|
2. Don’t forget you’re buying a business
Owning an investment property carries with it great joy and potential
as well as very difficult decisions. Getting rid of tenants, who to
rent to, whether or not to make that improvement, etc. Remember it’s
not a hands-off investment.
3. Stay rational, not emotional
An emotional purchase is not always your best investment. Pay
attention to the numbers, not necessarily to your heart.
4. Avoid negative cash flow
Unless you expect constant appreciation, don’t buy investment property
that eats like an alligator, it’s no fun! It may cause you pain and
force a sale before the benefits of ownership can be seen.
5. Do a thorough inspection
Look at every inch! Hire a professional inspector and ask the tenants
questions about the property.
6. Have adequate insurance
Get a professional insurance agent to make sure you are covered!
Tenants bring liabilities!
7. Treat your tenants as customers
Vacancies and turnovers are your largest expense! Charge fair rents
and attend to realistic tenant needs immediately.
8. Select qualified tenants from the start
Check references from previous landlords, employers, bankers, and
friends. Check credit, bank balances, and judgments. Drive by where
they currently live. A little work up front can save many problems
later.
9. Rent Right!
Low rent costs money, but can cut turnover and can decrease vacancies.
High rent increases cash flow and the value of the building, but can
increase the vacancy factor and turnover.
10. Don’t spend positive cash flow!
Remember, successful investors have free and clear
properties! Apply your cash flow to the payment and speed up that
amortization schedule!
Financing
For most transactions of five or more units you can obtain a 75% loan
to value. If the property is one of the 10 most expensive zip codes,
the lender may require a down payment of 30% - 40%.
Lenders
The lender will loan a higher dollar amount in the more affluent areas
than in the average location, but the property must still service the
debt. In the more expensive areas, investors might pay nine to eleven
times the annual rent. In most parts of the county properties can be
bought from six to eight times the annual rents. The lenders say that
you can pay a lot more for a great location, but the cash flow alone
does not justify the price in the glamorous zip codes. However, as
property values increase, returns on investment properties in higher
rent areas can be significantly greater than in areas where tenant
turnover is high and rents are low.
Inspections
Most prudent buyers use expert inspectors. You will look carefully at
the property and so will your agent. Most buyers are not construction
experts, nor are most brokers. Paying a few hundred dollars on a
$500,000 purchase seems like sensible insurance. When someone buys a
used car, they probably have a mechanic check it our before releasing
all the cash.
When you buy a house from the seller, the resident,
who is the seller, has a strong incentive for you to get full
information. The resident wants to get your money.
Apartment dwellers have no incentive to let
strangers into their homes. The renter is inconvenienced by a stranger
coming in and receives no benefit from that invasion of privacy. The
industry recognizes that serious investors need to see the inside of
the units. Yet sellers know that most people who write offers will not
pay what the seller wants. The solution is to write an offer with the
understanding that if the property does not show well on the inside
that the investor can cancel the transaction.
When you inspect you are looking for surprises. You
want to know if they look like what you might expect based on what you
have seen on the outside. If the outside is run down, you can expect
there will be some deferred maintenance on the inside.
You do not expect perfection. The units won’t be
model homes. That is why this process is called due diligence. You are
diligently checking the assumptions and assertions made.
There is a trade off between buying in an affluent
neighborhood and buying in a more challenged neighborhood. Each
investor will select the neighborhood that makes the most sense to
that investor. Once we know more about you we can help you determine
which may be the best fit for you. An excellent neighborhood is not
necessarily the best investment, regardless of the price. Sometimes
more challenged zip codes can be the superior investment, at the right
price, for investors who understand the residents and consequences.
We know that most apartment building investors have
worked hard for their money and want a want to get in on a good deal.
No investor has money to waste. No one plans on paying too much. Of
course, you want to be careful with your money. For this reason, you
need a great broker to help to increase your chances of success. Part
of what makes this arena so interesting is the motivated people who
want to improve their position. We have served investors successfully,
and we can help you minimize your risk and increase the likelihood
that you will be among those fortunate enough to close an escrow.
Cash Flow
Lenders will not make a loan unless they are confident that an
ordinary investor will have a positive cash flow. If you buy in
less-expensive areas you have a lower dollar loan per unit. The income
will support the lower loan. If you select one of the fancier
neighborhoods you will pay much more for units there. The lender will
loan more dollars, but a smaller percentage of the purchase. No matter
where you buy, the bank will only loan enough that the property can
make the payments and have extra cash left over.
More expensive units tend to require larger
percentage down payment. In almost every case, your cash flow is
likely to be other types of investments. Your cash flow may be from
two to four times as good as the cash flow that would come from stock
dividends. Income property investments offer a tax shelter, which is
not available from stocks.
In real estate, in most cases the increase in value
is even more important than the annual cash flow.
Acquiring Investment Properties
Many new investors make the mistake of buying "bargain" property for
rental housing without understanding why tenants choose the location
they want to live in, and the kind of home they want to rent. To get
good tenants you must own decent, safe and affordable housing in areas
where people want to live. Schools, transportation, shopping, churches
and jobs all affect the amount of rent a tenant will be willing to pay
to live in your property. And that determines the price you can pay
for a rental property.
When investors buy a property just because it is
priced $10,000 to $20,000 below market value, they often learn too
late why it was priced so low. Don’t get caught up in the most common
mistake made by inexperienced investors; when you become blinded by
the "good deal" you are about to make, you usually don’t see the rest
of the story. The price you can pay for income property must be a
factor of the Net Operating Income that it will eventually produce and
the resale value of the investment.
If however, you intend to put the investment in
your Four F Portfolio, and fix it up for a quick resale, your criteria
is totally dependent on a recent Market Analyses for that kind of
property, in that location, when the likely rehabilitation is
complete.
There are legitimate reasons for a decent property to sell well below
market. For example: divorce, death, and taxes, can motivate sellers
to take a quick cash offer that they would never agree to under normal
conditions. But perhaps the most common reason a seller can’t get a
fair price for their property is inadequate professional marketing or
"deferred maintenance".
If you are buying property for rental housing, the
purchase price can be relatively unimportant. What is as important is:
-- the amount of money it will take to make the property decent, safe,
sanitary and desirable to a desirable tenant, the terms of the sale,
and the market rent for that type of property in that neighborhood.
The Net Operating Income
(NOI) is the amount of money available for debt service, or as
return on investment from income producing real estate. To determine
the NOI, first calculate the actual or expected gross income. A single
family home's income is usually confined to gross collected rents.
Multi-family housing usually earns additional revenue from several
other sources as well, including: coin-op Laundromats, public phones,
extra parking spaces, etc. Then deduct all operating expenses which
include: taxes; insurance; maintenance; repair; allowance for vacancy
and uncollected rent (10%) The balance left is the property's NOI.
Potential
Talk to a real estate professional about an income producing property
and the very first words out of their mouth will probably be about the
potential to increase revenue by raising rents and improving
management practices. Unfortunately they often want you to factor
tomorrow's pie in the sky into the price you are willing to pay for
the property today. What they tell you about increasing revenue is
probably true, but most income property should sell for a price based
on the current NOI. The real up-side and profits in rental housing
actually come over time when you get steady increases in rent and
market value do to inflation and improving markets, while your
investment and debt service remain the same.
Condition
A property that is a good candidate for real estate investors almost
always looks to be in bad condition. That's OK, if it has the "right
things wrong with it". For example: needs paint, sagging porch, bare
bones landscaping, ugly wallpaper, or is dirty and unkempt. Even
seemingly major deficiencies like: plumbing, electrical, a defective
furnace or a bad roof, can be factored in the price you offer.
However, the "wrong things wrong" are: tiny bedrooms, lack of closets,
steep narrow stairways, one bath, and most importantly - bad location.
When considering condition, remember, homeowners buy pretty, landlords
should buy practical and the property's potential.
Market Conditions
The best buy, in the best condition, is worthless to investors if the
rental market is in the proverbial toilet because the military base or
a major employer recently closed. If a property is vacant it has
negative value to landlords. Market value is important to a homeowner,
but is only relevant to a real estate investor in that it reflects the
possible resale value, and the investors net worth on paper.
Terms
If you can buy with little or no money out of pocket, and the property
will cash flow at the asking price, it may be time to stop
negotiating. Any return on an investment with no money down is rather
large, isn't it?.
Real estate investors prefer "no money down, on a
land-contract or conditional sales agreement." Sellers often
(sometimes mistakenly) prefer cash. Fortunately there are a great many
options in between. The major advantages of land-contracts, to both
parties is: quick, clean and easy. There are no requirements prior to
closing except the agreement of the parties and filling out preprinted
forms. There are, of course, several things that should be done,
including a search to assure clear title, having a deed placed in
escrow and attorney's review of all documents.
The next best alternative for a typical investor is
assumption of existing financing, with perhaps a second mortgage taken
back by the seller for all or part of the difference.
If new financing is required, expect to put at
least 30% down and pay substantial amounts in closing costs. However,
even then there is room for creativity in the overall financing
package. For example: the seller can pay the purchaser for things like
deferred maintenance, major repairs and decorating at closing. There
can also be an agreement for the seller to provide secondary
financing. If a new loan is necessary, there are several sources
discussed in our Financing Section.
Resale Value
The price paid for every investment property should not only be a
factor of the NOI, but reflect the probable liquidation price in the
event of an emergency. Hopefully that will be about the same price
that you finally agree to pay when you buy a property. Always make
your purchase of investment property as if you are going to sell it
the very next day. Structure the terms and financing for resale, with
assumption guarantees when ever possible. Consider the property's
current market value.
Tax Ramifications
The IRS code is designed to provide incentives or penalties that
promote or discourage financial activity in America, according to the
political and public policy of the moment.
Real estate home ownership and investments in
rental property are perhaps the primary examples of how effective the
tax code is at effecting the value in what is purported to be a free
market place.
Although we do not believe that investors should
build or buy rental housing just for the tax benefits, they are
certainly a very important part of any investment plan.
The Internal Revenue Service assumes that a
building depreciates over time, so at the very minimum, a $50,000
residential rental property, depreciated over 27.5 years will produce
approximately $1,600 in tax shelter a year. The number is a bit
ambiguous because the IRS allows depreciation for improvements only,
not the land. Therefore, investors want to assign the lowest possible
percentage of the purchase price to the land. The rule of thumb is 10
to 20%, however if you can substantiate a lower number by checking the
allocation on the property tax rolls, or obtaining an appraisal
showing similar building lots are selling for less, by all means use
that lower number.
The tax shelter number can be enhanced
significantly by structuring the purchase to assign as much of the
value as possible to personal property which can be depreciated over a
much shorter period.
The really good tax benefits come through special
government programs that reduce your tax burden in order to promote
prevailing policy. Historical buildings and low income housing
tax-credits are just two examples.
Some Information was obtained from
Rental Housing On Line, with information, law, forms, forums, live
chat and vacancy listing service. Visit RHOL at:
http://www.rhol.org.
|
