Multi Family Investing, Condo Investing, Fix n flips, Short Sales, Foreclosures, 1031 Exchanges
I will break this one into several sections in case you have a particular area you want to invest in, though I will start where I usually do, and that is mortgages. Before jumping into the real estate investment world, you need to know the costs and the differences in obtaining money. One of my clients buys his investment properties cash and has straight cash flow, but that is not the norm. Interest rates on properties you will not be occupying as well as insurance rates are much higher. In multi families, once your building has more than 4 units, it’s a commercial loan and the down payment is 20% or more, though the return should be greater as the cost per unit should be lower. Even on investment condos the down payment needed is greater than an owner occupied and the interest rate is higher. You should have a meeting with a mortgage broker and your accountant to discuss what the ups and downs are and how to be properly prepared. In some cases, if not most you may want to form an LLC. This is done with an attorney.
There is no doubt that real estate investments can be lucrative and an investment tool for retirement planning, if done properly. Even in this down market, if you follow one piece of advice, you won’t go wrong. That is, cash flow is king. Even on making the worst mistake on buying the wrong building at the wrong time, if there is cash above your expenses, you can afford to hold on until the market turns. This rule even applies to fix and flips, which is the most dangerous investment in a down market. I will not venture in here to have you leverage equity in your current abode to purchase property as even though it is a method of buying more real estate, it puts your home at risk and compounds the pain in a down market. There are a ton of mistakes you can make in a charging upside market and recover well and even profit. So here goes the plan for different types of investments. You should also review the service providers and mortgage selection section on the website. This will be a guide for the cream puff type investors as well as those who are looking to make it a livelihood.
Even as a first time home buyers principle residence, multi families make a lot of sense. Where else can you live where the mortgage is mostly paid by someone else and you have the potential of making profit at the end as well. If you are planning on living in the building, up to a 4 family, there is a wealth of mortgage products with low to no down payment, that may be available to you. If this is a stepping stone to investing, you need to still follow the cash flow is king rule. If you are going to bail out at sometime to buy your own single family or need to get out for financial reasons, you are safe as long as the rentals exceed your mortgage and expenses.
My favorites for both owner occupied and cream puff investors are 3 and 4 families. The goal is to make sure that even if you have a vacancy, the other rents will cover the mortgage with no money from your pocket. The rougher the building and area, usually the greater the cash flow as you did not pay a premium for the location. You will be paying a premium in headaches however, as usually the quality of tenant is different and attracting tenants with good credit is difficult at best and the rents will not be as high. Collection rates are usually lower and there is a more likely event of evictions, which are costly.
Fortunately, in the down market scenario, ratios of the better buildings in higher rent areas are falling in line to be more favorable. I usually look for a price to rental income ratio of 100 to 1 to begin my investigation of a property. In theory, that means a property with $2,000 in rental income will not exceed $200,000 in price. I put out an email when one of those properties becomes available to my folks on the investor list. Email or call me if you wish to be on the list. Now realize that this is for investment purposes and is only a guideline. From here we have to look at taxes and expenses. Heating is usually a big expense, if not the biggest and it is great if each unit has their own heat source, paid by the tenant. This keeps your cash flow even.
Expect to pay an average of 1 ½% over the current interest rate for non owner occupied units and in the vicinity of $1100 to $1600 a year for insurance. Units with on street parking should be bought at a discount as the resale to similar units with off street parking is harder. Likewise, if you want a better shot at resale you will keep yourself below 5 units to open up to more buyers when it comes time to resell. If you are planning on using someone to rent your empty units for you, figure on one month rent as a cost and on top of that 10% of gross + expenses if you are going to have it managed.
I would have a lease drawn up by attorney and preferably an attorney local to your building because you may be using them for evictions as well.
On the buying end, make sure the building is zoned and approved for use as the # of units it is selling at. The town hall building and zoning department will have records as to the approved use of that building. Check with the fire marshal and the building inspector for any unresolved violations at the building and be sure that there is a stipulation in your contract for that. Obtain copies of the current leases for the building and write in a clause to the contract that the owner cannot renew or sign any leases without your review. This will avoid them adding a 2 year low rent lease into the building before you close as a favor to their favorite tenant. Leases run with the building and you will be stuck with it. In the contract and at the closing, you should be collecting from the seller, any deposits they are holding including applicable interest, which is set by the state. You must pay the tenant back after the lease, any deposit plus applicable interest if they fulfilled the obligations of the lease. The tenant forfeits the interest and the deposit if they break the lease, but be forewarned, they will probably not notify you that they are breaking the lease and will stay in the apartment without paying the last months rent. As a protection against this, some landlords in the day of the great rental market were collecting double deposits.
You do have responsibility for lead paint disclosure, so make sure you give a lead paint disclosure to the tenants in buildings pre 1978 and the lead information booklet. Also go through the apartment, the first day the tenant moves in, with the tenant and note any damage to the apartment, including carpet stains, etc. Have the tenant add any items they wish on there and have both of you sign and date it. This protects you when the tenant leaves and lessens dispute over what was damaged when the tenant moved in.
Certain agencies including HUD have programs, such as Section 8, that guarantee to pay low income renters rent, either partial or in full . The down side to some of these programs is you are subject to inspection and if there is an item in their inspection in default, they can hold back rent from you. The upside is that they usually pay a very competitive rate, directly to you with only the small balance paid by the tenant. If the tenant defaults, they can be cut out of the program.
When screening tenants, in a building that is not your primary residence, you must follow all fair housing practices, including making reasonable accommodations for handicapped tenants. You are given more slack with a building you live in. Realtors must always follow fair housing practices. Be sure to be familiar with the rules.
You cream puffs can skip out now and I will skip to 5+ family buildings. These are not for the part timers. These require a hefty down payment and therefore you will be looking at a higher rate of return if you buy the building properly. This means, however, dishing out 20% + as a down payment and at least 1 ½ % over the average owner occupied rate. The cost per unit should be way less. You are subject to a bit more scrutiny from town and state building officials the bigger you get and it is advisable to run a tight fair ship. Leases for all tenants should be similar to protect against unfair housing practices and tenants complaining to town officials. I suggest a strict compliance to dealing with late rents. This will result in higher collection rates and less problems. A goal should be, to make 10% a year after expenses on your initial deposit. As home prices increased, that goal is difficult at best to obtain , though as the prices decline, it may once again be feasible as the rents have not been impacted as much as home prices.
Your goal in these buildings is to create a cash flow that in some cases, folks can live on. The building gets paid down by the tenants and when the market peaks, you can bail out. A well run, well maintained building that is full or nearly full is the key to being able to sell. This is not always the easiest goal to obtain or we all would do it.
You must read my website article of condo buying for all the info on this one, however here are a few comments on investment condos. First of all, this is creampuff investing. Cash flow is still king, but you are not living off of it. You buy in the receding market and make sure your rent will cover expenses and maybe a little more. As of 2008, there are actually some condos out there in decent areas that are selling for $65 k. They would rent for around $700- 750 and in some cases where heat is included, more. Be aware that some complexes have rules about renting and make you live there for a year before you may rent out a unit. In some complexes, the heat and hot water are included in the fees and you may pass some of the expense off in the cost of the rent. You will still need at least 10% down to get in and your cash flow will not be great, however, they are easy to maintain, your tenant is paying the mortgage, and you can hold til an up market and sell at a profit. Not bad for a part time investor. Of course you need to know the rental market you are in and make sure you can rent it out and vacant periods hurt like the dickens, so make sure you get quality tenants and prepare for vacancies.
AGAIN I EMPHASIZE not everything for condo purchasing is in this section. Refer to my website for condo buying info for warnings and tips about buying condos.
There is lots of money to be made in fix n flips, but quite frankly in a down market it is much harder, so the rule of cash flow is king prevails again. The idea here to avoid down time is to figure your holding costs after the repairs are done and to make sure that the potential to rent at or above the holding cost is possible. As we are not looking into a crystal ball and cannot see the future, we must assume by patterns that we have several more down years. Therefore, by the time you close on your fixitup home and get the work done, your target sales price may have eroded. The idea of course is to never lose money, so it may pay to be patient and wait out the market and collect rent.
Once again, you must know your mortgage info and insurance info. Meet with these folks first and make them aware of your plans. They can give you numbers to work with on what you would qualify for, how much you need down and what the rates are. These are higher interest rate loans and you need to know the cost per $1,000 and if you will be able to get rehab money, which will also come at a premium.
To plan out whether a fixitup is worth it, make sure you have very sound numbers on making it habitable and it will meet code if necessary. There will be 1 good one for every 10 you look at. Pick neighborhoods with a strong rental market and decent resale. You must allow a percent for sales commission to be built in and heating/carrying costs. Your agent can do a market analysis of the property as if it were fixed up to see if the push is worth the shove. Always leave room for error and always know there will be another deal around the corner. In the 90’s, those in the know and those who weren’t made money when the market bottomed out. Those times are slowly coming back, but there is no rush as this cycle will take a while. DO NOT FOREGO PERMITS! Building inspectors cut homeowners some slack when they have done minor work without a permit. They are less than forgiving of investors. When you go to sell, you have the watchful eye of your buyer, their agent, a home inspector and an appraiser. Odds are, one of them is going to ask if certain work had a permit. In most fix n flips, there will be permit work involved.
Finding fix n flips is not hard. Have your agent set a price tag parameter on what you can spend. The agent can review properties that come on the market under your target price and identify ones that are well under the list price of homes in the area. For my fix n flip folks, we use 225k as a top and every day I look at the addresses and the price. If it seems low, I pull up the details for the home and review them in depth to see if it makes any sense. Currently, 1 or 2 homes a week are worth sending out, but not many are worth buying, however as the banks build an inventory of foreclosed homes, they are going to eventually have to fire sale them and some of my owner occupied clients have done quite well with them. Remember, this is an investment and the big mistake you can make is falling in love with the home and not seeing the forest through the trees. Your goal is to make money and you need to be conservative in the current market.
This is a newer trend in the market as banks are realizing they may have to take a hit, so they don’t have to foreclose on a property. It is better to work with an attorney, if you are on the selling end of one of these. In a short sale, the bank agrees to take less money than is owed on the property. The process for the buyer is long. A contract is submitted and not signed by the seller, but rather forwarded to the bank. We then wait for 13 puffs of white smoke signaling some one in an ivory tower at the bank and all the necessary management signoff folks, approve of the deal. Now these don’t appear to be way on top of the list of priorities of banks, at least not yet, so approval can take months and probably will. Currently it is January and one of my clients has had a bid in on one since July. We are hoping his kids won’t be through with college, by the time we get approval and the oldest one is 5.
The long and the short of this one is that these are not wildly well priced homes for the most part, but some are deals. They have more of a place in the realm of owner occupied buyers than investors and quite frankly if they don’t sell as a short sale, you can be a buzzard and wait for the foreclosure, which will be imminent.
Short sales are mostly listed through MLS and are noted as such in the listings.
For years I raised my eyebrows when folks were looking for foreclosures, because quite frankly in the 2000-2005 period they were not much of a deal, but folks would go on a frenzy overbidding on them. Basically, some of the foreclosures sold at up to $50,000 over the list price and it was questionable if they were worth the list price to begin with. I am sure some of the foreclosures now, were foreclosures then.
But lick your chops and get ready, because the fun has begun. We actually get to see wild price reductions on foreclosures and I believe we are only at the beginning. Now, many of them are junk and you better have a fixitup attitude and not be too picky, but there are also some good deals with great deals in the mix. You need cash as the banks are not too wild about 0 down buyers and most will not allow government loans. If you are buying in the winter, which many folks do, just so they can get me into 10 degree buildings with no heat, you will need to pay a company to dewinterize a home to get it inspected. This runs in the $600 range and then you have inspection costs. I would not forego the inspection unless you are extremely savvy. Many of these homes have been neglected and when you finally get to turn the water on and the heating system, you may get to see water coming out of areas, which you prefer you didn’t. Many of these homes were abandoned and suffered freeze damage and you will not normally get that info from the bank. Likewise, if there was water damage behind the walls, there will probably be mold somewhere. Just like fix n flips you will need to figure your repair costs carefully.
Believe it or not, the competition is not as fierce as it once was to jump on them, so at least at the time being, you may be actually able to negotiate on some of these .The banks are a lot faster at negotiating these, but it may take a day or 2 to get an answer and they come with pages of disclaimers and disclosures that set their time table for you to act and they don’t mess around. The disclosures basically say that you have x amount of days to do your inspection, have to pay for your own dewinterization and winterization and they wont fix anything. It is, as-is where is, let the buyer beware type deals with a load of paperwork.
Once again finding them is not hard. Most of them are listed in the MLS and you agent can find them for you. There are other types of foreclosures that can be very profitable, but you need cash. The ones you see in the paper for auctions, especially if they are absolute, can bring good deals. They have short review periods, sometimes, just the day of the auction and require substantial down payment. Even though your agent is not involved, you should have him or her do a market on the house before you go to the auction, so you know what the potential value is. A good agent has no problem doing this as they know you would probably use them for future business and it just makes good business sense to be a helpful agent. Read the fine print in the notices and do your research. Some of these buildings have tax liens, mechanics liens, sewer liens and utility liens that have to be paid by the buyer where indicated. You must get to town hall right before the auction and see what liens are on the property and if you are financing the property the liens have to be paid at closing. An investor friend of mine, who is hopefully not reading this far down, likes to go on the absolute worst weather days, so not many folks show up. I am sure he doesn’t want that cat let out of the bag.
He sets his price target and never goes over it. It can be easy to get caught up in the bidding and I recommend you go to 1 or 2 that you are not bidding on to watch what happens and learn the process.
Going back to a point that I made a couple of paragraphs back, it does pay to use your agents’ access to info. Don’t worry that we don’t get paid. We are also in the business to be a resource for the client and don’t always make money on every deal. It is way better to be involved from the beginning than to try to bail someone out of a mistake later. We know what is going on in the market and which areas are still selling at what price, so don’t go it alone. You are dealing with real money here.
Ok, folks ,this is rocket science so I dont excel on this one,though I do know where to get the answers. The bottom line is that you can defer taxes on the sale of investment properties, when you replace it with investment property of like kind at an equal or greater value than you sold. You should identify that you are going to do it, before you place an investment property on the market,but in no way should you close on that property before you identify the transaction as a 1031 exchange transaction. Then its too late. The idea in simplicity is that you can never touch the profit and a third party facilitator,of which I recommend Old Republic Exchange Facilitator Company (www.orexco1031.com), holds the funds and insures all federal laws are abided and the paperwork is properly done. In this way ,you can protect your profits from capital gains. Now the catch is you have a limited amount of time to identify and close on the next property, but if you work on it, it can be done. It may also be useful if you are moving to a new area and want to trade your investment property in for an investment property in the new area. Investment property is a some what loose term and by perusing the web site above, you can see where it may be beneficial to you. You definitely need the agent as a partner in both the sale and the purchase to coordinate the transactions and in some cases to delay the sale without losing the buyer while you do your shopping as the guidelines are rigid.
This is just a primer for you in the real estate investment world. I did not stick my money into the market the last time around, but this time you just might see me out there, looking to get involved with my own investments. Go carefully, go slowly and get all your facts lined up. You could add a few k to your portfolio. |
