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How To Conduct A Thorough Pre-Buy Property Inspection |
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Written by Thomas Lucier
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Thursday, 03 July 2008 08:42 |
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When making an offer to buy any type of property, include a clause in your purchase agreement that makes your offer contingent upon the property passing inspection. You must do this in order to avoid being bamboozled by an unscrupulous owner surreptitiously masking a property's major defects. Who should inspect your property for major defects depends upon how much construction knowledge and experience you have. If you lack the necessary knowledge and experience, you should hire a retired tradesmen or professional property inspector to snoop around and inspect the property for major defects that some owners will try and hide. |
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Last Updated on Thursday, 03 July 2008 09:11 |
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Written by Steve Cook
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Thursday, 03 July 2008 08:40 |
“Knowing what you know now, what would you do differently?”
This is a question that so many people have asked me, and it’s a tough one. Based on my current position and the blessings I have experienced, I really would not have done anything differently. I’m very pleased with my current situation as an investor, and I fear that if I had done anything differently, then I wouldn’t be where I am today. In my opinion, a more appropriate question is:
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Last Updated on Thursday, 03 July 2008 09:10 |
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A Game Plan For Success Investing In Real Estate |
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Written by Larry Goins
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Thursday, 03 July 2008 08:38 |
I want to share with you some ideas on using real estate to become debt free and build your cash reserves. It has worked for me and I have also shared this with many other investors and it has worked for them also. Many investors start out in real estate thinking that you have to “have money to make money”. That is not the case at all. You will need one of two things though; either good credit or cash…remember that it doesn’t have to be your cash or credit as far as that’s concerned. It’s OK to start out with other investors until you can do it on your own. I would rather share the profits and have some of something rather than all of nothing.
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Last Updated on Thursday, 03 July 2008 09:10 |
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60 Days To Your First Bargain Purchase |
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Written by Bill Bronchick
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Thursday, 03 July 2008 08:37 |
Finding good real estate deals is an art that takes time to master. Like any business, customers are what drive it. Your primary customer is the seller who is motivated to sell below market value. Finding motivated sellers requires advertising, marketing, salesmanship, and, like any business, keeping your nose to the ground.
Nothing happens and nothing matters in real estate until you find a deal. You cannot put together a deal without a motivated seller and you can only convince a motivated seller to do something creative or that involves a discounted price. A motivated seller is one with a very good and pressing reason to sell below market.
The most common problem new investors face is finding bargain properties. Many who start out in real estate investing quit without ever buying their first property. They go through the motions of looking for deals for a few weeks or months and then decide it doesn't work. They forget that finding motivated sellers is similar to the salesman finding his first customer . . . it takes persistence and hard work.
Find the Motivated Seller
At the cost of sounding redundant, the concept is simple: find motivated sellers that are willing to sell their properties at a discounted price or "soft" terms. Currently, the real estate market in some parts of the country is hot, hot, hot! Many people are complaining that the strength of the market precludes investors from finding deals on properties. The popular misconception is that in a rising market, even the most motivated seller can find a buyer for his property at full market price.
The truth is, you can find deals in ANY market. Real estate legend A.D. Kessler once said, "There are no problem properties, just problem ownerships." The definition of a motivated seller fits squarely within Kessler's idea. A logical person knows that time, money and effort can solve virtually any real estate problem. However, some people are too emotional about their real estate problems or have other motivating issues to deal with.
Some of these issues include:- Divorce
- Lack of concern
- Inexperience with real estate repairs
- Time constraints
- Death of a loved one
- Job transfer
- Landlording headaches
- Impending foreclosure & other financial problems
Farming Neighborhoods
Successful real estate agents utilize a technique called "farming" to increase their business activity. They pick a neighborhood or two and focus their marketing efforts within that area. You should try the same technique. Start with a neighborhood that is relatively convenient for you.
1. Drive the Area
Spend a few weekends driving around the area. The goal for you at first is to learn about the area, the style of houses and the average prices. Over time, you may expand your farm area, but stick with areas that contain the type of homes you plan to purchase. It is not necessary to begin your investment career by learning every square mile of a large metropolitan area; it is important to learn the value of "typical" homes in your target areas. This knowledge will enable you to make quick decisions about whether a particular prospect is a bargain.
2. Attend Open Houses
Visit open houses and "for sale by owner" (FSBO) properties on weekends. Speak directly with owners and their agents. Pass out your business cards. Make friends. Word of mouth and referrals are a big part of any business.
Part of the process of finding a deal is to know how to recognize one. Take a good look at the property and its physical features. After viewing a couple of dozen open houses in the neighborhood, you will get to know the value of the properties and the different styles of houses. When someone calls you about a house in that area, you will know the value by its description.
3. Look for Ugly and Vacant Properties
While you are driving around neighborhoods, look for vacant, ugly houses. How can you tell if a house is vacant? Look in the window! Of course, this practice may get you shot, bitten by a dog or arrested. First look for the obvious signs of vacancy - overgrown grass, no window shades, boarded windows, newspapers, garbage, mail piled up, etc. If you are not certain whether the property is vacant, knock on the door. If the owner answers, be polite, respectful and ask if he is interested in selling. In many cases, it may be a rental property, so ask the occupants for the name and telephone number of the owner.
If the property is vacant, ask the neighbors if they know the owner. Most neighbors are helpful, as they know "ugly" houses hurt their own property values. In addition, ask the mailman - they know all of the empty houses on the block. Leave a business card and write down the address of the ugly or vacant properties. When you get home, look up the name and address of the owner. Finding the owner of a vacant house can be difficult, which is why the persistent people who find the information make the most money. The name of the owner can be found by calling your local tax assessor's office or by looking up the deed recorded with the County land records.
If you want to contact the owner, it takes a little more digging. Try speaking with the neighbors or asking the post office for a copy of a change-of-address form on file for the property. Online services, such as www.infousa.com, will search public databases, such as the Driver's License Bureau and the Department of Motor Vehicles.
Some cities, towns and counties will "tag" a house with code violations. This is often a sign of a neglected or vacant property. Ask your city if you can obtain a list of such properties or find where this information is publicly recorded. |
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Last Updated on Thursday, 03 July 2008 09:10 |
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8 Steps to Getting Out of Debt |
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Written by Larry Goins
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Thursday, 03 July 2008 08:35 |
The recession is over and spending is going up. Interest rates may even begin to rise soon. According to a recent study Americans are carrying $683 billion in revolving credit card debt. That is not how much we charge but the outstanding balance that we pay interest on each month. WOW! Cambridge Consumer Credit Index stated recently that of all those people who paid less than the entire balance all but 13% made the minimum payment. Using a credit card on a regular basis is nothing more than habit. If you want to change your results just change your habit. You can even go so far as to leave your credit cards at home. Yes, I know it’s tough but if you don’t have them with you, you can’t use them can you? Here are 8 steps that will help you get out from under the burdens of debt. If you have young adult or teenage children I would suggest that you pass this along to them also:
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Last Updated on Thursday, 03 July 2008 09:11 |
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5 Things I Wish Someone Had Told Me Earlier |
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Written by Vena Jones-Cox
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Thursday, 03 July 2008 08:33 |
It is a major regret of my youth that no one ever bothered to tell me that working for a living was a drag, or that depending on a job to make you rich was a fantasy. I guess I was aware on some unconscious level that my dad's real estate investor friends were able to go to Europe for months on end while my friends' parents—even the ones with great jobs— were lucky to put 2 weeks of vacation time together each year, but I always assumed that my dad's friends had so much spare time because they were unemployable, never having been told that, despite their paint-spattered overalls and 15-year old pickups, they were multimillionaires.
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Last Updated on Thursday, 03 July 2008 09:11 |
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5 Ways to Collect Cash When Buying No Money Down |
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Written by Richard Roop
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Thursday, 03 July 2008 08:27 |
By definition, a real estate investor puts up some money and “invests” it into real estate deals. As a real estate “entrepreneur,” I prefer to avoid tying up any of MY money in my investments. In fact, I prefer to collect some of my profits on the same day I buy a house. That way I don’t have to be in a hurry a sell. Then I have money to further my real estate education, pay my operating costs, invest in systems to grow my business… and write myself a paycheck! Now, I’m willing to wait for my profit on the back end. And I’ll even consider “investing” small amounts into a house like a small down payment plus money for holding and touching up the property. Ideally though, I’ll want to quickly get my money back out when the house once it’s occupied by a buyer or tenant buyer. There are many different approaches to real estate investing. And I certainly don’t have the perfect plan. Your approach will depend on your own personal desires and skill set. But to put my “collect cash when buying” strategies into context, I’ll briefly describe my real estate business…
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Are There Good Deals in a Hot Market? |
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Written by Vena Jones-Cox
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Thursday, 03 July 2008 08:26 |
Q: I live in a market that's so hot that houses go on the market and get a close-to-full-price offer in less than a week. I can't buy properties here for less than full value, and no one is willing to carry terms, since there are thousands of qualified buyers looking for houses. Do I just wait for the market to slow down, or what? S.R, Philadelphia
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Last Updated on Thursday, 03 July 2008 09:11 |
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3 Good Reasons Not to Over-Finance Your Properties |
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Written by Vena Jones-Cox
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Thursday, 03 July 2008 08:23 |
With the advent of 90%-100% LAV loans on investment properties, many investors are taking the opportunity to finance or refinance their properties at a higher percentage of value than normal. Many are taking cash out at the closing, and many are choosing to pay close to retail for properties that qualify for this financing, on the theory that a no money down deal is a good deal, even if it only cash flows a little. Smart investors avoid the temptation (and the strong come-ons by mortgage brokers) to do this. Here’s why:
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Last Updated on Thursday, 03 July 2008 09:07 |
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100% Financing: Feeding the Desire to Acquire |
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Written by Ray Alcorn
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Thursday, 03 July 2008 08:22 |
At least once a week, someone posts to the commercial newsgroup seeking a way to finance 100% of the acquisition cost for an income property. I suppose it is fueled by the late night infomercials touting no money down deals and using pictures of Class A apartment buildings, never saying the one describes the other, but leaving a strong impression that that is the case. The way it comes across, one would believe that all you have to do to become a millionaire in real estate is to acquire the properties with “OPM”, meaning Other People’s Money, and then just sit back and collect the big fat checks they like to flash on the screen. Television is a wonderful thing. After the story is told and the product is sold, no one in the TV cast has to stick around and collect rent.
The quest for 100% financing in real estate reminds me of that joke about a dog chasing a car... what's he going to do when he catches it? I wonder, has he thought this through? I laugh every time I see a dog chasing a car, and think how much he is just like an investor high on the “desire to acquire.” That’s the peculiar state of mind that surfaces when the target of our desires looks so good that we’ll do anything to get it, with no regard for the consequences.
The Desire to Acquire
In real estate, the “desire to acquire” is present when the investor is willing to do anything to get a deal, any deal. Convinced that once you own real estate you’re on your way to the good life, they tap their home equity, or find a seller that will owner finance, and get a bank loan on the bank’s terms, not theirs. Now they’re in a deal, but have they thought it through? Let’s take a look at what happens when you “catch” the 100% leveraged deal.
The infomercial gurus teach that if you find the right seller, then you can structure the deal so that there is no money out of your pocket, and leave the impression that there will be plenty of money in your pocket after you do the deal. More often than not, that’s not the result. Let's say that you do find a lender that will loan 80%, and a seller that will carry 20%. In all but the rarest of cases, the combined debt payments are going to eat up all but the tiniest portion of the cash flow. It has to be this way, and I can show you why. Instead of projecting how much you’re going to make from the deal, think about it terms of the occupancy level it takes to break even. Then consider the difference between physical occupancy and economic occupancy.
Economic Occupancy vs. Physical Occupancy
Let’s face it, the deals that we look at with decent prices, motivated sellers, and opportunities for turnaround or upside are usually not the cream of the crop. If it were an “A” property, with well-screened tenants it probably wouldn’t be on the market at a price that would interest us anyway. So it’s pretty likely you’re going to inherit a less than stellar group of tenants. The first advice here is to factor delinquency into your projections to avoid a rude awakening later. Comparing the economic occupancy to the physical occupancy can be an eye-opening exercise.
Economic occupancy differs from physical occupancy, sometimes widely so. Economic occupancy is calculated as the actual cash collected divided by the total potential rents. The answer will be a percentage, and it is important, as we will see in a moment. Delinquency in apartment rent rolls is a fact of life. You are not going to collect 100% of the money due, on time, 100% of the time. It is not uncommon for even well-run apartment buildings to run a 5% delinquency rate, and poorly operated projects may run a 30% or higher rate. For calculation purposes, if the rent is past due past the due date it is not included in rent received.
In the same way, vacant apartments are also a fact of life in the apartment business. Vacancies are actually phantom expenses that only show up in an economic occupancy analysis. Together, vacancy and collection losses are typically projected to run 5% of gross income. In my experience that is a low number. In the twenty-five plus years I’ve been in this business, a more realistic figure is 5% for vacancy loss and 5% for delinquency and collection loss. In a twenty-unit complex with average rents of $416 per month, that’s equivalent to one apartment vacant for one year. Every investor quickly finds how easy it is to “tweak” these numbers on paper to make the bottom line more attractive. I prefer to err on the side of reality, and would advise that you, “Tweak at your own peril.” But we’ll use the 5% figure for this discussion, just to save the argument, and to prove the point that even using optimistic numbers a 100% leveraged deal is tough to structure.
Always Run the Numbers
Let’s use twenty-unit apartment building with potential gross income of $100,000. That works out to average rents of $416 per month. If it is a normal building, there will be about 40% expenses, ($40,000), including management, but not including vacancy and collection (delinquency) loss. Included in the expense estimate is a “reserve for replacement” deduction. This is an annual estimate of funds needed to perform capital improvements. An average figure is between $200 and $250 per unit per year. While many owners do not actually reserve the funds, some lenders will deduct the amount from the cash flow before calculating the debt coverage ratio. Other won’t, but that doesn’t mean the improvements won’t be required.
Lastly, if you use the standard projection of about 5% ($5,000) for vacancy and collection loss, then the building must have an economic occupancy of 45% just to operate (40% operating expense + 5% vacancy and collection expense = 45%). That leaves a Net Operating Income (NOI) of 55%, or $55,000. We call it NOI, but the lenders call it, "funds available for debt service." Ever wonder why? Read on.
Most lenders require a minimum 1.25:1 debt service coverage ratio (DSCR) to fund a deal. Some are higher, very few are lower. There's a good reason for that.
At a 1.25:1 DSCR, 80% of the NOI is used for debt service. (1/1.25=.80). In our example, the maximum debt service would be $44,000, ($55,000 x 80%), or 44% of the gross POTENTIAL rent. Add the 45% of expenses to the 44% of the debt service, and you need 89% economic occupancy to break even. That leaves 11%, or $11,000 for profit, pre-tax.
That’s with normal deal structure, and 20%-25% cash equity. At $416 average rent, the profit margin is equal to just over the annual rent on two of the twenty apartments. Or, looked at another way, if there are two vacant apartments for twelve months, and the rest of the complex operates normally, the project is going to lose money for the owner. The lender will get paid (in theory!), but the owner won’t. And that doesn’t take into account any increases in utility costs, insurance costs, property taxes, fix-up cost for a trashed apartment, or any other of a hundred things that can and do change during the year. Now can you see why the lenders are so tough on debt coverage ratios?
Pushing the Limits
So now let’s move to a deal that has 100% financing. Say you find the above building and the owner just has to get out. He’s willing to take $500,000. That’s an 11% cap rate on the $100,000 NOI, and sounds like a great deal. You’ve got a bank that will work with you on high leverage deals, and they offer to finance the deal with terms of 80% of cost, 7% rate, and twenty-year amortization. That’s probably a little low on rate nowadays, but a fifteen-year term is more typical of local banks. Further, we’re assuming you’ve got great credit, high net worth and are an experienced real estate operator and can get the best loan terms available. The seller wants out of town so bad he’ll finance the rest at 8%, with twenty-year amortization, but a balloon in three years. He wants out, but he does want his money.
The annual debt service on the first mortgage ($400,000) with the bank will be $37,214 with a DSCR of 1.47. So far, so good. The annual debt service on the second, seller held mortgage ($100,000) would be $10,037. That’s total debt service of $47,251, or 47.3% of gross potential income, and a cumulative DSCR of 1.16:1. Add 45% expense and a conservative vacancy/collection loss allowance, and the break-even economic occupancy level is increased to 92.3%. Or, stated another way, the best-case profit is 7.7%, or $7,700 per year. The most you can make is $641 per month, if everybody pays on time and nothing happens. That’s a cushion of one and a half apartments per year over break even, before any unanticipated costs or expense increases. That is a razor thin margin.
Now go back to the more realistic 10% vacancy and delinquency loss and the break-even economic occupancy becomes 97.3%. If anything outside the perfect world of the paper projection happens, anything, then you’re running negative cash flow. You’re upside down from the get-go, and few if any options to cure it. So now tell me, you’ve caught this deal, now what are you going to do with it? Can you imagine yourself a year from now being a “don’t-wanter” seller? I’ve seen it happen just that way so many times.
Is This Your Story?
I had a call a few weeks back from a fellow that bought a small apartment project we had looked at about a year ago in a town about thirty miles from our office. He wanted to sell, and called us because we are fairly well known as buyers in the market. He started describing the place and it sounded familiar, so I asked if he had bought it from “Mr. Jones”. He said yes, and I knew it was the same deal we had looked at.
I asked how much he was asking for it, and he said he was willing to take what he had in it, which was about $240,000. It had more land next door that could be developed with more units and he would include that with the deal. (We had offered the original seller $200,000, owner financing, no money down, and the development parcel next door free and clear, or $175,000 all cash. The Seller didn’t take either offer, and we walked away.)
I asked a few questions. Nothing much had changed. He had painted the place, but the rents were the same. I asked him how much he owed, and he said $240,000, twenty percent of which was financed by the Seller. He was three payments in arrears on the Seller’s note because there had been two vacancies he couldn’t get filled.
He mentioned that this was his first real estate investment and he really didn’t know what to do. I could hear the strain in his voice, and could tell he really wanted out. I said I was sorry, but I couldn’t help him. I didn’t preach this sermon, figuring he was already paying tuition for an advanced degree in the proper use of leverage. His desire to acquire was stronger than his desire to learn how to figure cash flow before jumping into a deal. He didn’t think it all the way through.
Pigs Get Fed…
If all of this doesn’t give you pause to think twice about high leverage, then consider this. If the building in our example is full, there are twenty tenants with payments due each month. That’s 240 payments due each year. That’s also twenty potential stories each month as to why you can’t get your money, 240 potential stories each year. What is the probability that of the 240 potential payment events per year, somebody won’t pay on time? That should make you wonder how well the tenants you inherit from the Seller were screened. Or did he just get warm bodies to fill the place to sell? Believe me, it happens.
Don’t get me wrong; there are situations where 100% leverage is possible and profitable. I’ve done it a number of times, but in every case there was considerable upside available, or a development opportunity that I could capitalize on to better the odds of success, such as my original offer on the deal above. We structured the two offers so that either way we could win. It had the potential to cash flow in the present, and plenty of upside in developing the property next door. We walked when we couldn’t structure the deal to win.
Someone else came along and wanted the deal bad enough to do whatever it took to acquire it. Now the Seller has a non-performing note behind a first mortgage that is barely being serviced, both secured by a property that is declining in value because of poor management and a tough market. Did anyone really win? There’s another saying that comes to mind here, “Pigs get fed, hogs get slaughtered.” That’s a barnyard expression to describe what happens when we reach for more than we’re entitled.
I hope you can see from this discussion why high leverage is a strategy that requires the experience, capital, and resources to use it properly. Be careful when you contemplate highly leveraged deals. Figure the break-even economic occupancy rate. Know what the costs are going in. Know the market. Know your own capabilities and be able to move quickly to capitalize upside. Above all, do not tweak the numbers to support your own “desire to acquire.” |
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