Here are two fallacies that often strike new real estate investors.   The first one bugs me only a little – the second one bugs me a lot. 

The first fallacy is the one peddled by late-night infomercial stars.  It’s the idea that it’s really not that difficult to find an old house, buy it for much less than it’s worth with no money down, and sell it for big bucks.   It’s true that some deals of this sort do happen, but they’re very rare.  If you start your real estate career thinking you’re going to get 50 deals like this on the way to that new Bentley, you’re actually on a fast track to disappointment.  (And if you really have done 50 deals like this – and have documentation, and don’t charge $1 million for people to see it – call me!)

The second fallacy is much more insidious and hits people who are much too smart to be fooled by the first one.  I’ll call it the Every Dog has its Day fallacy.  This means that any property you buy, no matter how big a loser, will eventually make money for the owner.  This view is underscored by two other views, both also erroneous:

1. All real estate rises in value over time.
2. When you own rental property, your rents go up over time, while your expenses stay the same.

We know in our hearts that this assumption is wrong, but still fall for projections that show it.

It’s certainly true that most real estate rises in value over time.  However, that’s not true everywhere.  I’ll give you two examples: Detroit, Michigan, and Buffalo, New York.  Right now in Buffalo, there are almost 800 houses listed for sale for $50,000 or less.  45 of those are listed for less than $10,000. 

 Why do you think Buffalo might have these wonderful deals?  It’s because Buffalo has been one of America’s fastest shrinking cities over the last 50 years.  The population is less than half of what it was at Buffalo’s peak in 1950.  This, coupled with the reason for the decline (there are no jobs to be found), has resulted in a huge drop in real estate values over decades.  Almost anyone who put their money in Buffalo over that time lost much of it.  By the way, this also means Buffalo rents dropped over the past few decades, so those Buffalo investors lost money every year on their way to eventually selling at a loss.

Detroit is in a similar way, with 6,900 homes for sale for $50,000 or less; 3,200 for less than $10,000; and a population less than half what it was in 1950.  Detroit’s motto, translated from Latin, is “We Hope For Better Things; It Shall Rise From the Ashes.”  I sure hope they are right!

This extraordinary hovel can be yours for $100 in Detroit.  Make an offer!

Thankfully, there are few true disasters like Detroit and Buffalo around the United States, although there are many cities where prices have risen only a little, stagnated, or dropped even before the real estate and mortgage crashes.  Even elsewhere, however, you might lose money over time because of the “expenses never go up” assumption.

 Suppose you buy a property for $100,000, with rents of $1100 per month.  Your expenses are as follows:

·         Monthly mortgage payment: $480

·         Insurance: $75

·         Taxes: $200

·         Allowance for maintenance: $100 (0.1% of purchase price)

·         Allowance for vacancies: $55 (5% of rent – assumes a 5% vacancy rate)

·         Utilities: $100

·         Legal, accounting, mileage and so on: $50

Obviously these numbers are going to vary widely for different properties.  It’s worth noting, however, that poorer communities usually have relatively high property tax rates.  They have to provide the same services as wealthy towns but with smaller tax bases.

For this example, however, your monthly expenses are $1060, which means you’re making a profit!  Congratulations!  It’s a very small profit, but should be much higher a few years from now because according to the second assumption, your rents are going to rise, and your expenses will stay the same.  Five years from now, your rents will be more like $1300, which means you’ll be making $240 per month in positive cash flow, which is excellent.  And, of course, you’re building equity.

So many new investors fall for this.  The truth is that every one of those expenses is going to go up except for the mortgage payment (assuming a fixed rate loan).  If they go up by more than about 9% per year, your monthly profit will decrease, even with inflation in rents.  And that can certainly happen.  In particular, property taxes, utilities (mostly heat and water/sewer, the two utilities most often covered by landlords), and insurance have all risen by 10% or more in many communities over the last five years.

The pinch will be even greater in communities experiencing rent stagnation or deflation.  If your rents stay the same and expenses go up even a little, your profit will fade and disappear.

That equity growth that was going to save your bacon?  That won’t happen, either.  If your monthly cash flow stays the same or decreases over a five-year period, your property will be worth about the same, or even a little less, at the end of that time.  Yes, you’ll have added a bit of equity through the principal portion of your mortgage payment, but not enough to make a major difference.

None of this is intended to turn you off real estate investing.  Many thousands of people have done very well with their property investments – yes, even some in Detroit and Buffalo.  They avoided losses by being very, very careful about where they bought.  They looked for towns and states that were growing, particularly in employment, a leading indicator for housing growth.  They avoided towns with a history of high property tax increases.  They looked for houses in neighborhoods where people wanted to live.  And, they sought out properties where they could reduce expenses by taking responsible steps to lower maintenance, utility and insurance costs.

Finally, they made sure they could sell on their terms by making sure they had enough cash to handle emergencies and daily living.

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Tags: equity, housing, inflation, landlord, rental-property, stagflation, tenant

With the Dow Jones Industrial Average having seen a steep decline along with most other major US and international stock indices, many American investors now are in despair about where they should position their investment capital. Meanwhile, the savings rate for American consumers has never been lower. As the credit markets continue to tighten and people have less access to spending cash this could further hamper an economic recovery.

The US government seems intent on doing everything possible to save the banks that are too big fail but they are also funding the high flying lifestyles and big bonuses of the Wall Street executives at the same time. For example, according to a Bloomberg report “Morgan Stanley has accrued $10.7 billion of employee- compensation expense this year, almost twice as much as its pretax earnings. The vast majority of this remuneration hasn’t been paid yet. Now it probably will be, assuming the firm survives through next month.” The outrage over tax payers funding the bonuses of reckless Wall Street traders with US taxpayer dollars should, in my opinion, be much more vocal.

It is one thing to raise a voice in a blog or to make a change with your vote in the presidential elections but I believe a much more effective means of protesting reckless corporate behavior is not to invest in the companies with your own money. An alternative to buying stocks from Wall Street is to invest directly in Main Street. There are numerous ways to invest directly in Main Street. One investment idea that is gaining in popularity for many is the purchase of an apartment building. It does make a lot of sense to have your money invested in a hard asset during times of inflation and economic uncertainty.

Here are some popular Main Street real estate investments along with their potential rewards and risks.

Buy a residential home and rent it out:

Rewards:

Prices of residential homes have declined dramatically over the last 12 months. You should be able to get a good deal. There are many foreclosures and bank auctions to chose from.

Risks:

Prices could continue to fall. Tax rates for residential homes in many areas are very high. Continued residential foreclosures could cause prices to remain weak for an extended period of time.

Buy land:

Rewards:

Land prices in many areas have remained somewhat constant. If you purchase land in a rapidly growing metro area you could see great appreciation.

Risks:

Raw land does not produce any income. Land is notoriously illiquid. This means that you may have to wait a long time to sell it when you need money. Prices of land increase and decrease rapidly. There is a lot of volatility in land prices.

Buy a shopping center:

Rewards:

Top national chains can be a source of predictable and stable income.

Risks:

It can take a long time to replace a commercial retail tenant. When you have a vacancy you still have to pay your taxes and insurance. More and more sales are taking place online. The future for commercial real estate in the retail sector looks very weak.

Buy an apartment building:

Rewards:

Apartment building investments can show a steady rate of return with stable base of renters paying monthly rent.

Risks:

If the economy continues to weaken many jobs will be lost. There will be an increased number of people who are unable to pay their rent.

Photo Credit: ckubber

Tags: apartment building, Economy, housing, main street, real estate investing, rental-property

What Make A Good Renter?

Is a good renter someone with great credit, or large deposit or maybe  high income?  The approach landlords take in qualifying their renter could be changing because of the housing crisis and the large number of foreclosures.

The main objective of renting your home should be to have a qualified renter that will pay rent on time and take care of the home to some degree.  Large deposits can maximize renters responsibilities to the care of your home, but what can be done to help minimize renters late pay or simple non payment and evictions.

The qualifying approach I encourage landlords to take is one similar to underwriting a loan.  The question that everyone should ask themselves before renting their home. Can my renter make the payment on a consistant basis and how?  This question is always answered by employment.  There are a number of way to increase the odds of finding a good renter just by looking at their employment.

Time on the job - The length time at the current employer is the first thing you should look at.  If a potential renter has been employed for a number years this helps build a case that consistant income can help provide for timely rental payments. 

Proof of income - Not only knowing where your renter works, but knowing exactly how much he makes is very important.  It is not out of the question to ask for the last two paystubs and last years W2’s.  While this may seen extreme, you have answered two critical questions.  Does your renter really work and how much do they make.

Debt to Income Ratio - While pulling credit can give you an idea of credit score and repayment history, how are you going to judge individuals that have gone through foreclosures and bankruptcies.  Sometimes a bad borrower is a bad borrower and you need to decline them for your rental,  but in today’s market place you will find more good renters with bad credit than ever before.  My suggestion is to look at credit, income and employment and determined a debt to income ratio .  This will illustrate whether they have sufficient income to cover their rent and debts.

This process is very similar to qualifying for a home mortgage.  It is up to the landlord to develop their own guidelines as to what is acceptable to their market place.  This is a very simple process to help increase the odds of a good renter - check employment, have proof of income, and determined debt ratio.

Tags: Credit, debt, employment, income, landlord, lease, rental, rental-property, renter, tenant

Okay, I’m not going to post all of my tenant rules here (although I will if commenters want to know).  This is more about why tenants need rules, why I have many more rules than most landlords, and how I enforce rules with a minimum of pain.

The TV That Woke Me Up

When I started landlording, I did what most of us do - grabbed a sample lease off the Internet, plugged in a few additions that made sense to me, and hoped for the best.  I realized the magnitude of my mistake one night as I was standing outside the building.  It was brought home to me in color.  Well, ex-color.  An ex-color TV that one of my tenants had left on the street in a forlorn hope that the city’s recycling center would take it away.

Now as homeowners, we know that just won’t happen.  Cities don’t take a lot of items in their recycling pickups, usually because those items may contain hazardous waste.  But the tenant didn’t know that - just like tenants often don’t know that leaving food waste in open bags attracts animals - or that when you play Led Zeppelin loud at midnight, not everybody in the building appreciates it - or that junk cars in the parking lot are less than attractive.

So why are tenants often so clueless?  One likely answer is inexperience - they may not have lived in apartments before.  Others are just not very swift.  In any case, the solution is rules - lots and lots of rules - combined with unbending enforcement.  Here are some rules for rules.

1. Give each tenant a separate copy of the rules and include the rules in the lease by reference. This means including a lease clause to the effect that the tenant must comply with all rules; that the tenant will be charged fines for some violations, and that other violations will be grounds for eviction; and that the failure to pay fines is also grounds for eviction.
2. Be specific in your rules. It’s not enough to say “Don’t throw out hazardous waste materials in the trash.” You need to spell out which items are unacceptable.
3. Don’t nitpick with ridiculous rules. I once knew a landlady who insisted that window shades needed to be at the same level for each unit in the tenant’s apartment. Her tenants almost never renewed their leases.
4. Go through the rules, one by one, when you take the application. Make sure the prospective tenants know that almost any landlord will also enforce these rules.
5. Watch out for rules that make sense to you, but are not legally enforceable. Some landlords do include unenforceable rules, hoping they can intimidate tenants into following them anyway. These landlords are breaking the law and may be fined or sued.
6. Although state and local laws vary, they typically do govern such things as occupancy limits (so many residents per bedroom), eviction proceedings, security deposits, and limits on visitors.
7. Be reasonable with your fines. A $100 fine for key replacement is likely to be thrown out in court. A $100 fine for disabling a smoke detector probably will not. What’s the difference? Key replacement is mostly an inconvenience for you – it costs you time and money to make the keys and get them to the tenant. On the other hand, a disabled smoke detector is a hazard that threatens the lives of everyone in the building.
8. Be reasonable with your eviction penalties. In this economic environment, we are all struggling to find qualified tenants. Do you really want to throw somebody out over a minor infraction?
9. Remember that you can only change rules in the middle of a lease with the tenant’s agreement.  That’s one reason to make your list comprehensive from the start.
10. Make frequent drive-bys in the first few weeks to make sure your new tenants are following the rules.  If you cut the tenant somee slack for the first infraction, make sure the tenant knows you spotted the problem and he’s getting a one-time break. The second time you must charge for the infraction.

Tags: landlord, landlording, rental-property, tenant, tenant rules

Very early on in my investing career I received a great lesson in rental property ownership.  In the early 1990s I saw the potential for the Las Vegas market and decided that it would be a good idea to have long-term investments in the area.  At the time there were about 5,000 people moving there each month and builders were adding new housing at a furious pace.  There was a good supply of resale homes and the rental market was strong.  I was looking for future appreciation as opposed to immediate cash flow.

I lived in New York at the time and I would be investing long-distance.  I did have connections in the area and I received recommendations for real estate agents and a property manager.  I knew that investing outside of my local area would have some challenges and I was prepared to accept that.  Further complicating matters was the fact that I was taking on investment partners.  I did have partnership papers drawn up and everything was clearly spelled out. 

One of the major advantages of investing in the area was that there were an abundance of newer homes with FHA mortgages, at the time these mortgages were fully assumable.  With partners putting in cash, I was able to acquire properties fairly easily.  My plan was to acquire two properties and see how things worked out.  If it went well I would look to acquire additional properties.

The Good House

After several trips to the area and looking at dozens of houses, I located a property that met my criteria.  It was a 3 bedroom, 2 bath house in an excellent neighborhood.  The only work it needed was to have the carpets cleaned.  The purchase was smooth as could be due to the assumable mortgage and there were absolutely no complications with the closing.  My property manager began looking for tenants right away and had located and qualified a young family that would be ready to move in almost immediately after we closed escrow.

I had purchased the house for just over $100,000, including all closing costs.  The rent was enough to cover the mortgage, taxes, insurance, management fee and an allowance for repairs and maintenance.  After everything I was left with about $150 per month which was added to the maintenance fund as well.  The tenants were absolutely perfect.  There was never a problem, they paid the rent on time, and the house was always immaculate.  They stayed there for five years until a job transfer caused them to move. 

The House of Horrors

We all know of parents who have a child that is so good that they can’t wait to have another, then Damian arrives with his Omen.  House number two was like that for me, if it had been house number one there would not have been a number two.  The second house was located in a different part of Las Vegas, but still in a good area.  The owners were desperate to sell and I was able to make a fantastic deal.  I was expecting to get even better cash flow than house number one.  It was also going to be a mortgage assumption so I expected a quick close.  My property manager began looking for tenants and had a family ready to go fairly quickly.

Then the fun began.  There were problems with the assumption because of missing paperwork and there were some title issues as well.  It took several weeks longer to close escrow than anticipated.  The tenants that were going to move in couldn’t wait and rented a different house.  We had to return their deposit because we couldn’t deliver the house when promised.  My property manager started looking for new tenants but was having a hard time finding anyone who qualified.  We eventually settled on someone who was looking for a six-month lease.  Big mistake.

The rent was constantly late and we had to file a notice to evict more than once, but they always paid before we could throw them out.  They left at the end of the six month term but left the house a shambles.  The carpets were ruined, holes in the walls, banister torn off the stairs and numerous other problems.  We kept the security deposit but that wasn’t enough.  They also moved without any forwarding address and we decided it wasn’t worth it to track them down.

After making several thousand dollars in repairs we rented the house again.  The next set of tenants were a problem as well.  They were constantly calling with one problem or another, rent was always late and rent checks bounced.  They left at the end of the lease and we rented again.  Problems again even though all of these tenants went through a screening process.  Because of extended vacancies, excessive repairs, eviction costs and other expenses this house was always losing money.

Lessons Learned

My partners were so fed up with that second house that they insisted on selling.  I can’t say I blamed them, but my preference was to hold on.  We did wind up selling house number two at a minimal profit after five years.  After taking into account all of our costs over the years, we made a profit of about $5,000, that amounted for about a 1% annual return.  Certainly not worth all of the headaches.

We also sold house number one at this point, a better result but not a home run by any means.  That first house netted a profit of just over $30,000 plus five years of positive cash flow.  When we calculated everything it amounted to about a 6% annualized rate of return. 

The end result was that I learned an incredible amount about owning rental properties and about long-distance investing.  It was also a lesson in working with partners.  I have invested with partners since then, but I am never eager to do so.  The rental property business is not an easy one but I have applied what I learned and my expectations are much more realistic now and the results have been much better.  These were not lessons that I could have learned any other way.  No book, course, guru or mentor could teach me as much as owning these rentals did.

Sometimes adversity is what you need to face in order to become successful - Zig Ziglar

Tags: las vegas, real estate investing, rental-property

I guess it’s a philosophical difference. I know several investors who have a bare-bones approach to getting rentals ready and maintaining them. I see their point because they are looking at it as a revenue generating object. Maintain just enough to protect the object and the investment.

On the other hand, I tend to go in the other direction and perhaps do too much to get a property ready and maintain it. But here’s the deal: my philosophy is to increase value and attract better tenants and keep them satisfied.

I don’t know if I’m right, but there is method to my fix-up madness. I want to attract a tenant who will be pleased with the house. I also have this idealistic notion that people will take better care of the property if they see I care about the property. Okay, you can quit snickering now.

Here is a list of reasons why I go a little overboard on fix-up and maintenance.

1. I want the tenant to know that I care about the property and that it means something to me.
2. I want the tenant to be proud of where they live.
3. I want the property to be much more valuable when I sell it than when I bought it.
4. I want to get a reputation of renting good homes in good condition and keeping them maintained.
5. I want to be respected as a landlord and attract tenants through word of mouth.
6. To minimize turnover and vacancy.

However, I do see that doing too much can negatively affect return on investment, so I have learned from other investors how to be frugal and not throw money away on vanity and a overdeveloped sense of aesthetics. Like everything else, I guess it’s about balance, but I tend to go more in the direction of doing more rather than less in hopes of getting a better return in the long run. Naive? What are you, and over-doer or an under-doer?

Tags: income property, landlord, real estate, real estate investing, real estate investor, rental, rental-property, tenant

Not too long ago I went to a neighboring town to check out an investment possibility for an investor I work with - rental subdivisions. The owner had built these homes in a college town 15 years ago and they were all basically the same style, cottages — some 2/2, some 3/2, 1400 sq ft and 1600 sq ft, respectively. This particular deal didn’t work out because the owner wasn’t budging on price and the numbers didn’t quite work out — I think he was basically satisfied to sell them one by one unless he could get his price for all of them, but it got me to thinking.

If it’s true that rentals will increase for awhile because of buyer caution and lender tightening, these, what I call rental villages, might be a good investment. Two reasons I think they might be a good investment are lower construction costs in this market and lower land cost. I looked online and found a cottage design that to me would be perfect — attractive and not too difficult or costly to build — and with the same basic design throughout the village it would be more efficient. My one concern was when you go to sell would all the cottages being basically the same style hamper sales.

The owner of the ones I looked at had already sold half of what he had, about 64 units, so it didn’t seem to hamper his sales. They were all painted in different colors (or not the same side by side) with minor differences among them, so they didn’t all appear to be the same house. It was actually an attractive “village” with nice trees and shrubbery about.

My thoughts were that a rental village of single-family homes would be more attractive to renters — I mean, if you are going to rent, why not rent in the best living environment possible. Most people don’t like apartments and the available rentals of single family homes is sort of hit and miss, at least here. I know that the vertical building of apartments is more cost effective because of land and construction costs of single family homes, but I looked at the prices of land slightly outside high priced land in town and they were attractive. I also think that when an investor goes to sell after holding them for awhile and letting the market improve, he/she might do better selling individual homes rather than one apartment building.

I think the key would be to make the village attractive with a common social area. I also think it would be wise to keep the properties in good condition and allow them to appreciate by putting the necessary money back in from cash flow to keep them updated and maintained. The owner I previously mentioned was getting top rent in his area and had such a demand he could pick and choose the most qualified renters who met his strict requirements. He had worked out sweet deals with businesses in town when carpet needed replacement or a paint job was due or appliances needed changing. He also had worked lease/purchases with some of the renters who needed time before purchasing.

I have put together a proposal for the investors I work with and wanted to pass this along. The numbers look good. The key is to be in an area where appreciation is likely to return in a few years. That’s the risk.

Tags: landlord, Learn Real Estate, real estate, real estate investing, rental village, rental-property, single family homes