharply in many cities.” And that’s a scenario that makes property investments in residential real estate all the more valuable in the coming months, if not years.

Let the unemployment rate be your guide

Ms. Foroohar makes the case that tight credit policies by banks are still placing a stranglehold on mortgage lending nationwide. She then makes a point I had predicted back in my article of January 1^st here, entitled “Predictions For 2013.” I had written then: “watch the unemployment rate.” I then went on to offer up these pearly bits of property investment advice:

“The unemployment rate will be one of the most important figures to keep a watchful eye on in the coming year. If it starts ticking upwards because of the effects of no deal being reached by Congress on the proverbial fiscal cliff, then look for overall U.S. rents to continue to increase as homebuyer malaise begins to sink in. So individual rental property owner’s should be able to see increases in their cash flow as the new year progresses. Clearly, residential rental properties will become even more valuable than they were in 2012. So it would behoove the individual property investor to continue to search for and acquire additional rental property in 2013.’

And now, five months into 2013, Ms. Foroohar backs me up. She quotes Jonathan Miller, CEO of a New York based real estate appraisal firm, who said “to have a sustainable and healthy market, all that really matters is employment….You need higher employment and wages to support housing consumption and looser credit. If we see some real economic growth over the next two to three years, then we’ll know the housing recovery is real. Until then, we’re in what I call a precovery.”

The bottom line

She then goes on to bring it all home: “ this precovery has been underwritten by the government at historically unprecedented levels. Every month, the Federal Reserve is purchasing $40 billion worth of mortgage-backed securities. And Freddie Mac and Fannie Mae stand behind the bulk of new mortgages.” Finally, she notes that “it has long been said that you can’t have a sustainable economic recovery in the U.S. until the housing market is back. In truth, it may be the other way around. Until you have more jobs, rising wages and a middle class that can afford to take out a mortgage….you can’t have a real housing recovery.”

Sounding like a broken record

And, as I’ve been saying for months, the housing arena does not indicate nor showcase the deeper, structural problems such as tapped-out consumers pinched by a slowing job market, higher taxes and lower savings. I had also previously written that “if the unemployment rate were to go up next year, look to continue acquiring residential rental property, since rent prices will then continue to escalate. And cash flows on rental properties would commensurately increase as well.” I would have to amend that statement slightly, and say, if the unemployment rate remains stagnant, as it has been, or goes up, then look for increased cash flows on your rental properties.

My best property investment advice continues to be taking your existing properties and make sure you continually maintain, if not upgrade, them in a down economy. Especially in this House of Mirrors economy, where rent prices continue to escalate. Continue to make your product more attractive relative to your competition. In this way you’ll be able to maximize cash flow and profits. Also remember the advice I gave in that earlier article on the coming shape of our economy, and how it will affect what you do in your property investing strategy for the coming year. “Consider the next year as a good time to try refinancing your investment properties to help increase your overall cash flow on all your collective properties. With rates at all-time historical lows, and with an economic downturn occurring, you’d be able to lock in excellent rates for the long-term on your portfolio of real estate holdings.

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