mcgraw-hill audio presents how to get started in real estate investing written by Robert Irwin read by William de freeze chapter 1 the hidden rules of successful real estate investing you want to get started investing in real estate but you're just not sure what you need how much money does it take what sort of financial condition do you need to be in what should be your goals what's a realistic timeframe is a particular mindset useful or even necessary these are reasonable questions to ask after all you don't want to dive into a pool until you've determined how deep the water is similarly you shouldn't dive into real estate investing until you've plumbed the financial depths involved in this chapter we'll answer these and other questions that first-time investors are likely to have how much money do I need not a whole lot of course the amount depends on where you're starting if you want to buy your first rental house and if you're willing to move into it for a while before you subsequently rent it out and resell it then the very best financing in the world is available to you you can get a mortgage for as much as one hundred three percent of the purchase price that means you can get financing to cover all of the cost of the home plus virtually all of the cost of the closing your out-of-pocket expenses are zero where else can you get into an investment for as little of course it's a different story if you buy a home with the express intention of using it as an investment rental you'll need to put about 10% down plus closing costs on a $200,000 home that's about twenty five thousand dollars a substantial sum of money should I invest full time in the beginning it's usually a mistake to invest in real estate as a full-time job for most people the best way to invest in property is usually on a part-time basis it's important to understand that initially it's unlikely that you'll get enough income to live on out of your properties after a few years when the properties have aged and values and rental rates have gone up it's a different story but for the first ten years it's better to think in terms of reinvesting rather than withdrawing income all of which is to say that you need to have a steady full-time job for at least the first ten years you are investing because your property won't likely yield enough steady income for you to live on the most successful real estate investors I've known your author included buy property for the long term if you go the long-term route you won't have to worry as much about making occasional mistakes because property values almost always go up with inflation and housing shortages so eventually you'll come out alright aiming at first just to break even most investors don't count on taking money out monthly after a few years however when rental rates go up they will probably be able to take out a strong steady stream of income so consider investing in real estate on the side for a while at least don't make it your primary objective in other words don't quit your day job just keep at it for enough years and you'll be able to retire early with a huge bounty to rely on you should plan on holding real estate investments for the long term because you're building your net worth the more properties you own presumably the greater your wealth over time and also because this wealth tends to be illiquid in the span of a few years you might easily acquire a million dollars or more in equity and property but you'll probably have very little cash in the bank this situation is spoken of as being cash poor a common condition for real estate investors being cash poor however is no longer the serious problem it was in the past today with equity loans and all types of refinancing possible it's much easier to get cash out of your investment properties when you need it all of which is to say a that if you own a lot of property and have a sudden big personal expense you'll probably have the means to easily cover it for example let's say a big personal expense comes up such as a sudden illness a wedding college education or the need for a new car anything that requires a lot of money to get the money you need you can refinance a property alternatively you could also sell a property but that could take more time and you would no longer have your investment I always cringe when I hear those who purport to be financial advisors advise young couples to put away a certain percentage of their income usually into stocks and bonds which these advisors often just happen to be selling so that the couple will have the money to pay for their children's college education and their own retirement this philosophy seems to be that you should live less well today by scrimping and saving so that you can live less well tomorrow how much better it is to own a bunch of homes and other real estate nearly paid off that you can harvest for the money you need for these expenses when you need it and you don't have to be scrimping and saving your entire life to pay for these expenses your attendance will handle that for you we'll handle that for you what's my time frame or how long will it take to make my fortune in real estate the answer is figure on as much as 10 years or more and 20 years is ideal yes you may be very lucky and come across a series of properties that you can flip split subdivide one property into two thus doubling your money or otherwise sell for a big profit but depending on that is like gambling on the lottery it's great if it comes in but don't count on it instead rely on the slow and steady and sure think of it in simple terms plan on buying one house every year or two for 20 years at the end of that time you'll own to 20 houses the first house will be roughly half paid off the return on equity from a mortgage is the greatest in the last year's the least in the first years thus after paying 2/3 of the time on the mortgage the house will be roughly only half paid off further inflation and housing shortages likely will make that first house worth two to three times what you paid for it no matter what you paid for it chances are that by the end of that 20-year period you'll have a million dollars or more in equity that you can convert to cash if you need to in addition you'll have positive cash flow as well remember rental rates on those early properties will go up because of inflation and national housing shortages in many areas just as prices do you'll be renting them for two to three times the original rent even though your mortgage payments will be roughly the same as when you started assuming you haven't refinanced all of which is to say that in addition to having a large net worth you'll also have a large monthly income over time this is the point at which you can retire from your regular job and live off your properties and remember we're not talking about doing something difficult or arcane we're talking about buying one property every year or two for 20 years what could be simpler of course there may be obstacles you could have a bad year and lose your job for a time but even if that happens while you might not be able to buy a new home that year you'll have the homes you already own to fall back upon of course those who see the glass is always half-empty we'll say you could get sick or die or the economy could nosedive yes those things could happen but they're going to happen whether or not you invest in real estate so why not invest and hope for the best what mindset do I need to be a successful investor there is really only one requirement that you understand the difference between your business and your personal life when buying a home for investment you will feel countless tugs against your better judgment to buy a property because it offers so many pleasing features you may love the layout of the kitchen the tile in the bathroom can be adorable the backyard may be perfect for your family the garage is ideal because it's big with lots of storage space and there's a workbench all of the above would be good reasons to select a home for your personal life a home that would be most suited to your tastes needs and desires however when buying investment property you need to put all that aside and let the reasoning portion of your mind take over you need to be all business the questions to ask are will this feature or that one be suitable for tenants is it easily replaced if it is damaged or destroyed will the feature make the house more or less saleable in the future you have to put aside all personal feelings when you consider the property you must be strictly business this also applies when it comes to money when it's time to buy or sell a property you must go for the very best deal possible you can't let yourself be swayed by feeling sorry for the other party's situation for example tenants may tell you that they can't or won't pay their rent because they have so many other bills you have to be strong enough to tell them the rent comes first and demand immediate payment if you acquiesce to a tenants problem it then becomes your problem because you don't have the rental money with which to pay your bills similarly when negotiating for the purchase or sale of a home you may find you're dealing with people who have all sorts of personal problems from illness to divorce to bankruptcy your heart may go out to them however the way you help them is not to make their problem yours by paying too much or selling for too little it's by removing a problem from them for example you can help a person who was destined to lose his or her house to foreclosure by buying it from them which will help to save their credit if you want to go further and give the money to get them back on their feet I applaud you however be sure you understand your motivation getting their home out of foreclosure was business helping them is charity both are admirable but it's important not to confuse one with the other what other qualities do I need to be successful I have been asked if a successful real estate investor needs to have a mind that pays attention to detail the answer is yes certainly but then again it's hard to imagine any line of endeavor were lack of attention to detail is an asset you'll find that you need to keep track of market values rental payments and all sorts of numbers a good ledger or a Palm Pilot will help but it's still up to you to remember the details I've also been asked if a person needs to be a people person to make a good real estate investor again it's hard to imagine any line of work where personal interactions aren't important however in real estate investing they can be less important than elsewhere you don't need to sell yourself to purchase investment property or to be a landlord although a pleasing personality and a determination to deal fairly with people are great assets here and elsewhere in this business many very successful real estate investors are reclusive you almost never see them and when you do they don't have 10 words to say on the other hand if you intend to sell a property on your own then it helps to be gregarious in nature you'll be dealing directly with potential buyers and if you have an ability to chat and make friends easily it will help of course you don't have to sell on your own because you can always sell through an agent thus it turns out that you don't need a lot of money to get started but you do need determination and the ability to separate your business from your personal life you also need to understand that you're in it for the long term so as I said don't quit your day job at least not right away chapter 2 finding good investment properties there are over 65 million homes in the United States and the vast majority are single-family dwellings for the beginning investor this inventory represents a huge treasure trove of getting started properties they are everywhere to find the best one for you you just have to know how to sift through the pile before jumping in however it's important to clearly define what we're looking for a house makes a great first investment probably the best however it's not just any house we want it's a house we can make a profit on that means that we must be able to buy it inexpensively the ideal investment property will sell for below market price where do we find it in this chapter we're going to consider five areas one properties listed with local agents two properties listed as for sale by owner or FSBO pronounced Fizbo three properties listed on the internet for foreclosures and properties listed as real estate owned Aereo's five government repos in any endeavor it's important to take advantage of what's already out there to help you in other words if you want to build a wheelbarrow it's wise not to set about reinventing the wheel already in place is a vast network of listed properties indeed at any given time probably around eighty five percent of the properties for sale are listed with agents so the first step is to tap into this resource I've heard many beginning investors say something like there's nothing good listed if there were an investor or agent would have already bought it that's a mistake in thinking normally there are so many properties for sale at any given time that there are bargains out there just waiting to be discovered further every agent I've ever known would much rather get a commission which means immediate income than by a listed property which means a long-term investment agents need that constant influx of cash that commissions supply to survive normally they buy for investment only as a last resort all of which is to say that the person who complains about the lack of bargains and listings probably hasn't taken the time to look only after you've spent a month or two checking out all currently listed properties in your area should you conclude that there's nothing for you in the MLS or Multiple Listing Service you'll want to work with an agent who has access to the Multiple Listing Service in your area agents who have MLS access are usually members of the National Association of Realtors n AR tell your agent exactly what you're interested in if you're just getting started chances are you're looking for a house both as a place to live and as an investment you have your choice of the greatest selection of properties on the MLS look for stale listings stale properties are those that have been listed the longest a seller who puts a property on the market on Monday isn't likely to cut his or her price by Friday on the other hand a seller who's had his or her property on the market for three months with no activity is likely to be very anxious to make a deal and cut his or her price to do it in a normal market a large number of properties will be in the stale category indeed most properties will take two months or more to sell in a slow market you'll want to extend your time frame to homes that have gone unsold for six months or longer in a hot market however you will have to reduce that time frame sometimes to a few weeks look for price reductions another indication that a seller is anxious to dump a property is a price reduction particularly a large reduction a seller who cuts the price by $1,000 is merely trying to attract attention a seller who cuts the price by $10,000 is serious multiple price reductions particularly when they come in close succession indicate a very anxious seller I once bought a home from sellers who were so anxious to sell that they were cutting their price ten thousand dollars a week until they finally sold the property if I had waited long enough I could have gotten the property for nothing although certainly someone else would have bought it long before then when you find a property that has been reduced in price and that otherwise seems suitable don't feel you have to offer the current asking price just because a seller has reduced the price doesn't mean the price is at rock-bottom treat a reduced price as you would any other the starting point for negotiations work down from there check for clues in the listings listing agents have a duty to protect their clients in this case the sellers and they must do everything they can to attract buyers this means letting buyers know when sellers are highly motivated to sell which they accomplish often by writing Clues into the listing look for phrases such as highly motivated or bring in all offers or wants to move immediately you get the idea the agent is sending out the word that this seller is very anxious and we'll consider lowball offers if the property is also listed with price reductions you probably have a real opportunity in the making check out the properties while this may seem simple-minded the fact is that some beginning investors prefer the paperwork to the legwork they will find a property that looks terrific on paper and make an offer another take real estate properties are not homogeneous that means that every property has unique characteristics no matter how good a property looks on paper you have to check it out physically before you make an offer for it you might find that this terrific property backs up to a dump site or it has high tension electric wires traveling over the fence line or the street in front is all broken up and the city has no plans to fix it or nothing takes the place of looking at a property these listings must be bargains beware in most cases these are far from bargains what you're looking for are the occasional fizz bows that can make you a profit while fizz bows are advertised really the best way to find the ones that would work for you is to drive through the neighborhoods in which are interested there are advantages of buying a property in an area close to where you work think of this area as your farm you'll define certain neighborhoods as good investment areas and on a fairly regular basis drive or walk through them look for signs that indicate a person is selling his or her home Fizbo when you find a Fizbo that looks suitable based on the criteria at the beginning of this chapter stop by and engage the seller owner in discussion find out what the asking price is and if there are any special features then check it out do a comparative Market Analysis CMA chances are you'll find that the Fizbo price is at or maybe even higher than market price how can a seller even think that you may be asking yourself why would I want to spend as much on a property without the benefit of an agent as I would with an agent the reason the price is so high is that quite frankly most Fizbo sellers don't think about the work involved in selling their property as much as they do about saving a big Commission hence they price their homes unrealistically you will occasionally find a Fizbo seller who seized the light he or she has priced his or her home below market in order to attract buyers rather than attempt to save a commission this seller will give the Commission to the buyer in the form of a lower price in order to get a faster sale this is someone with whom you can reason and negotiate this is not to say that you should immediately pay the full asking price even if it is below market you should still negotiate even lowball but it's much better to start with a realistic seller than with a seller who thinks his or her property is so wonderful that you ought to pay full price for it keep in mind however that buying Fizbo is more difficult you don't have an agent to handle the paperwork in other details many investment buyers in this situation will find it advisable to hire a fee-for-service attorney or agent to handle the paperwork for them it probably will only cost around $1,000 and if you're new to real estate investing it can be well worth the money work foreclosures and REO s everyone has heard about foreclosures through which an owner loses his or her property to the lender usually for non-payment of the mortgage most people also have heard that if you can pick up a property in foreclosure you stand to make a good profit what few people have heard of however our REO s these are properties that have gone through the foreclosure process are now owned by the bank and are for sale from the bank in this section we'll look at both foreclosures and Aereo's to see where there's opportunity for investors foreclosures step 1 the seller can't or won't make payments for whatever reason and the lender puts the mortgage in default step 2 after a legally determined period of time the lender sells the property to the highest bidder on the courthouse steps step 3 typically the lender is the highest bidder it takes control of the property and then attempts to resell it as a real estate owned property our REO we're going to start with foreclosures described in step 1 the seller can't or won't make the mortgage payments he or she is motivated to sell the property hoping to recoup any equity and save a credit rating this seller is going to at least listen to any offer that you make in a strong market one would think that there simply aren't any sellers in foreclosure that's simply not the case the foreclosure rate in good times may be half of what it is in bad times but in any time there are still plenty of foreclosures sellers are always losing property some of the more common reasons include the following the seller has overbore owed and can't make the payments there is an illness death or divorce in the family and no one takes charge of maintaining the property allowing it to fall through the cracks into foreclosure the seller moved and listed the house but the agent was terrible and no buyers were found and now the seller at a distance just won't or can't deal with the house anymore the seller simply doesn't care about the property rare but it does happen finding foreclosures there are many sources of foreclosure listings sometimes property listed with an agent will be in foreclosure if you find one of these you know you're dealing with a motivated seller sometimes a Fizbo will be in foreclosure again the seller is motivated but often he or she doesn't have enough equity to pay a listing commission in that case it's probably not going to be worth your time you need to carefully evaluate Fizbo foreclosures to determine what the sellers true equity in addition to often Fizbo foreclosure sellers are going this route because they are too stubborn to face facts they simply won't believe they will soon lose their property and they continue to insist on an unrealistic price there's usually very little you can do with a Fizbo seller in this frame of mind however occasionally you will find a Fizbo who wants to sell and is willing to negotiate realistically in this case you may very well be able to pick up a bargain other sources of foreclosures include title insurance companies who act as trustees and foreclosures they will often provide a list of foreclosures they are handling in addition there's almost always a local legal newspaper one that carries legal notices in which foreclosure notices are published pick this up and you probably will be able to find every foreclosure in town be aware however that frequently only the legal description of the property is given not the street address you can get the legal description translated at the County Assessor's Office but doing so can be a hassle also most large or metropolitan areas have a foreclosure bulletin this is a private publication that lists all foreclosures and it gives street addresses names dates and so forth it's everything you need however it usually costs a lot typically several hundred dollars a year to subscribe finally a number of websites deal almost exclusively in foreclosures and REO s for example you can try Bruce Bates calm B ru c e ba tes calm or RealtyTrac calm rea LT y TR AC calm when using any site however be sure to check that the foreclosure is indeed in your area indeed in your once you find someone who is in foreclosure it is then up to you to contact him or her directly and find out if there was a good deal available for you hopefully you already have a name and phone number now just give this person a call explain that you're an investor and that you're looking for property in the area you heard he or she was having some difficulty in making payments and you're wondering if there's a way to make a win-win situation out of it the seller gets to save his or her credit plus perhaps some money depending on the seller's equity and you get the property what you can offer to the owner is to make up the back payments and penalties and save the owners credit rating in exchange for the title to the property in other words you can offer to take it over the advantage here is that you get the property for virtually no money down plus whatever equity the owner may have the disadvantage is that the loan may not be assumable if that's the case you may not only have to make a back payments and penalties but also secure a new loan with accompanying points and fees in short it may cost you many thousands of dollars to take over this property and bail out this owner you may find that by the time you add up the costs it simply isn't worthwhile it's important that you calculate these costs as accurately as possible before you make any kind of offer to the owner you may find that it simply isn't worth your time to attempt to write the foreclosure and take over the property can i buy at the foreclosure sale yes you can you can purchase the property when it is sold on the courthouse steps at the time of the foreclosure sale the lender always offers the full price of the mortgage or trust deed but there is nothing to prevent you or anyone else from offering more your offer however usually must be in the form of cash so you will have to work out financing in advance and you will often receive no title insurance or other gain tee's as to the status of the property you might for example think you're bidding on a first mortgage only to find that it's a second or third this could be catastrophic for you buying at foreclosure sales is a tricky business and is best left to those who are experienced in the field if you're really interested in it try to find an attorney who specializes in this and work with him or her also check in to my book finding hidden real estate bargains McGraw Hill 2002 are Yoos ar e o stands for real estate owned it refers to property that a lender has taken back through foreclosure lenders hate this kind of property because on their books it shows up as a liability instead of as an asset therefore they are very anxious to get rid of it however they are not so anxious that they're willing to take a loss if there's any way to avert it there's a big advantage for a buyer in dealing with a lender rather than a home seller in foreclosure it's a clean deal with the bank there's no crying or recriminations also you can get title insurance and sometimes the bank will even help you with the financing in fact our REO s can be wonderful opportunities the trick is finding out about them strangely most lenders won't admit publicly that they have an REO problem many won't admit they even have any REO z-- thus you can't usually just walk in and ask to buy one this secrecy certainly seems to work against the lenders best interests at least on the surface one would think that the lender would be out there advertising those properties as heavily as possible yet the lender doesn't do you ever recall seeing a lender advertising under its own name for REO buyers it usually just doesn't happen most of the public isn't even familiar with the term REO the reasoning of the lenders is threefold as follows first a lender doesn't want to alert federal watchdogs that it has an REO problem keeping up a good face can mean the difference between considered to be in business or insolvent second depositors are wary about where they place their money yes we know every account is guaranteed to 100 thousand dollars but how many of us want to put that guarantee to the test we might bolt if we thought the lender were shaky in addition there are holders of amounts larger than $100,000 who frequently move funds lender to lender in an effort to tie up the highest interest rates these large depositors are not insured and they will pull their funds at the slightest whiff of trouble from a lending institution hence lenders are very careful not to admit they have many REO s if for no other reason than to protect their own image third there is the matter of the real estate market if it were to be widely known that a lender had an overhang of homes ready to dump on the market in a particular area that information could adversely affect prices this would backfire for the lender since it would lower the prices for the properties that was trying to sell finding our ríos the truth is that while lenders keep quiet about arias as far as the general public is concerned they are often open about them to legitimate investors after all they do want to sell them in order to get the money reinvested in a mortgage you as an investor therefore have to convince the lender that you're a legitimate buyer what you have to do to find arias is both tedious and simple it's tedious because you have to do it over and over again for each lender it's simple because the process is quite easy basically you need to let a lender know that you are a sophisticated investor you need to impress on the lender that you understand what an REO is and that you'd like to bid on one once the lender understands that you're a special and not part of the public only interested in deposits the lender will open up at least in a limited way therefore you need to call the lender and ask for the officer who deals with re owes then you need to make a case that you're an investor who has the means and desire to purchase sometimes you'll be told that this particular lender handles all re owes through a specific real estate broker you'll have to contact the broker other times you'll learn that the lender handles the re owes itself and there's a list of such properties you'll want to get the list checking out the REO it's common to find arias in distressed condition after all if you were the borrower and we're losing the house your equity and your credit rating would you be anxious to keep watering the lawn or to clean up when you left borrowers who lose their property through foreclosure tend to stop taking care of the property and some actually go out of their way to mess up the property their reaction naturally enough is anger and since they really can't take it out on anyone personally they typically take it out on the property when you get to inspect the REO it may still be in the terrible shape in which the lender got it back or it may be fixed up lenders are not fools they know that a distressed property will get them a distressed price on the other hand if they fix it up even just cosmetically they stand to get a far better price however if you arrive on the spot just as the REO is acquired and offered to take it as is the lender may agree after all time spent fixing up the property is once again lost interest to the lender when you find an REO in distressed condition don't turn your head away and discussed you may not be looking at a disaster but rather at an opportunity an opera buying an REO buying an REO is like buying any other property you make an offer to the lender if it likes your offer you've got a deal if it doesn't you can try to negotiate most lenders prefer all-cash that way they get rid of the property once and for all this simply means that you have to go to a different lender to get financing however don't expect great financing on REO s typically you'll be looking at 10% down or more plus closing costs on the other hand some lenders recognize the fact that they will get less from a cash offer so they agreed to handle the financing themselves for a higher sales price sometimes they'll even throw in a cash credit toward having the property fixed up if the lender handles the financing you'll often get the benefits of a lower down payment and easier terms plus perhaps some fix up money on the other hand you'll probably pay more than you would if you are buying strictly for cash problems to expect when buying an REO expect distressed properties they are more the rule than the exception that means you have to be very careful to check out an REO and determine your cost to fix it up some properties are simply hopeless a lender may give you a terrific deal on these but beware of what you're getting as is most REO ZAR sold as is even if the lender has refurbished it the lender seller makes no warranty to you of any kind this means that later on after the sale if you discover a problem that costs $10,000 to fix it's your headache na the lenders that's why the price is cheaper without disclosures while most states now require sellers to provide disclosure statements this regulation may not apply to a lender who is federally chartered this type of lender may refuse to give you any kind of disclosure statement except one that the federal government requires on lead for example after all the lender itself may have next to no knowledge about the condition of the property or if you do get a disclosure from a lender it may disclose virtually nothing the lender claiming it knows nothing about the property once again you're on your own no repairs certainly you'll want to get a home inspection in fact you'll want the most thorough inspector you can find however don't expect the lender to do anything toward correcting problems the inspector finds typically beyond basic refurbishing most lenders will make no repairs of any kind even if the inspector finds safety issues in that case the lender may insist you sign a statement that you accept the property at your own risk ari o--'s offer profits sometimes big profits but they are certainly not without risks I wouldn't recommend them for the very first time investor but once you've gotten your feet wet buying and selling a few properties you may find that REO s are worth the challenge government repos the government owns a tremendous amount of real estate almost all of it in the form of houses however it doesn't want this property so it's always trying to sell it you can sometimes take advantage of these sales to get into a property at a bargain price what follows is a list of the more popular government repo programs and how to acquire the properties HUD repos the Housing and Urban Development or HUD Department takes back homes mainly through its Federal Housing Administration program or FHA the FHA ensures lenders who make loans when a borrower defaults the FHA makes good the loan to the lender and it takes the property back at any given time it may have tens of thousands of repo homes for sale across the country you can check to see if there are any HUD homes in your area on the internet at hud.gov since the homes come back mainly through the FHA program and since that program has a maximum loan amount as of this writing of around 240 thousand dollars you're not likely to find many upscale properties here most are going to be in the moderate to low price range additionally the homes may not be in the best condition HUD usually does not fix up the properties that means that they may be in anywhere from average to really bad shape don't be surprised at the terrible condition in which you may find a HUD home remember that the former owner lost the property to foreclosure and there was little incentive to keep it up additionally since that time there may have been vandalism VA repos the Veterans Administration or VA has an extensive program of loan guarantees unlike HUD which ensures loans to lenders the VA guarantees the performance of a loan to a lender actually it guarantees only a small percentage of the top of the loan if the borrower defaults the VA pays off it's guaranteed portion however rather than simply pay out cash the VA because it is determined that it is more profitable to do so actually buys the property from the lender who forecloses and then resells it initially only those veterans who qualify were on active duty during specific time periods can get VA loans in order to buy a home after the VA has foreclosed however it opens the sale to anyone veteran or non veteran investor or owner occupant as of this writing the VA has over 21,000 homes for sale nationwide in its inventory and it is averaging over nine months to sell them Fannie Mae properties Fannie Mae along with Freddie Mac discussed next are the main secondary lenders in the country they underwrite most of the conventional non government in short or guaranteed mortgages that are made what this means is that when you get a mortgage from say XYZ lender the lender then in effect sells your mortgage to Fannie Mae or Freddie Mac from which it receives enough money to go out and make additional mortgages if however you fail to make your mortgage payments and fall into foreclosure its Fannie Mae or Freddie Mac through whatever lender happens to be servicing the mortgage at the time that takes the property back those agencies then have to get rid of it similar to the way in which HUD or the VA must dispose of their properties this again can present an opportunity for investors Freddie Mac properties like Fannie Mae Freddie Mac offers single-family detached homes condominium units and townhouses however Freddie Mac often cleans and fixes up its homes before offering them for sale if you want to submit an offer on a home for which you propose doing the fix-up work yourself chances are the Freddie Mac will still at the least clean up the property to some extent before you buy it through its home steps program Freddie Mac will offer homes to owner occupants at competitive interest rates with 5% low down payments and no mortgage insurance it will also offset some of the title and escrow costs these homes however are almost all competitively priced at market Freddie Mac homes are offered through a select group of lenders to find out more about them check out the web site home steps calm chapter 3 evaluating cashflow this chapter grew out of an email that I received at my website Robert Irwin dot-com from a reader complaining that he was having trouble getting a property's rental income to cover the mortgage and other expenses how do I know in advance whether a property I'm interested in buying is an alligator or a cash cow and how do I reduce negative cash flow in a rental property I already own he asked an alligator is a property for which your expenses are so high that you can't cover them with the rental income and your monthly losses negative cash flow eat you alive hence the name a cash cow is a property for which your rental income exceeds your expenses and each month it gives you milk in the form of money in your pocket positive cash flow in this chapter we'll look at some solutions to the age-old problem of evaluating investment property in terms of its cash flow how do I calculate income versus expenses if you are planning to invest in real estate it's important that you understand exactly what your expenses are likely to be if you already own investment property you need to know at all times where you stand financially Vasavi your investment income is much easier to estimate or determine unless you have a vending machine or two it's simply the total of your rents for the property a useful tool in both situations is the rental property income and expense sheet at the end of every month for our rental property you already own you can draw up an income and expense report to help gauge the status of your cash flow these figures will give you a very exacting look at how well you did that month how do I calculate the tax benefit note determining the tax benefits of owning a particular piece of real estate a task requiring a high level of expertise the following discussion is intended strictly as an overview and might not apply in your situation before making any move that would involve text consequences see a good accountant or tax attorney like most people you have probably heard that real estate ownership can provide a tax shelter don't the tax advantages offset the monthly cash loss no not entirely at least not in most cases it's true that you may get some tax advantages out of owning rental Realty virtually all of your expenses with the exception of the principle portion of the mortgage payment that which repays the loan can be used to offset your rental income for the purpose of determining your profit when you add to that an amount for a depreciation your monthly expenses could exceed your monthly income that amount a loss might be deductible from your other taxed income can I increase the rents if your rents aren't enough to cover expenses why not just increase rents the answer to that question depends on the amount of leeway there is between the rent you are charging and the rent most other rental property owners in your area are charging in the real world in the open market for rental units you are in competition with every other landlord investor increase your rents beyond the prevailing market rates and you'll have nothing but vacancies that's the case once you already own the property however there are some things you can do to avoid a negative cashflow problem before you buy for example buy a less expensive property for which your mortgage taxes and insurance that is your expenses will be lower than your rental income I'm sure many listeners will be quick to point out that if you pay less for a property you will get less rental income from it so even though your expenses will go down because of a lower purchase price so too will your rental income yes and no is different from buying and selling in the sale and purchase market the price is usually well defined for each property being controlled to a certain extent by lending practices in the area for example you can get a cma comparative market analysis that will pinpoint the value of the home with rentals it's less clear for example a 3-bedroom 2bath home may rent fairly consistently for around $1000 in your area however homes with three bedrooms and two baths may sell anywhere from 120 thousand dollars to $160,000 in the same area in other words if you buy a three and two at the lower end of the price range you'll very likely still be able to rent it for roughly the same amount as if you had bought the property at the upper end of the price range yet your monthly expenses will be far less in the lower priced property so one way to lower your monthly expenses is to buy right in the first place Chapter four working with agents starting out in real estate investing is just like starting out in anything else because it's all new at first you're going to be at a disadvantage you won't know the area the way deals are constructed what to expect in the paperwork and so on that's why I suggest that first-time investors do not go it alone listening to a book like this will certainly help get you up to speed on how things are done however for advice on your specific location and on specific deals that you're considering you need a professional in short you need a real estate agent how do I find an agent I can trust everyone who buys or sells property asks himself or herself this question however the question takes on a slightly different meaning for an investor you not only want an agent who is trustworthy in the sense of looking out for your interests someone who is straightforward and honest but you also want an agent who has experience you can trust this means someone who has been in the business a long time who has seen it all who can advise you not just on buying a home but on investing as well where do you find this person actually agents who fit that description do exist and in almost every nook and cranny in the country however you may need to separate the wheat from the chaff while the majority of agents come into the business for a few years to try their hand only a relative few stick it out for decades and make a career of selling real estate nevertheless every town does have some of these career real estate people traditionally an agent with so much experience would be found in a one-person office you could simply ask other agents which of the local agents have been around the longest or you could call the local real estate board and see if they will tell you which brokerage has the greatest longevity however in today's world most successful real estate people have gone under the umbrella of a national companies such as Coldwell Banker century 21 Remax or prudential this is particularly the case in larger metropolitan areas in these markets it is harder but not impossible to identify the type of agent you're looking for first a word about the type of agent you want to avoid many highly successful agents today have a very high profile in the community they sell a lot of properties often very high priced ones and they make no bones about telling everyone of their success you can see their ads popping up on shopping carts and grocery stores before the movies start in theaters and in local magazines and newspapers typically they say something like number one agent in the community or sold over 1 million dollars in homes last year or top producers today many agents are working as a team husband and wife or just partners so you'll see two faces on the ad all of this means that this agent sells a lot of properties and makes a lot of money but how much they make shouldn't interest you this is not to say you're looking for agents who don't sell rather it's that you're looking for an agent who will take the time to work with you to find just the right property my experience is that too many of these hot agents just churn and burn they hop from prospect to prospect and if you don't buy within the first showing or two they'll dump you and move on after all they have a certain volume of sales to maintain indeed one hot agent I know tells his clients as soon as he meets them that he's not only the number one agent in his area but he is also capable of finding the right house for them on their second trip looking the first trip he says is to let him determine just what they want if they don't buy or at least make an offer on that second trip then they aren't really sincere indeed he tells them that unless they buy then they are wasting his time he goes to great lengths to make the potential buyers feel guilty for not purchasing if people don't in fact buy he dumps them and moves on there are plenty of buyers he says why waste time on those who won't act immediately needless to say he sells a lot of properties and makes a lot of money but I can't help wondering if his clients really get what they want further I wonder how well he would serve an investor who wants all sorts of additional information such as the amount a house could rent for how good the tenant bases in the area and so on as an investor you don't want this type of agent you don't want to be the victim of someone who processes real estate buyers in haste whose eye is riveted to his or her bottom line rather you want someone who is successful enough to have the time to invest in his or her clients who is willing to take as much time as necessary to help them and who is determined to get for them just what they want typically the right agent for a beginning investor will be someone who's been in the business long enough to become financially secure a career agent ideally this person should own investment properties on his or her own so that he or she knows what it is to invest and to be a landlord further this person should have enough income from his or her own investments that he or she doesn't need to churn and burn to turn over prospects quickly in order to maintain a high volume and a high income just from sales that means that the right agent will probably have the following profile can I cut expenses assuming you've done all you can to increase your rental income is there anything else you can do to get closer to break even on a property you already own can you cut your expenses that of course is the big question fixed expenses taxes there's very little you can do to cut your property taxes it might be possible to have the property reassessed but unless market values overall have dropped a revaluation is just as likely to result in a higher assessment as in a lower one this is most likely a fixed expense that you have to pay insurance as with taxes insurance tends to be a fixed expense you could shop around for a cheaper policy but remember in addition to fire insurance as a landlord you also need high liability insurance in case a tenant gets hurt on the property and sues you again there's probably little you can do here maintenance this item covers routine expenses such as paying the water bill and lawn pool and garden care services repairs this expense is actually a reserve you put away fifty bucks a month so that when a five hundred dollar water heater goes out you have the cash to pay for it if the house is much older fifty dollars a month is probably not enough you might have to put away several hundred dollars a month to be ready to repair a roof or heating system if the house is nearly new and in good shape you might be able to reduce this reserve we are left with only one expense that we can control in some way the mortgage payment we can reduce the mortgage payment in a variety of ways you can plan ahead so that if interest rates are high when you make your purchase you can go for an adjustable rate loan this type of loan typically begins with a teaser rate that is below market often as much as 1 to 3 percent or more lower the savings can huge just keep in mind however that these teaser rates disappear rather quickly often within a year or two your interest rate on the adjustable loan will rise to market or even above that's the time to refinance if possible to a lower rate mortgage or to resell on the other hand if interest rates happen to be low when you buy get a fixed-rate 30-year alone this will lock your mortgage into the low rate so that when interest rates rise you won't find your monthly expenses going up it's important to understand the relationship between how much you put into the property and your monthly expenses the less you put of your own money into a property the greater your leverage and ultimately your profits however your monthly expenses will be greater too because you'll have a bigger mortgage on the other hand the more you put of your money into a property the lower will be your mortgage payments and the less difficulty you'll have in covering them with rental income put more down and you'll have lower mortgage payments which of course are much easier to meet but doesn't this fly in the face of the advice that says use other people's money OPM the more of your own money you put in the less of OPM you're using won't that reduce your profits yes and no your profits will also be reduced if each month you need to put money into a property to keep it out of foreclosure in other words if you need to make huge payments not covered by rental income put less money down and you might get nickel and dimed to death it's important to remember that buying and renting real estate is a balancing act the closer you get to break-even the better and investment your property is the ideal rental investment in fact will break even or produce a positive cashflow thus use as much of OPM as you can but balance that with your own money after buying right and getting the lowest mortgage payment possible through wise financing is there any other time putting in more cash makes sense as we've said if you can find a property that offers high rent with low expenses and you financed the property wisely you can get by putting in little to no cash of your own on the other hand if you buy a property with a lower rental income and higher payments you'll want to put your money into it to reduce the mortgage amount to where the monthly payments are balanced by the rental income sometimes however your goal is not simply to rent the property out but to turn it over for a big profit when properties are appreciating rapidly you may need a time frame of only a year or two sometimes much less during that time you hope to resell for a big profit to make a killing on a market upswing so you may overlook the goal of buying close to break-even and instead buy a property for which the rental income doesn't come close to meeting the expenses in this sort of situation putting in a lot of cash to keep the mortgage payments low can make sense think of it this way if you have the cash what else would you do with it your choices are limited stocks bonds and interest bearing deposits chances are you'll make far more on it by putting it into a piece of real estate that has the potential to generate a quick profit besides with lots of cash and a quick buy you can sometimes persuade the seller to significantly reduce the price I've known investors who had put as much as 50% sometimes 100 percent down on a short timeframe with the intent of reselling ultimately your decisions will line up with your investment goals as we've seen you can determine a property's cash flow by careful analysis before you buy if you need to lower a negative cash flow for a property you already own you can do so in the ways that we've suggested however always keep in mind that some property simply will never break even or produce a positive cash flow no matter what you do short of paying the entire price for them in cash you profile of the right agent one middle-aged or older remember it takes a while to build up a string of properties and accumulate wealth in real estate while there are some very excellent young agents it's not usually done overnight to active in real estate for at least a decade there are many private investors who have made their fortune and then turned to selling as an agent as a pastime they rarely have the people's skills to help you you want someone who's been in the business as an agent for a while five years being the minimum ten being better beware of beginning agents those in business less than five years they will be learning on you three successful it's possible to be in real estate and never really make it there are a lot of agents who are at the periphery of the field typically these agents have outside income perhaps retirement from another field they dabble in property and occasionally sell a home but they don't own much property themselves and they really don't have a handle on how buying and selling for investment is actually done the worst thing about these agents is that they may give you advice gleaned from their own experience sometimes bad advice for willing to take time with you the right agent will quickly realize that you're sincere about investing and will also realize that if he or she plays their cards right you'll buy multiple properties through him or her over a period of many years in short they'll understand that you represent a renewable resource hence they'll be willing to assist you show you properties over many months suggest courses of action and so forth in other words they'll be interested in a long-term relationship five honest straightforward and pleasant notwithstanding all of the above qualities you'll also want your agent to have those characteristics that every agent should have you'll want him or her to be on your side you'll want to know that you can trust what he or she says and you'll want him or her to be able to get along with you where do I find the right agent we've already suggested trying to find the agent who has been around in town the longest however if real estate in your area is handled predominantly by franchise or national companies as it is in most places then I suggest the following procedure finding a good agent locate a large office within the area in which you want to buy remember one of your first tasks is to identify your farm or geographic area where you'll buy be sure to go to that office not another branch of the same company go into the office and ask to speak to the broker manager each office is typically organized with a broker and a number of salespeople the broker is the one who runs the show if you just go in and ask to speak to an agent a generic term that can mean either broker or salesperson instead of a broker you'll get the next person up this is the salesperson who's on duty that day and he or she is often a beginner once you're a link to this person you'll be stuck with him or her other agents don't like stepping on the toes of their associates and stealing clients when you get to see the broker explain exactly what you're looking for the most experienced agent in the office to help you get started investing for the long term explain that you don't want a hotshot you want someone who has the time to explain the business to you that person may turn out to be the very broker you're talking to but probably not because brokers who run offices rarely have the time to spend with first-time investors more likely it will be another broker who has parked his license there when you find an agent who you think is a likely candidate to be just right for you interview him or her ask the following questions how long have you been active in the business selling real estate not just investing on your own a good answer is 10 years or more do you invest on your own if so how many properties do you have a good answer would be 10 or more how many properties have you sold over the past year a good number is at least eight that's only one every month and a half would you be willing to work with me or us over the long haul a wise broker will wait to answer this until he or she has had time to interview you to see just how sincere you are when you found someone you like test your choice go out with this person to look at property see what he or she suggests you do remember if it turns out you made a mistake you can always say goodbye and continue your search should I work with one agent exclusively or many this is an age-old question in real estate that I am constantly asked is it better to work with one agent or with several the answer is it depends when you're first starting out I suggest that you find one good agent as explained before and stick with him or her like glue your loyalty to the agent will be paid off by his or her loyalty to you and advice and help that you really need however once you've become an experienced investor then you may want to work with several agents of course you won't expect the kind of loyalty or attention that you'd receive by working with one agent exclusively however by then you may not need it when you're an advanced investor you may want to work with a group of agents in order to have the best chance at finding a specific type of property with commercial industrial or apartment properties sometimes agents will keep listings to themselves you'll let them know exactly what you're looking for in terms of property and tell them that you're working with others however by then they should have confidence that you will buy through the agent who finds what you want you'll also let them know that you'll pay a buyer's commission if necessary for their efforts making this offer will encourage the agents to continue to look for property that you can use and to call you when they find them oh you when they find them should I use a buyer's agent absolutely especially since you're an investor there's been a lot of talk over the last few years about buyers agents versus sellers agents and a lot of the people doing the talking haven't really made clear what the pros and cons are be sure you understand the differences an agent must declare whom she or he works for there are three possibilities the seller the buyer or both called a dual agency this has nothing to do with who pays the agent it is perfectly acceptable for the seller to pay an agent who works for the buyer in fact it's done all the time the reason that it's important that you use a buyer's agent when you're purchasing property is that there are important legal and ethical issues involved if the agent declares for you then he or she has a fiduciary responsibility to you this takes many interesting forms for example if your agent happens to learn that the sellers are actually willing to accept $20,000 less than their asking price your agent is duty-bound to give you this information on the other hand if you're working with a seller's agent that agent would be duty-bound not to tell you and instead to protect the interests of the seller sometimes agents will declare that they are performing in a dual role that is that they are working for both parties to my way of thinking working for both parties is not acceptable a dual agent is neither fish nor fowl he or she can't fully represent you without hurting the seller and vice versa thus the dual agent often ends up trying to Shepherd a deal through the pipeline without anyone really getting hurt the unfortunate result for you the buyer is that you're not likely to get what you want a bargain some excellent agents are able to handle the dual role but for my money I'd go with a buyer's agent any day which brings up another point who pays the buyer's agent do I have to pay the buyer's agent if the seller pays the sellers agent then it stands to reason that the buyers should pay the buyer's agent however as noted earlier that's not how it usually works typically the seller's agent will list a property for say a 6% Commission the sellers agent will then list the property with the Multiple Listing Service MLS or otherwise agree to co broker the property with other agents this typically means splitting the Commission 50/50 thus the agent who finds the buyer gets half the Commission there's no reason that can't be your buyer's agent and the sellers agent ends up with half thus the seller actually ends up paying your agent sometimes however the sellers agent will refuse to Cobra a property as noted this occasionally happens in bigger investments such as apartment buildings or commercial or industrial properties this means that the sellers agent will want the entire Commission or at least the bigger share of it in that case you might indeed need to pay your buyer's agent a commission or a portion of it however in this circumstance hopefully you won't mind because the deal will be big enough and generate enough profit to make the Commission worth your while can I ask the broker to take less usually that's a mistake it's important to understand that there is no set or fixed or standard Commission in real estate that was done away with decades ago after a series of legal cases today the Commission is what the agent and the client agree that it is and it can be any amount however that being said most good agents will demand a minimum Commission below which they will not work they may say for example that they are worth a full 3% half of a 6% Commission and they don't want to work for Less they will have to split that 3% with their office average agents split it 50/50 but top agents get as much as 80 or 90 percent of their portion of the Commission if you then badger them to cut their rate you're asking them to work for less than they feel they are worth some extremely honest agents will simply refuse they know their value others may grudgingly acquiesce but you may have poisoned the relationship between you they will surely resent what you did and then you'll always be wondering if they are doing as good a job as they should my advice is to do one of two things if you want to pay less first of course find out how much the agent wants then either agree to the amount or find another agent who is willing to work for less and tells you so right up front should I use a discount agent in the past there were very few agents who would work for less than a 6% Commission years ago most wanted 5% then it went to 6 and in some areas they are now asking 7% in fact to help make ends meet some offices are also trying to tack on a transaction fee of several hundred dollars this extra money does not go to the agent but instead goes to the office to cover its expenses not covered because it may be paying a top agent 80 to 90% of the Commission it takes in I've never met a buyer or seller who was happy about paying a transaction fee and I expect these will fade away over time today however there are many agents in almost all communities who will work on a discount basis some with very steep discounts that means that selling agents will work for as little as 1% instead of the 3% selling agents typical Commission keep in mind however that these may not be the sort whom you want and need when you first start investing the reason is that these discounters may compensate for a lower Commission by providing less service if you're going to use a count broker be sure you get it in writing exactly the services that the broker will perform and be sure that the services specified are the services you want and need Chapter five cutting closing costs few agents stress it and even fewer outside the business understand it but closing costs are the real bane of investing in real estate consider if you buy or sell stocks or bonds the transaction charge even for a full service brokerage is likely to be only a few hundred dollars at most the fee can be as little as under $30 with a discount stock broker in contrast with real estate the closing costs are almost always thousands of dollars for example a seller who uses a full-service agent can expect to pay around 8 percent of the price of the home in closing costs for the same property the buyers closing costs can be two to four percent that means that the combined closing costs for the buyer and seller amount to 10 percent or higher on a $200,000 home that's $20,000 a fair piece of change for the person who buys and sells a home every decade or so statistically people in the United States change homes about once every 8 or 9 years the closing costs may seem like a lot of money but not enough to make them change their habits when they buy and sell real estate 85% of sellers still use agents and 90 percent of buyers do on the other hand for the investor who may buy and sell one or more properties every year these costs can be quite onerous if you're paying out 10% for the round-trip it's going to take a big bite out of your profits therefore it's very important for the investor to seek ways to reduce those closing costs we'll see just how you can do that in this chapter negotiating the closing costs in real estate everything is negotiable including the closing costs normally buyers pay their share and sellers theirs as determined by local custom however there's nothing to prevent your having the other party pay your closing costs why would the other party be willing to do that actually they wouldn't if I'm selling my house and the buyers ask me to pay their closing costs my answer is no what a ridiculous question case closed on the other hand if the buyers right into the purchase agreement a clause that says their purchase is contingent on my the seller paying the closing costs then it's a slightly different matter now it's the case that if I want the deal I have to pay their costs if I don't pay their costs then I chance losing the deal the buyers here have made the closing costs a deal point a deal maker or breaker of course if you demand something in one area you're likely to have to give something up in another area if you ask the sellers to pay your closing costs chances are they will want you to pay a higher price what you gain with one hand you lose with the other right not necessarily remember as a buyer investor it's highly unlikely you'll be going in at full price instead you'll lowball the sellers hoping to pick up the property at a bargain price all of which is to say that there's probably going to be a lot of negotiation before the final price is agreed upon when that's the case my suggestion is that you do not bring up the matter of your closing costs rather you bargain as ruggedly as you can for the price if the sellers ultimately agree to your original lowball figure and forget about asking them to pay the closing costs you're already getting the house at a bargain-basement price on the other hand what's more likely is that they'll come down some while you come up some eventually the negotiations will reach a crisis the sellers simply won't come down any further if you can live with their final price then at that point agreed to it provided they pay for your closing costs in other words stop arguing about price and sted turned to terms it's positively amazing how often sellers will agree to terms if you give them their price for example you may be buying a $300,000 property and after negotiations you're down to offering $240,000 while they're insisting on $250,000 only $10,000 separates you if you can live with a $250,000 price a reduction of roughly seventeen percent of the asking price not bad then agree to it providing the sellers pay for your closing costs since these could be an additional 3% that's another $7,500 thrown your way even better it's in the form of cash that you would otherwise have to come up with its $7,500 that you don't have to take out of your pocket to make the deal the sales price remains $250,000 however you get a credit toward your closing costs of $7,500 of course it works both ways when you're the seller you can demand that the buyers pay for your closing costs or a portion of them because of the Commission sellers closing costs are usually far higher than buyers but to make the deal they may be willing to do it don't think this is an unusual occurrence it happens in transactions all the time however it will never happen unless you insist upon it wise investors make it a regular issue to insist that closing costs be part of the deal a different way to avoid paying the closing costs from out of pocket cash is to finance them here instead of the sellers footing the bill the lender does yes it can work but you must be careful to find a lender who is agreeable and doubly careful to be sure the lender is fully aware of what's happening you don't want an angry lender to later come back and try to either raise your interest rate or rescind your loan because some vital information was held back from them to see how this works let's assume that you're getting a 90% loan putting down 10% of your own money the property is priced at $200,000 so at full price the loan amount would be $180,000 with your coming up with $20,000 down further let's say there's an additional $5,000 in costs the question is how do you finance that $5,000 once again we're going to assume that as an investor you're not going to pay full price indeed let's say that after negotiations you can see that you and the seller will probably agree on a price of around $180,000 that means that you'll need to put down $18,000 with the lender making a new mortgage of $162,000 however the closing costs are still $5,000 at this point you make this offer to the sellers instead of a final purchase price of $180,000 you'll pay the sellers the purchase price of one hundred eighty five thousand dollars or five thousand dollars more and they in turn will give you a five thousand dollar credit is that agreeable notice the difference between this and the previous deal in that case the sellers credit to you for closing costs was below the final price here the price is higher this should make any difference to the sellers since they're getting the same money anyhow however it will make a big difference to you at a sales price of $180,000 your mortgage is one hundred sixty two thousand dollars at a sales price of one hundred eighty five thousand dollars the mortgage is now one hundred sixty six thousand five hundred dollars or roughly five thousand dollars more what you've effectively done is create $5,000 from the mortgage which will now go to pay your closing costs you've financed them there's no sleight of hand involved Oh that's happened is that you're paying a slightly higher price for the property and the seller in exchange is paying your closing costs it's the same to the seller you've just got a loan roughly five thousand dollars higher as I said you've financed the closing costs a lender may object to the transaction just described the lender may say that the true sales price was five thousand dollars lower and thus so should be the loan to my way of thinking this makes little sense the loan is or should be based on the value of the property as determined by an appraisal no lender worth its salt will offer a mortgage without an appraisal and if the property appraised is out at the full price in this case 185 thousand dollars what's the difference how the negotiations went in addition the loan should be based on the loan to value LTV not on the LTV plus closing costs thus as long as you still put the full downpayment into the property in this case 10 percent you should be meeting the lenders criteria for making the loan nevertheless if the purchase agreement reflects a price increase at the very end of negotiations a lender may object saying that the purpose is to get a higher LTV than is warranted on the property in all probability the lender is simply worrying that there's some hanky-panky going on that they're not aware of and they just don't want to take any chances there is a way to avoid this problem first find a lender who doesn't object many do not then make sure your written offer only reflects the final purchase price you can simply tell the seller what your final offer will be and why you want it handled the way you do if the seller agrees write it up that way agrees write it up that way we're living in an age of amazing creativity in financing today the old rules that stipulated 20% down no longer apply today if your credit is good enough and your income is sufficiently high you can alone for the entire purchase price of the property indeed in some cases you can get a loan for a hundred and three percent of the purchase price meaning that the lender will roll your closing costs into the mortgage to find out about one hundred three percent financing contact a good mortgage broker he or she will be able to run the numbers and a credit check to see if you qualify keep in mind however that this type of financing is available only for owner occupied property in other words you have to intend to live in the property to qualify for that type of financing if you're buying for investment that is you don't plan on living in the house forget it the financing available to you probably will be ten percent down as indicated before keep in mind that the cost is often higher for financing that includes the closing costs in the mortgage that means that chances are you'll end up paying a slightly higher interest rate for the mortgage however to get the better financing is probably worth it making the purchase and sale without a broker the biggest single cost in a transaction is usually the broker's commission this cost is usually paid by the seller but if a buyer's broker was used the buyer may have to pay some of the commission as well if the round trip costs for a transaction are roughly 10% very often 60% of that amount goes to the agent obviously one way to cut costs would be to sell or buy without the services of an agent there is nothing wrong with doing this no one says you must use an agent to handle a real estate transaction for you however it's very wise to rely on a good agents experience when you're first getting started only a fool would wander into an uncharted wilderness without a guide you don't want to be that fool when you first get started investing on the other hand once you've got a series of transactions under your belt it's a different story now you've got the experience and since as an investor you're always in the market looking for properties you may want to handle the entire transaction yourself keep in mind however that while you may know you're competent to handle a real estate transaction the other party you're dealing with may not be as confident I've often seen the case in which the seller is perfectly content to sell his property as a Fizbo for sale by owner but the buyer insists that an agent handle the transaction further in these situations the buyer sometimes insists that the seller paid that agents fee usually half of a full commission or 3% you may rail at the seeming unfairness of such constraints because you know what you're doing and acting on your own as a seller and you don't need an agent but the buyer may simply say to you no agent no deal so in this situation you get the agent and pay the fee or look for another buyer eliminating the points for the buyer the biggest cash closing costs are usually the points to get the mortgage if you're getting a mortgage for $200,000 and you've agreed to pay 2.5 points that's $5,000 out of your pocket 1 point equals 1 percent of the mortgage amount and 2.5 points equals 2.5 percent of the mortgage amount in the past there wasn't much you could do to curb this expense today however with most lenders you can reduce or even eliminate the points by simply agreeing to pay a higher interest rate indeed lenders use points as a device to enable them to offer you a loan at a rate lower than the prevailing market rate for example say that the going interest rate is 7 percent however to appear competitive the lender wants to offer a mortgage at six point six 5% to do that however would mean the lender would incur a loss on the loan by lending below market so the lender instead collects the money up front when he or she gives the mortgage by assessing points the lender may charge three points for example using a complicated calculation it may turn out that six point six five percent interest plus three points yield a seven percent return to the lender as far as the lender is concerned loaning money at seven percent strayed or at six point six five percent plus three points comes out exactly the same thus when you try to obtain a mortgage and the lender says it's six point six five plus three points why not ask how much is it with no points the lender should be able to make a quick calculation and in this case say seven percent thus by paying a slightly higher interest rate along with slightly higher monthly payments you can avoid having to pay cash upfront in the form of points dealing with the title insurance and escrow companies the last biggest expenses in the closing costs are the fees that go to the title insurance and escrow companies in the past these fees tended to be relatively small however in recent years some companies have jacked up their fees to incredible sizes today some companies are charging two and three times what they charged only a decade ago therefore if you could cut these fees you could save hundreds if not thousands of dollars on a transaction there are two ways to cut them the first is to simply shop around title insurance and escrow companies compete for business and their rates vary checkout half a dozen in your area you'll probably be astonished at the differences then when you're making your deal insist that the escrow in title insurance be handled through a company with a cheap rate once you explain the other party to the deal should be happy to go along but the agent might not although bundling of services through which the agent gets a kickback is unethical and in some cases illegal many agents insist that both buyers and sellers use the escrow and title insurance company of their choice sometimes one that is affiliated with their real estate company they often use a very convincing argument that goes something like this I've been involved in hundreds of deals and the only ones that went sour were those that didn't use this company this is the only company in which the people are reliable and you can count on them to do the job right pretty convincing isn't it furthermore it might be true nevertheless if your cost conscious you may be willing to take a chance on a company whose rates are half of those of the company that the agent is pushing just remember that it's up to you and the other party to decide on which escrow in title insurance to use the agent can suggest but cannot normally demand the second way to reduce the costs is to cut a deal with a particular escrow and title insurance company after all remember that you're an investor who's likely to bring in a lot of business if you're there every six months to a year with another deal particularly as the deals get more expensive there's a lot of money to be made by the company so tell them that you'll deal with them exclusively you'll bring all your purchases and sales to them if they will give you a special rate don't think this type of arrangement is something new or unusual title insurance and escrow companies regularly offer reduced rates to better customers even if you're just a consumer who happens to sell a house within a year after you bought it the company may cut a deal of anywhere from five to twenty five percent if you're an investor who brings in deals on a regular basis you may be given a regular discount transaction costs strangely named closing costs take a big piece out of every real estate transaction the more you can knock them down the greater your profits Chapter six seven techniques used by successful investors if you're just starting out investing in real estate chances are one of the big questions you have is what makes for success what techniques do the big winners in the field use what are the moves that will lead to a bright future in real estate for you here are seven techniques that I've observed are used by most successful investors in real estate if you practice them regularly you will enhance your chances of joining that winning circle to one concentrate your efforts just as no one can be all things to all people neither can an investor hope to be successful buying all kinds of properties in many different areas when you first decide to invest in real estate the opportunities will seem unlimited you can buy houses or condos strip malls or apartment buildings industrial properties or bare land you can choose to invest in the mountains or near the coast in downtown areas of major cities or in the suburbs in rural areas or in farmland you can buy new or resale or even build yourself there is a type of real estate out there that will excite every interest what's important to understand however is that it's unlikely you'll be able to successfully invest in all of it rather the best way to begin is to limit your scope and then concentrate on your area of choice until you become expert in it in real estate as in most other fields knowledge is king if you have more knowledge than others you'll be able to discern true bargains and avoid pitfalls while others go astray and of course the way to gain that knowledge is to study hard and focus your attention that's why I always suggest starting with single-family owner-occupant homes these are everywhere they are easy to purchase and to rent out and even if you guess wrong the first time you're not likely to get badly hurt further as you buy your second third and more homes you'll get to know how the real estate market and in particular how the single-family home segment operates you'll become expert in evaluating these types of properties you'll get a keen understanding of their financing you'll be able to see in a home those features that could increase its value that its seller missed in short you'll develop a sense for identifying bargain property of course that doesn't mean that you're limited to single family homes forever it's just the best way to get your feet wet once you've gotten some experience it's wise to dabble in as many different types of real estate as possible one very successful investor I know moved his family to a mountain community and began buying and selling ranch land over the course of a few years he became quite expert in the field and he now controls many excellent ranch properties further agents and other new investors consult with him before they make their own purchases another successful investor I know decided to concentrate on duplexes double-unit homes she buys and sells these on a regular basis she's identified virtually all of them in her area and knows many of the owners by name they know to call on her when they want a quick sale she actually makes a market in these properties on her own similarly other investors specialize in apartment houses or industrial buildings or in commercial centers however these people usually didn't start there rather they started small and worked into it most started with single-family homes I also recommend that you raise a farm this is a geographical area where you plan to buy all of your properties it can be as small as a single neighborhood or as large as several cities but what sets it apart is that you concentrate your efforts there and not go afield by farming a single area you get to know the neighborhoods intimately you know which are on the way up which are stagnant and which are declining you even know the homes block-by-block that means that when a potential investment property comes on the market you don't need to waste time investigating schools and crime statistics local governmental policies and homeowner association attitudes you already know all this indeed if you're really on your toes you'll even be aware of previous sales and be able to tell what the home is worth within a few hundred dollars further you may have a specific location in mind so you go door to door asking owners if they're interested in selling in this fashion you can pick up homes even before they come on to the market and sometimes get real bargains in the process of course by concentrating your efforts in one area you maximize your time and save needless expenses you can be close if a rental needs a faucet fixed and not need to call out an expensive plumber or if you need to find a tenant you can put the ad in the paper field the calls show the property and rent it up instead of paying twelve to fifteen percent of your rental income on a property manager if you want to sell a home you can easily spend time sitting in it at an open house when you sell it as a Fizbo in short concentrating your efforts in a single area is the efficient way to buy investment property to spend more time buying than selling and be prepared to lose deals one of the keys to successful real estate investing is to buy right in fact some investors feel so strongly that they use the motto you make your profits when you buy not when you sell by this they simply mean that the characteristics that make a property resale for a big profit are already built into the purchase by the right property in the right location for the right price and your sale success is certain by wrong and you'll spend a lot of your time trying to figure out how to dispose of the property without taking a loss of course that means that you'll need to become adroit at property analysis it's easy to say by right but quite something else to know which property is right and how much to pay for it one of the hardest concepts for most new investors to accept is that they'll make many offers that fall through before they get a successful deal suppose you find a house that you want to buy the location is perfect the home itself is ideally suited to be an investment and you've determined the right price to pay and as only 8 percent less than the seller is asking if the asking price is $200,000 the offer is for one hundred eighty four thousand dollars how much sweeter and easier a deal could it be so you make your offer fully expecting the seller to accept only the seller is stubborn she feels that the house is worth every penny she's asking and she won't come down a dime she won't even counteroffer suddenly your perfect deal is in jeopardy the house is right but you can't get it for the right price what do you do as in football you punt you move on the trouble is that many investors worry that they won't be able to find a better deal they worry that maybe their own calculations are wrong they worry that while they're trying to figure out what to do someone else will come in with a better offer so you go back and change your original calculations okay you figure you can easily pay 2% more and still come out so you send in a new offer 2% higher than the last $190,000 only now the seller is emboldened here you're sending in a new offer without her even countering you must desperately want the house why should she even think about coming down in price so she ignores your offer what do you do now remember football you punt and move on but this is the perfect house you'll never find another to match it and besides within a few years no matter what you pay it will be worth more and you'll make a profit so you throw in the towel and offer the full price $200,000 eight percent more than you originally calculated the home is worth of course you'll get the deal assuming the sellers ego hasn't blossomed to the point where she now wants more than the ask price but what kind of a deal do you have certainly over a very long period of time you'll come out okay that's the beauty of real estate but during that time you've lost money you've paid eight percent sixteen thousand dollars too much for that house if you get into a financial bind and need to sell quickly you'll lose money if the property appreciates at a reasonable rate of 4% a year it will take two years just for you to get back to market value not counting transaction costs it's the sort of move that an inexperienced consumer buying one house every decade or so would make it's not the move of a successful investor in short you bought wrong and that imperiled your profits what's worse you may learn the wrong thing from your efforts you may learn that in order to buy a house it's not what you calculate its worth that counts it's what the seller is asking you may continue on to buy more properties at inflated prices ruining your profits as you go the moral of our little story is that when the seller is uncooperative remember football and punt remember there are more than 65 million homes in the country and in any given year probably up to 10% of those are for sale that's a huge inventory to choose from there's no lack of opportunity there is however often a lack of fortitude remember you determine what makes a deal a good one if it's not good you don't need to buy into it perhaps one more example will help I recently was called on by a friend to help with the purchase of a home in a downtown area of Philadelphia since I wasn't familiar with the area my advice was more philosophical than a practical plan of operation Jerry called from Philadelphia and asked what he should do he had made an offer of $300,000 on a house the sellers were asking three hundred sixty thousand dollars they were apart by about 17% of the asking price the sellers had come down ten thousand dollars and Jerry had gone up twenty thousand dollars the sellers then wanted three hundred fifty thousand dollars he had offered three hundred twenty thousand dollars the difference was thirty thousand dollars or about eight percent of the original asking price but they wouldn't budge they countered his last offer by again offering three hundred fifty thousand dollars my initial response was to ask him what the problem was obviously this was not a deal made in heaven there was a huge gap between what the sellers felt their house was worth and what Jerry felt was a good investors price to pay simply move on punt but Jerry said it's beautiful it does need some work but once it's put into shape I should be able to rent it out easily of course at the higher price I can't break even even after taxes but the area is only a few blocks from one of the top areas in town it'll be real easy to resell and it's beautiful it's nearly a hundred years old and the lines are just classic I've always wanted to own such a beautiful house I thought a moment then asked him if he had considered all of this when he made his original offer of $300,000 of course I did he answered haughtily I then asked him why he had increased his offer by twenty thousand dollars how had his figures changed Jerry stammered a bit and said he went back and recalculated he figured that maybe he could squeeze out a few hundred dollars more in rent if he fixed it up really nicely also maybe the comparables weren't in quite as good shape as this property would be when it was fixed up in short he figured he could come out with a higher $320,000 figure which was still thirty thousand dollars less than the sellers were asking okay I replied then from what you're telling me it seems that it's quite safe for you to pay $300,000 for the home on the other hand if you're willing to take some risks and if everything goes just right you might get away with paying $320,000 for the house that's probably not the best way to buy but just maybe you'll come out but I continued the sellers are in no way interested in the $320,000 price they want $30,000 more and from what you're saying no way does the property warrant that much more money so what's the problem simply punt walk away but Gerry whined it's the sellers they just don't see that their property is worth less they simply won't listen to reason do you think if I came back at $325,000 $5,000 more they would see the light now I understood what the problem was this was no longer an investment for Gerry it was a love affair he had fallen for the house and in his emotional condition no price was too much to pay for it my final advice to him was to wait and see why not give it some time I suggested don't do anything for a few weeks maybe by then the sellers will come around in the meantime why don't you keep your options open why not keep looking for other investment houses in other words maybe in a few weeks your infatuation with the property will pass and reason will again take hold in your mind Gerry agreed I got a call about a month later no the sellers of that original home hadn't come down in price but he had found another property that was even better situated he had made a lowball offer and after some countering he had bought it at a good price he still regretted missing out on his beautiful house but his pocketbook was going to be fatter for having let it go the moral of the story is that in order to get a property at a price you want to pay you may need to make offers on 2/3 a dozen even to dozen different properties when the sellers don't go along you remember football and punt you move on to the next property in short you simply play the numbers there are a lot of good potential investments out there if one doesn't pan out keep making offers until you find one that does that does three identify the neighborhood loser and buy it it's a very rare for a good property to jump out and stare you in the face but this does often happen in the form of the neighborhood loser this is a property that because of some underlying factor no one wants and as a result its selling for considerably less than its neighbors it's helpful here to think of the word crisis in Chinese it actually has two meanings danger and opportunity the neighborhood loser is the same it's a house that could be very dangerous to buy it's detracting feature could prohibit it from going up in price and could make it difficult to resell on the other hand if you're creative and can identify and correct the detracting feature you can almost overnight jump the property's value okay now that I have your interest what do I mean by a detracting feature it could be anything from purple paint to being next to a large billboard it could be a home that's too small or too large for its neighborhood it could have no view in an area of view homes what makes this property easy to identify as I noted is that it jumps out at you typically its price is far lower than its neighbors and the problem is usually easy to see it's a property that's crying out for attention a few years ago a neighborhood loser jumped in my face I was looking in the East Bay area of San Francisco in a town near Walnut Creek all the homes were tract built but they were well designed with a custom look they were expensive at the time going in the $400,000 all except this one house that was listed but not selling for $350,000 why I asked myself and I went to see it from the street it seemed normal enough except that it was slightly below road level that means you looked down on it this is not a desirable feature but it is not in itself anything terrible particularly since the drop was only a couple of feet however when I went through the house and into the back yard I immediately saw the problem the house was literally in a hole the homes on both sides and in back were on higher ground that meant that the neighbors could literally look over their fences and down into the homes back yard there was not even a semblance of privacy and no one wanted to buy a home where they would be under a magnifying glass all buyers had passed on the property I calculated that the house was selling for at least $50,000 less than its neighbors I offered $325,000 and the sellers accepted without countering they were thrilled to get out I had bought the property for 75 thousand dollars less than its comparables not counting the poor location but you may be thinking to yourself the one thing you can't change is location true you can't move the house elsewhere but sometimes you can disguise a location along one side I immediately planted quick-growing shade trees when I bought them they were about six feet tall when I sold the house two and a half years later they were 12 feet tall and they filled out to screen that neighbor's property along the back of the property it had a deep lot I planted several fruit trees after a couple of years they not only shielded the property from the neighbor back there but they provided fruit as well another positive on the final which was most closely to the level of my property I got the neighbor to agree to a seven-foot instead of a 5-foot fence and planted bougainvillea a plant that grows quickly and tall clings to fences and provides beautiful flowers now that side was shielded too the final problem was caused by the fact that water runoff from the neighboring property all came through mine on its way to the street that meant that my backyard was wet and puddling a large part of the year and that there was standing water under the house a French drain which is essentially a pipe with holes in it placed underground collected the lot water and moved it to the street a sump pump under the house ensured that it remained dry when I went to sell the house still in the same location still in the same hole it did not look like it had any problem at all indeed the backyard was a wonder of seclusion it had beautiful flowers on one side tall trees on another and fruit bearing trees in the back it no longer was the neighborhood loser it was a winner and I got a good price for it equal to comparable well located neighborhood properties needless to say the profit was very satisfying the moral to this story is that when a neighborhood loser jumps up and stares you in the face put on your creative cap begin thinking imaginatively trying to discover if there isn't some way you can turn the situation into an opportunity in my case careful landscaping was the key in another case it may be repainting or fixing a foundation or roof or there are always neighborhood losers what's really rare are investors who can see beyond the dangers posed to the profit potential for rent relentlessly as an investor in real estate you will also inevitably become a landlord you'll own property that you will need to rent out when you first start you may have only one or two rentals however after a few years you may have four or five or even several dozen with many properties getting the rent in to cover your mortgage and other expenses is critical therefore how you handle yourself as a landlord will determine to a large degree whether you'll be a success or failure in the field as a landlord you will need to rent relentlessly by this I do not mean that you'll be unfair far from it what I mean is that you'll be all business you won't let personal feelings cloud the issue and as newcomers to the landlord market quickly discover that's much harder to do than first appears I have a good friend Joe who's been in the investing landlord business for nearly 30 years Joe now owns close to 90 properties needless to say he's quite wealthy but he still handles his rentals on his own in fact that's his full-time job and it's really a pleasure to watch him at it he's fair with his tenants I've never heard any complained that he wasn't but he's all business for example he has a policy of no pets in most of his properties he feels that pets leave odors ruined rugs and otherwise create high wear and tear therefore he does not allow them in his best properties he does allow them in some of his properties that he says are his dogs I'm sure that there are many listeners who have pets and who indeed love pets I include myself in this group as a landlord you will have a choice to make to allow pets or not your own experience will help you to determine how you want to handle it you to determine how you want Joe always asks prospective tenants if they have a pet it's on his rental application form and it is a question he puts to them directly most people answer truthfully if they do have a pet then he simply says he doesn't rent the property to tenants with pets where his all business attitude comes in is when the prospective tenants say something like well we really like the rental so we'll get rid of our pet his standard reply is I would never rent to people who would get rid of their pet it's hard for a pet owner rental applicant to argue with this when I asked him about this response that he wouldn't rent to prospective tenants even if they agreed to get rid of their pet he answered people don't get rid of their pets when I was first in the business I used to believe them then I discovered that a few weeks or months into the rental term the pet would reappear a person who has a pet simply won't leave it behind they just say they will to get the rental so I don't rent to them that's his opinion by the way it's important to understand that Joe has a pet terrier named Charlie which he loves and he would never get rid of Charlie Joe also exhibits his business attitude when it comes time to collect the rent if a tenant is more than a day or two late he immediately goes to see that tenant in person unless it's an oversight which it sometimes is he insists that the rent be paid immediately I have watched Joe in situations like this and he is all business while tenants sometimes don't have the rent they always have an excuse they had a medical emergency or their relatives needed support or they were late getting paid from their work or they threw a terrific party with the rent money or Joe responds I understand you have problems but the rent must come first you will always need a roof over your head and it won't be there if you don't pay your rent no matter what your problem you must pay the rent first he explains that he's found that people always have some money available and reserved it's just a matter of priorities if the landlord is willing to wait they'll put something else first but if the landlord insists that he or she be paid first than the rent the number-one priority and gets paid on time of course if the tenants really cannot pay then Joe insists that they move out but as I said he's fair I've seen him give tenants five hundred dollars to help them move when they were in a really distraught situation on the other hand I've seen him quickly go to court to get an unlawful detainer action eviction when tenants wouldn't cooperate or even discuss the problem with him does Joe rent relentlessly yes he makes sure that he always gets his rent on time if he didn't he wouldn't own as many properties as he does or be as wealthy as he is is he unfair I've never seen him to be he provides good clean properties at a fair rental price he simply expects to be paid in return if tenants have problems he sympathizes but he does not make their problems into his own by allowing late rent will you as a landlord need to be as relentless as Joe probably not I find that I'm much more of a softy than he is but then again he owns a lot more properties than I do five sell and buy on your own when you're getting started you definitely need all the help you can get that includes the services of a good experienced broker however once you've established yourself in real estate you may want to consider handling deals on your own the reason as described in Chapter five is the high transaction cost mainly the commission to the agent an agent's fee is usually 6% for residential property as much as 10% for some investment properties such as apartment buildings strip malls and so on if you can handle the transaction yourself that could be money in your pocket and it works both when buying and selling when buying directly from the seller you may get a price reduction for at least part if not all of what would otherwise be an agent's fee when selling there's no Commission to if you don't use an agent however it's important to understand that agents earn their fees if you don't use an agent you will have to do his or her work that includes the following when selling advertised the property to find a buyer when buying scout to find a suitable property negotiate directly with the other party right up the purchase agreement handle all the paperwork open and manage the escrow accounts arrange for financing close the transaction it sounds like a lot but once you're experienced with many deals under your belt it will all seem doable in fact most experienced investors I know regularly scout out and buy properties at advantageous prices all on their own six hold from market highs and the art of holding in this book we talk a lot about buying and selling real estate in doing so you may have gotten the impression that this is what successful investors do all the time without regard for anything else nothing could be further from the truth the savvy investor pays very close attention to both the overall financial condition of his or her area and the country as well as the real estate market and in particular whatever segment they are in in the residential market investors were selling high priced property after the turn of the century when others were buying them the reason was that prices had risen to historic highs and the investors were sometimes selling for a 200% profit of course in order to sell the investors had to have first purchased these same investors had bought these properties during the severe real estate recession of the early 1990s at that time prices had fallen by as much as a third of earlier values in many areas bargains galore were out there and the savvy investors picked them up rented out the properties and held them until got better as I said it was an obvious move but relatively few people actually did it the reason was that in 1999 to 2002 when prices were shooting up most people wanted to buy hoping to resell at even higher prices and in 1995 to 1997 when prices were collapsing few wanted to buy for fear that prices would go even lower the truth of the matter is that most people buy and sell at just the wrong times spurred on by the emotion of the market a successful real estate investor however will put emotion aside and buy when prices are low sell when they are high and hold until the right time all of which is to say that while it's important to be in the market it's equally important not to churn your properties you don't want to sell just for the sake of selling being able to wait out the real estate cycle until prices move up eventually prices will almost certainly move up in most real estate markets because of inflation and housing shortages is in fact much of the key to success in real estate however being able to hold means that you must have stable properties this gets us back to the concept of the break-even you will find that you can't hold on to a property with a serious negative cash flow while you make grit your teeth and hang on to one or even two such properties a dozen will quickly drive you to bankruptcy therefore to reiterate your goal should be to buy properties for which the income comes close to matching expenses that is those properties that you can sit on for years if necessary until prices go up and you can sell for a profit however even the best investors sometimes buys a property that turns out to be a dog no matter what he or she tries the property loses money each month when that happens my philosophy is to dump the dog seven keep your day job the best way to invest in real estate is to do it on the side and in your spare time the reason is that you won't have much positive cash flow in the early years investing in real estate can be a no brainer it's a matter of simply acquiring properties one at a time until you're wealthy you just have to make a few sacrifices such as initially keeping your day job to accomplish it here then are the seven techniques that I have found almost all successful real estate investors use one concentrate your efforts to spend more time buying than selling and be prepared to lose deals three identify the neighborhood loser and buy it for rent relentlessly five buy and sell on your own six hold from market highs seven keep your day job after seven buying apartment office and commercial buildings while I've stressed that the best place to get started investing in real estate is with single-family homes they are the easiest to buy and you can simply ride the wave of their price appreciation they are not your only options in real estate many investors graduate to other forms of profitable investment in this chapter we'll look at two apartment houses and commercial buildings moving up why move up you could as many real estate investors do spend your entire career at the single-family home level and as we've seen you could do very well at it but if you want to make more money and quicker the answer can be larger properties for example if you own a 20 unit apartment building or a 10 unit strip mall you not only can expect to reap profits over time but if you obtain the proper financing you also may be able to obtain significant cash flow right from the beginning in other words you may be able to afford to hire someone to manage the property so you don't have to constantly be collecting rent and fixing broken dishwashers further at the end of the month you may have considerable money in your pocket over and above expenses plus if you buy write and improve the properties you may have significant and rapid equity growth small wonder that many investors opt for the bigger properties on the other hand the potential for loss is also greater if you have only one rental house you need to find only one tenant even in hard times you can always drop your rent a few dollars a month and keep your property fully occupied with larger properties you may need to find 10 or 20 tenants in tough times you may be able to rent out only half or three quarters of your units resulting in serious negative cash flow problems in short you can lose a bigger property more quickly and more easily than you can a single-family house thus going big not only promises greater rewards but also greater risks let's consider an apartment building with an apartment house prices are directly tied mainly to rental income simply increase your rent and you can produce significant profits overnight further the rental market does not always move at the same rate or in the same direction as the market for single-family homes for example in any given area there may be a shortage of rental units but a strong supply of single-family homes thus rental rates can be going up at the same time that single-family home prices remained stagnant or decline you may be wondering exactly how rental rates determine profits in apartment buildings in theory is actually quite simple for example let's say you have a 10 unit building where each unit is rented for $500 a month or $5,000 monthly or $60,000 annually the value of the property is based on that rental rate double the rental rate to $10,000 monthly or $120,000 annually and you've doubled the value of your building if you paid $500,000 for the building initially double the rents and now you have a property worth $1,000,000 keep in mind that this can happen while prices for single-family homes have moved up not at all if you happen to put 20% down $100,000 on your apartment building your profit is now 500 percent or $500,000 with apartment buildings you can obtain magnitudes of profitability of course as noted earlier the risks are also great if the rental rates were to fall in half so too would the value of the building commercial buildings as well as office buildings operate in a similar way their value is directly determined by their rental income the greater the rental income the greater the value by a building at one level of rental income and increase rents you can sell at a higher price we'll go into this in more detail shortly another major factor in the financial aspects of owning commercial buildings and industrial buildings - however is the strength of the tenant leases long term leases with strong tenants those likely to continue to pay their rent year after year with escalation clauses mean a higher value short term leases and weak tenants mean a lower value improve the leases and you improve the value additionally there are other factors involved with these properties for example typically the rent for commercial buildings is determined by the front foot since access to the public is critical to businesses the more exposure the more valuable the location thus a tenant will pay according to how many feet are directly accessible to the public as well as how good the location is if you can devise some way to increase access to the front footage you can increase rentals for example opening the second floor of a mall to direct access from a parking garage can increase the value of the front footage of units in the building in office buildings or industrial buildings on the other hand access to the public is not usually a valuable factor thus the front foot usually doesn't matter for offices the primary concern is the total amount of floor space thus these buildings are rented out on the basis of square footage so much per square foot per month this is the reason that office buildings can be built so high even to the point of skyscrapers the tenants often don't care what level they're at as long as there are working elevators of course as long as the rent is affordable views from higher floors often command higher rents on the other hand as we've seen the higher you go the less foot traffic and hence the reason that commercial buildings malls are rarely if ever more than three stories tall if you've a mind to purchase an apartment building my suggestion is that you start out small no more than six to eight units also I suggest you attempt this only after you have already purchased and rented out several single-family homes you will have developed your skills as a landlord in this fashion when you approach an agent or seller of an apartment building you will be advised that there are a number of methods of determining value you can capitalize the net income you can check comparables or you can simply hire an appraiser however the rule of thumb system called the gross income multiplier GM or GIM is often used by savvy investors to produce a quick and surprisingly accurate estimate of value so we'll discuss it here we'll discuss it here Harry's apartment building Harry had been investing in real estate for about five years when he chanced upon what he considered a real opportunity it was an eight unit apartment building that the owner wanted to get rid of in the worst way she was selling direct Fizbo without an agent the owner a widow in her 70s named Sheila had owned the building for several decades she had kept it fully occupied by always charging rents slightly lower than market however now Sheila was an ill health and she wanted out quickly Harry saw an opportunity to jump in and get a bargain price Harry asked around to several agents and learned that most were using a GM of around ten that simply meant that they took the total rental income for a year and multiplied it by the number ten to calculate the value of the property the units were rented out for an average of five hundred dollars apiece so the monthly gross for eight units was four thousand dollars and the annual gross was forty eight thousand dollars when the GM of ten was multiplied against this it gave a value of four hundred eighty thousand dollars for the building when Harry asked where the GM number had come from a real estate agent admitted she didn't know another set it was simply a way of quickly quantifying the relationship between price and rental income in an area for example apartment buildings that were selling for around $500,000 were bringing in around $50,000 in gross annual rents hence the GM of 10 was used if price has moved up to $600,000 for buildings that grossed 50 thousand dollars in annual rents then the GM would go up to 12 if prices move down to $400,000 per $50,000 in rents it would go down to 8 Harry asked why prices would go up or down in relationship to rents and she answered that the fluctuations were caused by the cycles of supply and demand sometimes more people wanted apartment buildings other times fewer wanted them and demand dropped she admitted it also had to do with the cost of money and prevailing interest rates the agent asked if she could handle the transaction for Harry but he declined saying that he felt he was getting a good buy and since the seller didn't want to use an agent he was unwilling to pay for the service the agent shook her head and wished him good luck the agent also pointed out that the GM could move up or down depending on the condition of the building an apartment house in terrible shape usually commanded a lower GM than one in tip-top shape Harry conducted the survey of Sheila's building and discovered that there had been lots of deferred maintenance the units had not been painted in years and the carpeting was tattered also many of the appliances were on their last legs the tenants however were reluctant to complain because they were paying a rental rate that was below market in addition the roof needed repairs and the building overall looked shabby it was in need of a complete paint job on the outside and an upgrading of the landscaping Harry went back to the agent and asked if a lower GM should apply because of the poor condition of the property the agent shook her head she said the demand for rental property was strong and Sheila's apartment house wasn't really that bad so Harry offered Sheila full price $480,000 he agreed to put 20% down $96,000 obtained from profits made on buying renting and selling single-family homes and to attempt to get a mortgage for the balance from a bank the purchase offer was of course contingent upon his getting financing getting the loan however proved to be more difficult than Harry had anticipated the banks complained that he had no previous experience with apartment buildings further he was stretched thin already because of his other real estate holdings in the end he obtained a 70% mortgage at an interest rate higher than the market rate while Sheila carried back a second mortgage for 10% at the market rate the sale took about 60 days to complete and then harry had the building he had Sheila walk around and introduce him as the new landlord to each of the tenants then he was on his own his first big shock came when the very next month three of the tenants told him they were moving out it turned out they were actually relatives of Sheila and she had exaggerated the amount they were paying in rent they were in fact paying only a fraction of the income Sheila had projected for them when Harry called Sheila about this she agreed she said that she had put them down for a fair market rental rate even though they were paying about less than half you can certainly rented for what I said they were paying I just credited them with half the rent because of debts I owe them in the past suddenly Harry had a big rent up problem but his woes weren't over as the old tenants moved out they demanded their cleaning security deposits back they each claimed to a paid Sheila $1,000 and it was fully refundable when they left provided that the apartments were left in reasonably clean shape which they were again Harry called Sheila she confirmed that she had the Cleaning security deposits but refused to turn them over she said they weren't part of your purchase offer you never mentioned them Harry had to agree that was true but said he never thought about it she said she was sorry but since it wasn't part of the sale she considered these funds to be her money Harry would have to pay back the cleaning security deposits out of his own funds Harry had to dig deep to pay back the security deposits of the three moving tenants and he was even more dismayed to learn that when the remaining five tenants eventually moved he would have to pony up their deposits as well on the other hand he realized that as soon as he rented out the apartments he would be able to charge a cleaning deposit to the new tenants and that would help offset the drain on his cash at the drain on his cash Harry had to come up with cash and had three out of eight units immediately empty it was a crisis however he remembered that a crisis not only was dangerous but it also offered opportunity he borrowed money on his credit cards and as soon as the old tenants moved out he had their apartments repainted put in new appliances and carpeting and raised the rents he also had the exterior of the building completely repainted fixed the roof and put in attractive landscaping then he asked $750 a month a $250 increase Harry had done his homework and he had learned about investigating rental rates from owning single-family homes he had looked around carefully and discovered that apartments of the size he had were renting between 500 and 800 dollars a month in his area depending on condition he fixed up the condition and moved from the bottom of the market range to near the top as soon as he got the empty apartments rented up he announced to the remaining tenants that he was raising their rents $100 a month he explained that as a new landlord he had higher mortgage payments to make than Sheila who owned the building free and clear and he had made improvements three more tenants moved out over the next three months Harry went in refurbished their apartments as he had done with the other units where tenants moved out and rented those for $750 apiece within six months Harry's monthly rental income had soared from $4,000 to $5,500 his gross annual income was 66 thousand dollars making the building worth six hundred sixty thousand dollars using a GM of ten of course he had spent about ten thousand dollars a unit fixing it up sixty thousand dollars so his increased equity was actually only one hundred thousand dollars nevertheless a handsome sum Harry figured that over time he would fix up the remaining rentals increased the rent and boost his equity even further in addition the increased rental rate gave him a positive cash flow allowing him to have money left over each month after paying for the mortgage taxes maintenance and repairs two years later Harry had increased rents again until he was averaging $800 a month per unit or six thousand four hundred dollars total his annual gross was seventy six thousand eight hundred dollars giving his building a value of roughly seven hundred sixty eight thousand dollars however when he went to talk with some agents he discovered they were now using a multiplier of eleven the market had gone up as more investors wanted apartment buildings of course the market can also go down Harry's apartment building was now worth 800 $45,000 his equity had grown to three hundred sixty-five thousand dollars in just two years were he to sell he would make a very handsome profit indeed from Harry's experience we've seen what an investor can do with a modest purchase in an apartment building it's important to understand however that we've glossed over many of the pitfalls of owning such property for example Harry could have had serious tenant problems he might have had tenants who not only refused to pay the rent but then refused to leave he would have had to resort to an unlawful detainer action in court eviction to get them out and when they eventually moved they might have left the place a mess requiring heavy-duty refurbishing no this doesn't happen all the time and if you're a scrupulous landlord who carefully qualifies tenants it may never happen at all but it is a risk additionally we've assumed that Harry was free to raise rents at will this is not always the case many communities have some form of rent control through which they limit the size and frequency of rent increases further economic conditions were fairly stable for Harry but that's not always the case sometimes and economic downturns a number of tenants may not be able to pay their rent nor can they move out which can leave the apartment building owner with long term rental headaches all of these things could happen they are the risks assumed by an investor in apartment buildings however if you pay careful attention to the details of the business and you have a bit of luck they won't happen and your profits will be significant buying a strip mall for profit Henrietta also was an investor in real estate who cut her teeth on single-family homes after a few years in the field she wanted to move up and she felt that commercial real estate was the ticket for her Henrietta looked around and quickly realized that the easiest way into the field was to purchase a strip mall this type of property goes by many different names but in general it is basically a small shopping center of anywhere from three to a dozen stores located typically on the corner of a busy intersection we're not talking about Walmart or Macy's rather these properties typically consist of small businesses such as a pizza parlor or a dry-cleaning business or even a convenience grocery store these are relatively small properties with small businesses just right for the beginning small investor Henrietta contacted several agents and found one who specialized in small commercial real estate he showed her several properties one of which appealed to her it was a strip mall that had five stores it was on a corner of an intersection that was fairly busy there was a convenience store a small Thai restaurant a camera shop and two vacancies the owner explained that the previous tenants had just moved out and he did want to rent up the unit's instead leaving it to the new owner to pick and choose whom he or she wanted for new tenants the agent said that the owners explanation was baloney the previous two tenants had gone out of business and the owner simply hadn't been able to find any new tenants the apparent reason was that the strip mall was short on parking the restaurant needed parking for fairly long periods of time while the convenience store and the camera shop needed lots of short-term parking that left little to no parking for any other tenants and starved them of business in short the landlord couldn't justify the rent on a front foot basis because there just wasn't enough customer traffic Henrietta asked how much the property was worth and the agent explained that the value was related to the leases he would have to evaluate the total value of the leases over time the strength of the tenants their ability to stay in business for the term of the leases and the chances for re-rented to new tenants in addition the type of lease would be important in this case they were net leases which meant that the tenants would pay for their own repairs maintenance and even the taxes these are sometimes referred to as net net or even net net net leases depending on how much of the costs the tenant bears as it turned out all the leases were for five years and each had only one year left the agent explained this was both good and bad it was good in that Henrietta could now negotiate new leases hopefully had better terms it was bad in that the existing tenants might decide to move out leaving her with more vacancies it turned out that the seller was asking $700,000 for the strip mall and Rihanna's rental income for the year before mortgage expenses would be about $100,000 providing she could get all of the units rented however with the two vacancies her actual income would be closer to $75,000 Henriette asked about financing and was told there was a $300,000 existing mortgage on the building that could be wrapped when she asked what that meant she was told that the owner was willing to give her another $350,000 second mortgage and wrap it around the first the agent explained that this would mean that Henriette would pay on a $650,000 mortgage directly to the seller the seller would then make the payments on the first and keep the balance of Henrietta's payment for himself as due on the 2nd the agent explained that this avoided having to obtain any new financing which might be advantageous for Henrietta because she had no previous experience in commercial properties which might make it difficult for her to obtain the necessary mortgage she would however have to come up with $50,000 cash down the agent said that in such transactions small down payments were just as common as full cash deals dis common is Henrietta bought the strip mall the first thing she did was remove a planter area that had helped separate the mall from the street this resulted in five additional parking spaces then she rerouted the strip mall traffic by making the driveway one way only prior to that cars could enter from both streets it was a corner lot with the new one-way driveway drivers would now have to enter from one side and exit the other this accomplished two things first it allowed quicker and easier access to the stores from the parking lot and second it prevented cars from having to cross the busier street to enter the parking lot a practice that had been tying up traffic at the intersection and making it more difficult and less desirable for potential customers to stop at the strip mall in addition she had the parking area and had new white parking lines painted on it also she redesigned the parking lanes so that they would all go in the same direction meaning people could get in and out more easily than they could in the past finally she put up signs indicating that parking was limited to a maximum of twenty minutes in the lot the convenience store owner and the camera shop applauded her moves since their customers rarely stayed more than 20 minutes but the Thai restaurant owner was furious he said he now had no parking for his customers because they typically stayed one to two hours for meals Henrietta was sympathetic but she told him she had read his lease and it did not provide for specific term parking his customers would have to park on the street the owner said he would leave he would break his lease she said she was sympathetic and if he wanted to leave she would agree to terminate the lease he was out within two months then Henrietta rented the restaurant space to a take-out deli kitchen at a higher rent than the Thai restaurant had been paying with parking available the front foot rent seemed much more reasonable to tenants she also quickly rented the remaining vacant units to a dry cleaners and a small video store now all of the tenants required only short-term parking which was readily available at the end of the year henrietta negotiated rent increases with the convenience store owner and the camera shop owner she insisted all her leases be for a minimum of five years with annual increases based on the tenants sales as well as inflation since business was now up because of the parking solution the tenants agreed armed with her new leases Henrietta went back to the agent who calculated out the value of the property Henrietta was now pulling in nearly one hundred sixty thousand dollars a year and the longer term stronger leases helped increase the value of the property the agent said she could get well over a million for it perhaps a million two or three Henrietta was successful because she accomplished for a commercial property what she had learned to do with single-family homes she bought a property with an identified problem cured that problem and was able to increase rents in so doing she very quickly increased her equity in the property it's important to note that while we have seen how profits can be made we have skimmed over certain aspects of purchasing a commercial property for example we haven't gone into detail on the actual pricing or leasing the reason is that this is a fairly complicated procedure and involves not only evaluating leases as noted but also involves determining the return on investment cash on cash both of which are beyond the scope of this beginning book if you're interested in buying commercial property be sure to contact a real estate specialist who can give you a detailed evaluation of any property you are considering looking for an office building Gerry found what looked like a terrific real estate investment it was an office building at the edge of an industrial park the park was made up of light manufacturing businesses and offices the building that Gerry found stood alone on the corner of two streets and it was distinctive in appearance while all the other buildings were of cement construction this one was of wood with cedar wood panels stained dark color it stood out and was quite attractive unfortunately it was also in terrible shape the owner had neglected repairs for half a decade it was in desperate need of a new coat of wood stain several of the windows needed replacing and the roof had some issues Gerry figured he could quickly fix it up and increase its value the building was rented to two tenants one on each of two floors the top floor tenant was a telemarketing firm that had six months left on its lease the bottom floor was rented to a music publishing company that had a very long 10-year lease of which four years were yet to run both were net leases meaning that the tenants paid for all their utilities and maintenance but not building repairs such as roof leaks the tenants were also responsible for any property taxes attributable to their business both leases were negotiated during the down cycle and real estate that occurred during the mid-1990s at the time the owner was desperate to find tenants so he had offered a sweetheart deal the rents were extremely low in the neighborhood of $1 per square foot since each floor was 1,000 square feet the income from each tenant was one thousand dollars a month or two thousand dollars total at the time that Gerry was looking at the building he was told that as a rule of thumb a multiplier of 12 was used meaning that the building itself was valued at roughly 290 thousand dollars note the square-foot costs very enormous Lee across the country in San Francisco for example during the dot-com craze values of up to $70 a foot or more were not uncommon that is more recently slip to perhaps half that amount in some rural areas values of as little as 50 cents a square foot are not uncommon since the economy in the area had since turned up Jerry figured the rents were extremely low for the boom times all he had to do was pick up the building based on their low rents weighed out the tenants and then released to these or other tenants doubling or more the rent in effect doubling or more his buildings value the owner however was savvy to how the market worked he knew that the market had been low when he rented to his current tenants and that it was now high he was well aware that he himself could double or more the current rents as soon as their leases were up and thus increase his building's value accordingly he was asking $600,000 close to twice what Jerry figured the building was worth based on current rents when Juri pointed this out the landlord said that the current tenants would be out in six months and four years respectively then rents could be jacked up to levels that would warrant the price he was basing his price on the future value of the building Juri pointed out that setting the price in that way was unfair no one could be expected to pay today what a building would be worth tomorrow the seller said he didn't care he wasn't in a hurry he could wait if someone came along who saw things his way he'd sell if not he wouldn't he wasn't willing to budge even a nickel ultimately Jerry passed on the building he figured that the owner seller was being unrealistic however that's the sellers prerogative the moral of this story is that Jerry came in too late in the office building cycle in his area he should have bought the building several years earlier when rents and prices were down of course you can't go back into the past but you can wait for the future as we noted the office building market fluctuates perhaps more than any other area of real estate all jury needs to do is to wait a few years and perhaps concentrate on other types of real estate investing during that time eventually the office space market will inevitably get over built and that's the time he can jump in and buy at a bargain perhaps even the very same building that he looked at we've looked at a variety of real estate investments that you may want to consider once you get your feet wet in single-family housing the options we've described our apartment houses commercial buildings and office buildings just keep in mind however that these are specialized investments requiring expertise to evaluate finance and a price if it's your first time you'd be wise to secure the aid of a real estate agent who specializes in the field there are four morals here the first is that you should never believe what the county assessor says a property's land value is very often these assessments are only a fraction of the real market value in California and other states for example assessments are made upon sale and not significantly updated even when prices increase in other states assessments can be as much as 10 years or more behind the market you should check it out yourself second an overlooked law in a built out development can be very valuable the lots true value is based not on what the land originally sold for when the area was an agricultural field but on what it will be worth when it's developed when the lot comes up for sale contractors will often bid on the opportunity to get it and calculate their profit from the combined home and lot third you must always thoroughly check out bare land for utilities and other hookups janet was lucky and that they were nearby in the street but in the case of rural land it might have been necessary to have the hookups dragged for hundreds of feet sometimes miles which would have cost far more than she could pay finally you never know if someone will sell until you ask a word of caution however when dealing with elderly people be sure they are competent to enter into the transaction else later on a relative or other interested party could say you used undue influence to coerce them into signing and attempt to rescind the deal land speculation is like any other type of speculation in a commodity from gold to soybeans to stock and bonds if you guess right you can make a killing if you guess wrong you can get killed changing the lands use the biggest profits I've seen in land speculation have come about when land was converted from one use to another for example I have seen tremendous profits made when undeveloped land was bought and then resold later as prime industrial or residential Lots initially the land was worth a few thousand dollars an acre to the farmers who owned it but as developed land it became many times more valuable of course there are significant impediments to getting the land use changed as Mark would find out like Janet mark had started out investing in residential housing and as he acquired more experience he wanted to move on to something bigger and better so he began checking around his city until he found a parcel of about three acres an acre is 43,560 square feet which in many communities roughly equals the size of five or six typical residential tract Lots the land had been used for vegetable farming but in recent years with homes built all around it had been allowed to grow fallow now it was nothing but weeds the nearby homes however were selling in the $350,000 price range mark contacted the owners farmers who owned several other parcels of land and they agreed to sell the parcel for $50,000 an acre or $150,000 for the three acres a price that was about four times what the land was worth as agricultural property mark gave them $10,000 cash in exchange for a two-year option to buy next mark went before the local Planning Commission and asked to have the land use changed from agricultural to single-family residential however before he made his appeal he did his homework he did an evaluation of all surrounding property to show that it was mostly residential he also took a petition around to the nearby neighbors to sign that they approved of the development some of the neighbors objected because they had hoped the area would be developed as a park mark pointed out that it simply was too small for a park but that nice homes would get rid of the dust and blighted look of the open field most neighbors signed more importantly there was no open opposition mark also got an architect to create a rendering showing how streets could be put in and he got approvals from the local utilities in sewer district for eventual connections he proposed four Lots per acre plus of course wide streets and sidewalks it took the better part of six months but eventually approval was granted now Mark had to go to the state in order to subdivide land into twelve Lots for per acre for three acres approval from a state real estate department or Commission is usually required this normally takes the form of getting subdivision approval mark learned that his request would be filed in a queue in which it would sit until other land developers who had already filed their subdivision maps were processed he was told that the procedure could last as much as a year or more further there was all sorts of documentation required and in order to get it right he would need to engage an attorney who specialized in subdivisions mark began to think he had bitten off more than he could chew so he contacted a couple of experienced builders and asked if they would like to partner with him they said that they didn't do such partnerships but one offered to buy the land directly from him for $75,000 an acre that would give mark a $75,000 profit on three acres of course he would get only paper a second or other inferior mortgage initially the cash would come much later after the land was subdivided and the homes were built and eventually sold then Mark learned about a quirk in the law in his state a subdivision map was required only if the land was to be subdivided into more than four Lots if he subdivided it into just three Lots no such filing was required so he offered the property up for sale and one acre parcels zoned for residential use with four Lots per acre small builders jumped at the chance to get good residential land in a prime area and he soon sold the Lots off for $100,000 apiece total $300,000 or a $150,000 profit on three acres part cash and part paper as part of the transactions he bought the land from farmers by exercising his option which he then sold to the contractors all through the same escrow process of course now it was up to the contractors to get a subdivision filed or perhaps to build only three homes per acre mark realized a substantial profit for his efforts and he did so in less than a year splitting land into smaller Lots another way to make money in real estate is to increase the size of the pie where there was only one lot make to Marcie did just this after a careful search she found an older house on a hillside located just outside the city limits of her town the house itself was sitting on an acre of land it was positioned to the front of the plot near the street fully half the remaining land was open space behind the house where the owner had planted fruit bearing trees it was an exclusive part of town and the property was for sale for $400,000 nearby homes on half acre lots sold for about as much this house had the added advantage of the bigger lot but on the negative side it was old and rundown balancing things out the sellers were a middle-aged couple who owned their own business they were relocating to a different state Marcie tried to negotiate the price down but they were adamant so she eventually paid full price Marcie arranged for 90 percent financing and bought the property immediately after the purchase she had the lot surveyed isolated the back half acre and dedicated a strip of land up the side to the street she now had two Lots the front lot on which there was the house and the back or flag lot with its own access to the world she advertised the back lot for sale at $200,000 it only took a few months to find a buyer who was willing to pay $175,000 in cash she thought she had everything licked until she tried to close escrow on the deal Marcie discovered that the lender who had given her the loan on the property when she bought it had the entire property listed as collateral the lender was not willing to give up even an inch of land and dilute its collateral Marcie begged and pleaded to no avail so she tried an end-run she had the property refinanced this required a escrow and title insurance however as part of the refinancing she had the property lines redrawn reflecting the split off of the back lot she offered the new lender only the lot on which the house stood since the house was on its own lot with nearly half an acre of land the lender did not object she got new financing separated off the back lot and sold it for $150,000 in cash then Marcy fixed up the house and resold it for $450,000 her total profit on the land split was $200,000 the moral here is that where there's a will there's a way the biggest problem with splits tends to be the lenders who almost never will agree to reduce their collateral thus you'll have to get new financing on each side of the split or on only one side as was the case here it's worth noting that splits come in many different flavors in San Francisco for example where land is very pricey I've seen clever investors buy flats buildings were each floors a separate unit and split them condo style for big profits in other cases I've seen investors split lots and buildings on them into duplexes or triplexes where the structure would allow it the whole idea of the split is to create two or more parcels where previously there was only one and in the process of course make a profit the final land purchase we'll consider is the scraper this refers to a property where the land is very expensive and the building isn't thus the building is scraped off the land and a new more appropriate one put up scrapers tend to occur primarily in older areas where prices have gone through the roof for example in parts of the San Fernando Valley of Los Angeles scrapers have become common here older smaller tract homes sometimes having only 1,000 square feet were built on very large Lots times a third to half an acre this was the way it was done back in the 1950s when land was cheap these homes and their Lots originally sold for under 12,000 dollars today however nearby newer and much larger homes on the same size Lots are selling for well into a million dollars hence the opportunity Stephen also had gotten his start in real estate in single-family homes however his specialty had quickly developed into fixer uppers he looked for run-down homes that he could fix up and then resell at a profit while searching he came across the house on Maple Street it was a typical tract home for the area 50 years old rundown but on a huge third acre lot and surrounding homes had been scraped with newer mansion like buildings erected in their place the seller was asking $450,000 for the property to Stephen that seemed like an exorbitant price for a run-down 1000 square foot house however the seller also realized that the value was in the location and the lot not the house however the seller was hamstrung by the house it was on the lot and instead of adding value it actually detracted most buyers simply wouldn't consider it as a place to live at the listed price on the other hand they weren't willing to undertake the task of knocking it down and starting from scratch Stephen however had the entrepreneurial spirit he negotiated and eventually got the house for close to $400,000 then he had an architect draw up plans for a 3,200 square foot mansion he got the plans approved by the city and hired a builder to do the work it took less than a day to scrape the old house however its connections to city sewer and utilities were saved saving Stephen some additional hookup costs Construction took four months and when it was finished the new building had cost him $425,000 he had eight hundred twenty-five thousand dollars into the deal now he offered the property for sale at one point three million dollars and he got no offers the real estate market had taken another of its cyclical dips and high-end buyers were few and far between the house sat on the market for five months with Stephen making huge mortgage payments until he finally unloaded it for nine hundred seventy five thousand dollars he did make nearly seventy five thousand dollars after expenses however he could have made far more if the market had not turned and in the meantime he had many sleepless nights wondering if he would come out okay at all scrapers are one of the scariest types of land deals to handle they are best done by those who are already in the building trades contractors can save costs and handle construction for far less than an investor who has to hire it out thus a contractor's margins are lower in good times scrapers can be wonderful investments and I've seen investors rake in huge profits on them but if the market turned sour or costs are too high it's also very easy to lose land investments are great and are one of the many different types of investments you may eventually want to try your hand at just remember however that they are usually for those who already have had some experience in the field chapter 9 flipping properties whenever I hear the term flipping I'm always reminded of a fish out of water however flipping has nothing to do with fishing rather it's a term that came about because it characterizes the rapid turnover of a property flipping ownership it means selling a property right after buying it indeed it can mean never really taking title but instead making a profit by tying up the property and then quickly dumping it flipping becomes fashionable mainly when there's a hot market when properties are jumping up in value by rates of 10 15 sometimes 25% a year or more it's fairly easy to lock in a price and then resell for a higher price in very short order for example you may buy a house for $150,000 and in a hot market be able to quickly resell it for $175,000 if you're careful about how you do this and avoid most of the transaction costs you can pocket a quick twenty five thousand dollars in some cases of course the profit can be substantially more on the other hand in a more normal market with perhaps five percent price appreciation annually flipping is more difficult it's much harder to find a property for which the price will go up so rapidly that a flip is justified but for savvy investors who spend time looking bargain priced properties are available and flipping these does make sense in a cold market it's very hard to find a flippable property with prices declining it's simply very unusual to find a buyer who is willing to pay more than you did indeed most buyers want to pay less to flip real estate you need to follow certain rules these rules are not hard and fast but if you break them you could suffer rule one by lo the only way you can gainfully flip a property is to pay less for it than market price or buy it market and wait for values to rise you cannot make money by / market for properties or buying ones that do not quickly go up in value rule to lock in the low price by locking in a price you can resell for a higher price if you don't lock in a price then the seller can easily sell to the next person and make the profit himself or herself rule 3 have your rebuy ready a rebuy er is the person who buys the property from you since time is of the essence and these deals you can't lock up a property and then go out looking for a rebuy you must have one who is ready to act and that's how it's done no not really as will quickly see but those three rules form the basics of course there is one other consideration and that's to keep yourself out of trouble while you're flipping you do this through full disclosure you let all parties know what's happening that way there's less chance someone will come back later on and say he or she didn't know what was going on and hence was cheated what about flipping new homes have you ever seen lines of people waiting outside the sales office when new homes go up for sale this happens when the market is hot and there are shortages of homes did you think that all of those people were waiting in line to buy a home to live in if you did you were mistaken many of the people who wait in long lines to buy new homes are hoping to flip the property if there are 20 new homes being built and the demand is for 500 as has been the case in some areas over recent years that means that 480 people are not going to get a new home if you're one of the lucky 20 you can quickly sell to one of the unlucky others indeed sometimes people will even sell a good place in line if it's close to the front for hundreds or thousands of dollars to cut down on this practice some builders have taken to getting the names of people in line however it's usually easy enough to say that the person whose name on the list was simply a placeholder for the new buyer who takes his or her place what about flipping resales savvy investors are always on the lookout for properties that are for sale at below-market if they find them they tie them up and then quickly resell them sometimes the sales are from foreclosures or REO Zoar probates or just from sellers who want out quickly and are willing to take less what are the steps in flipping a property it's really not that hard to do the key is to lock in the price once you locate a property that's below market you present an offer that ties up the seller if the seller accepts you have a period of time in which to resell depending on how that offer was structured your time period can be anywhere from a minimum of about 30 days to a maximum of about six months you then bring in your rebuy er one who actually purchases the property who concludes the sale with the original seller the money transfer is all done in escrow the new buyer gets a mortgage and puts up a cash down payment in the usual fashion a portion of the purchase price goes to cash out the original seller and you get the difference usually in cash but sometimes in the form of a second mortgage for yourself there are two methods of accomplishing this assignment and options the option is the easiest to understand real estate options are not much different from stock options for the buyer they are an opportunity but not a requirement to purchase for a set price by some future date for the seller they are a commitment to sell usually for a set price by a set date the basics of an option are fairly straightforward first you locate the property and make an option offer if the sellers accept you next give them option money perhaps $1000 at minimum and they in exchange give you the right to purchase the property usually at a fixed price for up to a certain amount of time typically no more than six months or a year next you find a rebuy er someone who will purchased the property from you at a higher price this is the person whom you hopefully have ready to go finally you exercise the option at the low fixed price agreed upon by the seller and then sell to the rebuy er at the new higher price keeping the difference which is the profit in actual practice all of these moves are made simultaneously and the seller pays the normal sellers closing costs and the rebuy er pays the normal buyers closing costs with very few transaction costs left for you to pay and it really is that simple the key of course is finding the right priced property the right seller and the right rebuy er the right property is one that is either undervalued or in an area where prices are accelerating the right seller is usually someone who wants to get out and is strapped for immediate cash remember in order to get an option you pay the seller some money it can be any amount but it has to be enough to persuade him or her to give you an option a typical amount might be between five hundred and five thousand dollars depending on the value of the property the biggest problem with the option is the time factor the term of the option is negotiable usually options run from 30 days to six months but they can be for virtually any length of time the trouble is that sellers usually want out quickly and a seller who is willing to give you an option of more than 60 days is unlikely to be willing to also give you a good price in the past options in real estate were used primarily for properties other than residential they were used to buy land commercial or industrial buildings farms and so on they were used to allow the buyer time to obtain difficult financing for example or to secure a change in zoning or for some other similar reason recently however they have been increasingly used in residential real estate as part of a flipping strategy in these cases the time frame is typically very short less than three months and the amount of option money given to the seller is likewise usually small typically under $5,000 $5,000 how do I handle the paperwork for an option you can get an option document at most stationery stores or legal supply houses however you should take it to an attorney who will rewrite portions of it to suit your specific deal this is what the seller will sign to give you the option when it comes time to exercise the option you simply open escrow as if you were going to buy the property however your rebuy er does all the qualifying for the mortgage and puts up all the down payment and normal closing costs when the deal is ready to close your option is exercised for a moment you own the property but then it is transferred to the rebuy er it is all handled in escrow note while an option is not complicated there is plenty of room to make a mistake therefore certainly the first time you use it you should have someone experienced such as a good agent or attorney lead you through it yes that will cost more but in the long run it can save you a lot of headaches and possibly money another way to tie up the property without buying it is to use an assignment of purchase in this type of arrangement you make an offer to purchase usually for cash however when you make your offer you state that the buyer is your name or assigns what this means is that either you can buy the property or someone else to whom you have assigned the contract can buy the property later on you have your rebuy er step in and you assign the purchase contract to him or her your rebuy er actually gets the financing and makes the purchase and you pocket the difference between what you paid for the property and a higher price that the rebuy er pays getting a seller to agree to an assignment however can be tricky some sellers won't go along with them or assigns sales contract the reason is that they don't know who will eventually purchase the proper they are afraid that you might not be able to get a needed mortgage and want a back door out or that you're planning to sell your contract to someone else which is in fact the case and that person may not qualify for a needed mortgage in order to calm the sellers fears you may need to put up a bigger deposit or avoid putting many escape clauses into the contract which can increase your risks unlike the option the ability to assign the contract runs only as long as the purchase contract is in effect typically 30 to 45 days that means that you've got to find a buyer and conclude your other end of the deal very quickly hopefully you have done your homework and have a rebuy er waiting in the wings this person picks up the assignment and actually moves forward with the purchase of the property again you never actually make the purchase the transaction is basically handled in escrow at the end of the deal you get your money out typically in cash the advantages of assignment are the following you don't need to put in your own cash you have to put up only the original deposit when you buy the property from the seller and you get this deposit back from your rebuy er you can expect to get your profit out within 30 to 45 days you don't have to qualify to obtain a mortgage of course it's not all a bed of roses there are some risks you actually do commit to purchasing the property to protect yourself from having to complete the purchase in case you can't find a rebuy er or your rebuy er falls through you'll want escape clauses but escape clauses weaken your offer and lessen your chances of getting it accepted so to make the deal you may not be able to include many or any and have to take a big risk assignments have been used in real estate for a long time however as noted before you need to include lots of escape clauses in the deal in case you can't find a buyer in the short amount of time that you or in case that buyer for some reason can't complete the purchase how do I include escape clauses escape clause what's that an escape clause is one that says the sale and purchase are subject to or contingent upon something if that something happens you can gracefully without financial harm back out of the deal in modern transactions there are three widely accepted escape clauses that most sellers will agree to without blinking one disclosure contingency you must approve the sellers disclosures if you don't approve them there's no deal but the time limit here is very short in California for example it is statutorily three days and if the sellers disclose nothing wrong it's awkward to disapprove the deal two professional inspection you get to approve a professional inspectors report don't approve it there's no deal usually you have 14 days to get the report and then either approve or disapprove it and if there's nothing wrong with the property it's hard to disapprove of the report three finance contingency you have written into the contract that the deal is contingent upon you're getting financing no financing no deal and you're out without penalty this usually runs for 30 days but you must reasonably look for financing look for fun are there any big problems with assignments there's an inherent problem in using an assignment to flip a property it's simply that when most sellers discover that you're reselling the property at a substantial profit they're likely to be unhappy after all they could conclude what are you adding to the deal they feel that your profit should rightly go into their pocket never mind the fact that for whatever reason they couldn't get the price you're reselling for on their own if they could have they would what you're bringing to the transaction is your marketing expertise as a result you could have an angry seller on your hands who may refuse to sign off on the deal unless he or she gets more money or even worse wants to take you to court to avoid just this sort of confrontation it's important to inform the seller of what's going on remember even though it shouldn't make any difference what you do with the property after you and the seller agree on a price it's better to let the seller know upfront what's happening to avoid any problems later on should I disclose to the buyer - absolutely yes if you handle it wisely by letting the buyer know what you're paying for the property and getting confirmation that he or she knows on a signed statement there shouldn't be any problems indeed the buyer may be impressed with your real estate acumen and want to work with you on a future deal on the other hand if you conceal this information that you're tying up the property for a low price and reselling at a higher the buyer may discover it later on and think you were trying to pull a fast one and go after you keep in mind that most rebuy errs won't care that you're flipping or how much you're making on the deal just as long as they're assured they aren't paying more than market price if they see that they're getting a good deal they will usually be satisfied remember the right way to handle a flip is to be sure that all parties know what you're doing and get it in writing in case someone should later have an attack of memory failure what if I can't cash out sometimes it's hard to find a rebuy er who can come up with sufficient credit to get a mortgage at almost 100% or who can come up with sufficient cash to make a big down payment for a smaller mortgage therefore you may find that to make a deal it's to your advantage to get a second mortgage on a flip this works in the same way as described before for options and assignments however in this scenario when it's time for you to get your money out of the deal there isn't enough cash to make it happen so you give the rebuy er a second mortgage you then get paid so much a month until you get all your money back which usually happens a few years down the road when the rebuy er sells the property once again alternatively you could sell your second mortgage at a discount for cash in the early years of the mortgage however expect the discount to be very heavy as much as 50% because the buyer of the mortgage assumes the risk that the rebuy er of the property won't keep making the payments of course it goes without saying that you would want your rebuy er to be a good credit risk because if he or she defaults on the loan you won't get all of your money out of the second mortgage many investors age these second mortgages for six months to a year before selling them for cash aged mortgages have a much smaller discount should I always flip a property sometimes you'll have the option either you can flip the property or you can hold it what should you do the answer is that whenever you can flip a property do it don't hang on to the property the reason is simple for every flippable property you find you'll find a dozen or more perfectly acceptable properties that you can hold finding holders is easy finding flippers is hard further you need the cash that flipping can generate holding properties tends to drain cash away often there is some small negative cash flow and it can take years before you can get cash out of the holders in order to buy more properties there's really no big decision here if you can generate cash from a flippable property go for it you can always find a holder tomorrow when should I check with my attorney flipping properties is a great way to make quick money in real estate but it's loaded with pitfalls therefore be sure to check with a good real estate attorney before trying any flip as I said that will cost you a few bucks but it can also save you a lot of money and headaches in the long run chapter 10 earning profits from rentals if you're going to invest in real estate at some point you will have rental properties and you will be a landlord it will be up to you to find tenants collect rents clean up when tenants move out and maintain and repair the properties how well you do this will determine to a large extent how well you succeed in real estate in this chapter we'll go into the basics of what you need to know to be successful at rentals we'll see what makes a good rental and how to keep it profitable how to find a good rental property how to find good tenants how to keep good tenants how to profit from rentals how do I find a good rental property there are a lot of clues that you can look for to help you determine whether a home will make a good rental if the property has these attributes then chances are it will if it doesn't you'd be better off looking elsewhere look in areas with a plentiful supply of tenants in other words you should look in areas where there are jobs nearby to supply a tenant base also the type of workers should be suitable to the rental for example if you have a low income property and most of the local workforce consists of highly paid white-collar workers you might not find tenants easily similarly if you have blue-collar workers in the area you might have trouble finding tenants for a high-priced property the property should match the tenant base look in areas with a shortage of rentals ideally yours will be the only rental in the air obviously that's not going to happen but if there are too many rentals chasing too few tenants you'll have trouble check local newspapers for for rent ads to get a sense of the supply also visit a few of these rentals to learn what your competition is and ask a few real estate agents who specialize in rental properties what the rental market is like look for modern homes you don't want an older house that will require lots of repairs ideally the home will be under ten years old preferably under three and it should be in good repair when you buy it unless you're looking for a fixer-upper don't look for elaborate homes nothing fancy you want beige carpeting not white which is easily soiled and difficult to clean you want to avoid a swimming pool with high maintenance costs and lots of liability a smaller lot with less landscaping to keep up is better and so on look for homes that offer good rental incomes look for properties that offer a good ratio of rental income to cost this is tricky you want your monthly income from rents to come close to covering your expenses the only way you can do this is to avoid overpaying for the property which means that you'll want relatively cheap rentals by close to your home there's one last but vitally important criterion buy close to your home if there's only one thing you get from this book it should be don't buy rental properties far from home no more than half an hour away that's how important I think this advice is how do I find good tenants some investors complain that it's harder to find a good tenant than to find a good rental property I don't believe that's the case I've rented properties for more than three decades and with only a few exceptions always had good tenants the simple rule here is that if you check out your tennis before you rent to them you will avoid problems later on how do you check out prospective tenants you talk to them and get them to fill out a thorough rental application these are available in books that specialize in renting as well as from agents and attorneys the application includes permissions for you to run a credit check contact current employers and call previous landlords when people apply to rent a house or apartment from you there are five things to look for obtain a credit report don't expect that all of your tenants will have sterling credit indeed if they were wonderful credit risks they likely would be owners instead of tenants rather look for a history of making payments on time if the applicant doesn't make timely payments on other bills chances are the rent will be late too you can get a credit report by contacting a local credit bureau you can also have a local real estate agent run one for you remember you must have the applicants permission to do this check with previous landlords make this call and make sure it's not just to the current landlord who may be willing to tell you anything to get rid of a bad tenant most landlords will be unwilling to go into detail but one question almost all will answer is would you rent to this person again the answer can be very telling remember you should have permission to do this match the tenant to the property if you have a big house expect to rent to families with kids if yours is a small place be sure you don't get too many bodies in it also keep track of the number of cars and motorcycles that tenants have too many will clog driveways and can become an eyesore trust your instincts when you talk with prospective tenants how do you feel about them do they seem like people who will likely make the rent payments on and keep the place up or do they seem like vagabonds who are interested only in quickly getting in and then paying slowly or not at all and messing up your place I've found that heating my gut feelings is often the best way to predict tenant behavior verify their income a tenant who doesn't have a job probably can't make the rent payments no matter how good the credit report seems you'll want to call the current employer and verify the length of employment likelihood of continued employment and salary be sure your application signed by the prospective tenant gives you permission to make this call employers won't normally tell you an employee's salary but they will usually confirm a number that you give to them offer a clean rental in addition to the techniques mentioned before you'll also want to be sure that you offer a good clean rental this means that the walls are freshly painted or at least cleaned the carpet is without stains and dirt the appliances have been cleaned and so forth it costs only about $100 to have a professional cleaning crew make a place spotless in just a few hours the theory here is that if you have a dirty apartment you won't find a clean tenant who will want to rent it rather the only people who will rent a dirty apartment are tenants who won't keep things clean the way to find a clean tenant is to start out with a clean rental it will appeal to the right kind of tenant for you how much should I charge it's a good idea to charge a little below the prevailing market rates for example if rentals similar to yours are going for $1,000 a month rent yours out for nine hundred and fifty dollars obviously you're going to rent faster because of the cheaper rent but you'll also appeal to those tenants who are savvy about the market and know a good thing when they see it in other words a rental at slightly less than market often attracts a better tenant you can find out what similar properties are going for by becoming a pretend tenant for a weekend check out the rental properties in your area by going to see them talk to the owners you can identify yourself as a landlord most other landlords will be happy to chat should I ask for the money up front first time landlords are sometimes hesitant about asking directly for their rent don't be you're in the business of collecting rents and you can't be shy about it this is particularly the case when you're selecting a new tenant I always ask for a substantial deposit the deposit should go toward both the cleaning of the property after the tenant leaves as well as to maintain the security of the rental in case there's damage or failure to pay rent there's much confusion about deposits technically in most states the money you receive from a cleaning deposit is yours to spend when you receive it however when the tenant moves out you're under an obligation to pay it back provided that the tenant leaves the premises reasonably clean and without damage the problem that many landlords get themselves into is that they spend the deposits as soon as they get them then they don't have the money on hand to pay back the tenants when they move out often landlords in this situation try to re rent quickly and get a new deposit from a new tenant in order to repay the old this is a kind of trap that's best to avoid even if not required by the state I always keep tennis deposits in a separate account ready to return to them when required how big should the tenants deposit be the answer is as big as possible but more money the tenants put up as a deposit the more responsible they are likely to be they will always be eyeing that big deposit at the end of the tenancy anticipating getting it back many states however limit the maximum deposit amount sometimes to one and a half or two times the monthly rental in addition there's also a limit to how much you can reasonably expect a tenant to come up with for example if your rent is $1,000 a month and you demand a $2,000 cleaning deposit that's $3,000 to move in you simply may not find that many tenants who have that much cash available thus you may find that you're charging a smaller cleaning deposit in order to attract tenants again always ask for the deposit up front never allow the tenants to move in without paying all of it a tenant who moves in having paid no deposit or having made only a partial payment will feel less pressured to look out for your premises the deposit is your leverage and you don't want to lose it also always get the first month's rent or first and last if you are using a conventional lease upfront don't let the tenant move in with a partial payment the reason for getting the money upfront may seem obvious until you've been a landlord for a while and a future tenant pleads with you to accept partial payment he or she may owe $2,500 to move in but only have one thousand two hundred and fifty dollars won't you please accept the $1,250 with the rest promised in only a week or two no don't do it a tenant who can't pay all the move-in money upfront likely won't be able to make the monthly payments as they come due this is an important rule not to overlook how do I keep good tenants you keep good tenants once you have them by making them happy that may sound difficult but it really isn't here are some easy to use guidelines that really do work stay out of their hair yes come by once a month to collect the rent unless they mail it in advance and check out the property but don't be there more often they've rented the place and are entitled to quiet enjoyment of it no tenant likes a Snoopy landlord and many will move out if you're too nosy leave your tenants alone for the most part and you'll do well of course this applies only to the tenants who pay well and keep the place clean it's a different story for bad tenants always take the tenants calls usually tenants don't want to be your bosom buddy so they will call only when there's a problem but when there is a problem they want someone else to be on the other end of the line you can maintain an answering service an answering machine or even a cell phone but be sure that when the tenant calls either you answer the phone or get back to him or her in a very timely fashion fix problems fast when the tenant calls it could be a leaky faucet a broken window a stove that doesn't work a dishwasher that spills water on the floor or anything else what you must do is quickly determine if it's the property's fault or the tenants fault and usually you can't do this unless you zip out there to take a look remember you bought close to home right once there if it's the tenants fault explain that you'll have it fixed right away but they'll have to pay for it the money will come from their deposit but then they'll have to pay to bring the deposit back up to its full level if it's the property's fault such as a broken hot-water heater tell them you'll fix it at your cost and fix it immediately within hours while you might be willing to stay in a house without hot water or whatever the problem is tenants who are paying rent won't they expect things to be fixed as soon as humanly possible and unless you want to lose them you'll see that it's in fact done just that fast make regular upgrades to the house fixtures and features things where out carpets get holes in them paint fades and gets dirty none of these things are the fault of the tenant they're just wear and tear caused by normal living and you should plan on upgrading your rental over time some landlords do this every five years some every three some every seven the whole idea is that if the tenant moves out because the places rundown due to your lack of maintenance it's going to cost you more money in advertising lost rents your time and so on then if you had fixed it to begin with and for a new tenant you'll need to spruce up the place anyway therefore spend the money and keep the existing good tenant avoid being an arrogant landlord what many unsuccessful landlords do is become arrogant they feel that because they are the property owner the lowly tenant should bow before them sort of like saying the tenant should be grateful to the landlord for providing a roof over his or her head that kind of thinking may have prevailed during the Middle Ages but it has no place in modern day life rather the landlord tenant relationship is one of mutual benefits you provide the housing the tenant provides the rents neither is superior in some strange way to the other if you don't like the tenant you can ask him or her to move you can also raise rents if the tenants don't like you or the rents you charge they can move elsewhere in short tenants and landlords need each other if you can remember that it's strictly a business arrangement you'll do better as a landlord how do I profit from rentals as we've seen profits from real estate usually come from selling for more than you paid inflation and shortages in the supply of housing and other types of real estate forced prices up and that allows you to make your profit however there's another way to make money in real estate that we've only touched upon and that's by collecting rents when your rents are higher than your total expenses you have positive cash flow as that increases and you put more and more money in your pocket you begin to make money from your rentals generally speaking when you buy a property you lock in your expenses an exception would be if you have an adjustable rate mortgage with which the interest rate and the monthly payment can fluctuate you do not however lock in your rental income over time it should go up at least a match inflation and if there's a shortage of rental property in the area to beat inflation the way you take advantage of this is to raise rents when do I raise rents you raise rents when you can justify it given the rental market note I didn't say you raise rents when you need more money or when you have unexpected repairs or when you think the tenant deserves to pay more all these are irrelevant to your rental rate the rate of rent you can charge depends entirely on what other landlords are charging for rents in your area when rates go up overall you can raise yours too how do I get rid of bad tenants bad tenants usually fall into two categories either they pay late or don't pay at all or they make a mess of the property chronic behavior of one or both types suggests that you may be better off without the tenant sometimes you simply want to get rid of a tenant to put yourself in a better state of mental health if you have a month to month tenancy normally a 30-day notice to move is all it takes with a lease however the tenant has the right to keep the property as long as the conditions of the lease are met until the term is up often a year or more to get rid of a bad tenant in a lease you may actually have to pay them off this could mean giving them several months rent to move out you'd only do this for a tenant you really couldn't stand of course the ultimate way to remove a tenant who won't pay is eviction this involves an unlawful detainer court action you'll need an attorney at least the first time you try it if you mind the store and raise rents when appropriate keep good tenants and get rid of bad ones over time you'll find that your rewards in the form of positive cash flow from your rental property will positively amaze you eleven identifying tax advantages and real estate investments if you make a profit you'll probably have tax to pay on it it's just that simple however you may not have to pay that tax right away or ever depending on how you apply the tax code in this chapter we'll take a look at real estate taxation special note what follows is not tax advice it is simply an overview of some of the federal tax rules affecting real estate investment property for tax advice you need to consult with a tax professional such as an accountant or tax attorney calculating depreciation if you own investment real estate you can depreciate it when you depreciate real estate you consider a certain percentage of its cost we'll talk more about cost later each year as a reduction in the value of the property almost all business assets can be depreciated cars for example are depreciated over a lifespan of five years in a straight-line method you might take 20% a year of the cost of the car each year over five years as a loss of value residential real estate must be depreciated over twenty seven point five years again using a straight-line method equal parts taken each year you would take one twenty seven point five of the value usually the purchase price plus transaction costs less the value of the land each year as a loss of course the value of property goes up not down so how can you take a loss on an asset that's increasing in value a helpful way to understand this is to think of it as a paper loss most assets deteriorate over time even a house will eventually fall away to dust so instead of simply waiting until the end of its useful lifespan arbitrarily decided by the government you take a portion of the loss in value each year but you may reasonably wonder while the house will eventually deteriorate the land never will how do you depreciate land costs the answer is you can't you can depreciate only the building not the land the only exception would be land that had an asset that was depletable such as gas or oil and that's not the case here is depreciation an expense yes it is as you will hear in the following list it's an expense like your other rental property expenses typical rental property expenses mortgage interest taxes insurance water service garbage service maintenance and repair fix up advertising pool and garden services depreciation if you keep track of your rental property expenses on a monthly basis it is a simple matter of adding them up at the end of the year to figure out your tax situation to do that you subtract your total annual expenses from your total annual income and the result is your profit or loss does depreciation contribute to loss it certainly does as soon as you begin to look at properties out there in the real world you'll come to realize that there are a few properties for which the income comes even close to paying for the actual cash expenses when you add the paper loss of depreciation to your cash expenses you almost always find that there's a loss for the year once depreciation is subtracted there is almost always a loss as a result at least on paper an income generating property that actually shows a positive cash flow more money coming in than cash expenses going out turns into a big loser as soon as depreciation is subtracted from the income how does depreciation reduce the tax basis of the property earlier we said that depreciation reduces the cost of the building by a certain amount each year the cost we were referring to is the price the owner paid to buy the building and that price is used as a starting point for computing the tax basis other costs that are considered part of the tax basis are such expenses as closing costs once the tax basis is established for the property it is used to determine the owners profit or loss on the property over time if the owner sells the property the selling price is compared to the tax basis to determine whether the owner had a capital gain or loss the tax basis as we said for most assets including real estate property is their cost however with real estate other considerations can affect the basis for example you have to pay substantial transaction fees when you buy property most of these fees are added to the basis if you were to build an addition to the home the cost of the addition would also be added to the basis understanding the tax basis is important because it and the sales price determines the capital gains tax you'll have to pay when you sell your capital gain on the property is the difference between the adjusted tax basis and the sales price how were capital gains treated in the past in decades past anyone regardless of his or her income could write off losses on real estate what they were actually doing however was converting their ordinary income to capital gain income because income from capital gains was taxed at a lower rate than ordinary income the preceding explanation went by rather fast so let's take it again a bit slower let's consider just one year in that year the property sustained a loss of $7,000 primarily from depreciation that $7,000 was then deducted from the investors ordinary income that meant that the investor avoided paying ordinary income taxes read at a high tax rate on $7000 then the very next year that property sold and it showed a $7,000 capital gain attributable to depreciation the investor then had to pay tax on this amount however because it was a capital gain as opposed to ordinary income the tax rate was lower thus the great tax shelter benefit in real estate was that it converted ordinary income to capital gains which were taxed at a lower rate what about seller financing some of the best financing for an investor actually comes from sellers sellers often don't care whether or not you intend to occupy the property or rent it out indeed many simply don't ask further sometimes sellers are eager to give the buyer financing if you find a seller in this position you can get some surprisingly good financing deals why would a seller want to finance a buyer one reason a seller would want to finance a buyer is that the seller is having trouble selling the property he or she hopes that by offering the buyer financing the sale will be quick in this situation the seller often anticipates that the buyer will have some credit problems else why wouldn't the buyer get institutional financing and is prepared to accept it thus if you can't get an institutional loan for one reason or another seller financing is probably your best alternative interestingly seller financing is often so good that many very successful investors buy property only when they can get seller financing a second reason that sellers might want to finance a sale is that they are looking to invest their money in a bond of some type that will pay them a higher interest rate like a mortgage this is particularly the case with older sellers who may have paid off or nearly so their original mortgage if they get cash for the sale of their house they might want to avoid the risk of other investment vehicles preferring instead to simply stick their money in a bank or in a CD and collect the interest however a mortgage typically pays higher interest so they are thrilled if you give them a mortgage instead recently banks were paying under 2% interest while home mortgages were paying close to 7% a real incentive for a free and clear seller to opt to handle the financing are other types of financing available the first rule in real estate is that everything is negotiable and the second rule is that creativity pays so yes there are all sorts of other types of financing available for example I've seen family financing a son or daughter may want to buy an investment house they have the income to handle it but not the cash so the parents popped for the down payment and closing costs then they share ownership typically the son or daughter will handle the management of the property and when it's time to sell the family will split up the profits this system of course is not limited to families it will work with friends or even perfect strangers however a word of caution put everything in writing people even friends even close relatives often forget what was said months or years earlier when it's time to sell you want to have in writing exactly how the profits or if something goes wrong the losses are to be split up further you want to be sure that there are solid escape clauses allowing you or another party to exit the deal if situations change for example you could lose your job or your sibling friend or son or daughter could need to move out of the area all of which is to say that if you intend to use any type of shared financing spend the bucks to have a good attorney draw up a rock-solid agreement it won't cost that much and it could save lots of hassle and money later on asset based financing yet another type of financing is to borrow not on the property you are buying but on other property such as stocks or bonds that you already own the advantage in securing this type of financing is that you can obtain loans at very low interest rates often through stock brokers and banks another financing method that experienced real estate investors frequently use is to borrow on property they already own in order to make a new purchase for example you may have three rental homes and which you have substantial equity you can refinance these properties either with individual loans or with a blanket loan on all three and use the funds to buy a fourth house if you've ever played the game Monopoly you already know the basics of how this method works other financing as you can see the types and sources of real estate financing available to you as an investor are limited only by your imagination don't feel boxed in by rules you imagine exist if you can come up with a creative idea try it it just might work be creative but have a plan and before you take action talk it over with a financial adviser such as a good real estate agent tax attorney or accountant this is William de fries for mcgraw-hill audio thank you fruit and redwood audiobooks and is based upon the book entitled how to get started in real estate investing copyrighted in 2002 in the name of Robert Irwin all rights reserved published by arrangement with the mcgraw-hill companies incorporated [Music]
