All Forum Posts by: David Beard

Just curious, Max, what is the rate on the 7 year ARM currently, and what are the bank fees (origination points, processing, underwriting, the fees other than those paid to 3rd parties)? Does it have a 30-year maturity as well as 30-year amort? When it start to float, what is the index and margin? Is there a floor rate below which it can't go? Will they finance rehab expenses?

If they also have a 5/1 ARM and 3/1 ARM, what are the rates on those?

Sounds odd. I did one 60 days ago, and close on another next week (with US Bank). Are you sure they're not referring to the 90 day owner title seasoning requirement, meaning that whoever you buy the property from has to have been on title for at least 90 days? This is a so-called "anti flipping" rule.

Although if the housing agencies are trying to put speed limits on investors, it wouldn't surprise me.

The vast majority of professional fund managers fail to beat the market, with super-computers, access to CEOs, and all the data on the planet at their disposal. To think that the little guy can beat the market consistently over time seems extremely unlikely.

It seems pointless to me to talk about "what if" you'd invested in Google, WM, Apple, Fed Ex, Microsoft, whatever. You'll never know more about one of these businesses than professional fund managers. If you made a mint on one of these, great, but there was a huge luck component, not something I want to rely on.

The market is skewed toward computer-powered manipulators. "High frequency" trading firms use super-fast processors and trading algorithms designed and tweaked by PhD's in real time every single day to rake tens of billions of dollars out of the pockets of average investors each year, through manipulation of bid/ask spreads and direct data pipes into the major exchanges. The exchanges look the other way because of all the revenue earned.

Hedge fund managers run equally complex processes, with armies of PhD's, lots of bribery-induced insider trading info, to also outmaneuver the little guys.

It just seems that real estate offers a much more level playing field for the smaller investor due to the sheer physicality of it, the need to see it, touch it, do accurate rehab estimates, etc. There are countless inefficiencies and supply/demand imbalances which can be exploited.

No doubt, as Jason said, there is money to be made investing your "private equity" into smal businesses that you have knowledge of (such as Joel mentioning buying a beaten-down restaurant franchise that will generate 60k of fairly passive cash flow). This is more like RE in many ways and unlike investing in publicly traded stocks.

Yes, you can depreciate existing personal property in the house using 5 years accelerated MACRS depreciation, including:

Appliances
Carpeting
Other "removable" flooring (not adhered or glued down)
Drapes, blinds, window treatments
Awnings attached to house
Fancy lighting fixtures

You will need some support for your values, either an appraisal from a used appliance dealer, printout of Craigs List ads, etc.

You can also depreciate land improvements over 15 years: landscaping next to house, fencing, sidewalk, driveway.

You need to subtract all of this from the total costs, and depreciate the residual over the standard 27.5 years.

Bryan --

Your true ROI will be about 4 or 5 points higher than your cash ROI, depending on the amortization term of the loan. No real need to specify a target for that.

DSCR = NOI divided by P&I. Your NOI is assumed $300 (gross rent * 50% expense ratio). Your P&I is unstated (it's some fraction of the $500 PITI), but let's assume it's $350. Your DSCR is then 300/350, or 0.86. Anything below 1.0 obviously denotes that you will be cash flow negative OVER TIME --maybe not this year-- as you incur repairs, vacancies, etc.

You already knew that's where you stood; you just want to fix it. If the gross rents pass the 2% test, then you may want to keep the properties and get longer-term financing in place. Nobody likes closings costs, but they're a necessary evil to get the right financing into place. They'll dampen the ROI going forward, but will typically be recouped many many times over by the positive spread you earn on the bank's money.

If the rents are considerably below 2%, then you need to think about selling them and seeking more optimal investment opportunities.

Ryan -- I would expect commercial lenders to be very skeptical of a neophyte taking on a small apartment complex, but if professional mgmt will be utilized, perhaps that mitigates those concerns.

No question there are quite a few REO/SS apartment deals out there, where the prior owner simply overpaid. However, these almost always require some rehab and turnaround efforts, which seem a bit of a stretch for beginners.

Properties that are humming along well already are NOT bargain priced, sporting single digit cap rates typically, and that kind of return doesn't excite me too much.

Please describe a typical deal that you are seeing that would work.

Bryan -- you have great questions and should be commended. There are several rules of thumb here to keep up with, I think.

Gross potential rent - you want this to be at least 2% of your cost (purchase+rehab) per month if rents are in the $500/mth range. As rents go up, you can lower this target. A reasonable way to do this in many areas of the country is to subtract about .1% from the 2% target for each $100 that your rents are above $500. So for a nicer $1,000/mth property, you can use 1.5%. This reflects the flat reality that nicer properties are going to command a price premium when you buy, for a lot of reasons, and generally would be expected to hold their value better and attract better/longer term tenants, and offer easier resale to a retail owner/occupant buyer should you need to sale.

Expenses - assume these will be 50% of your gross rent (in this context, expenses includes vacancies, taxes, insurance, prop mgmt, repairs, replacement reserves). While it's reasonable to assume that the operating expense ratio will decline modestly for nicer properties with higher mthly rents, please always assume at least 50% to be conservative!! (Also keeps you out of arguments on this site!)

Net Operating Income (NOI) = Gross Potental Rent less Expenses. When taken as a percentage of your cost (purchase+rehab), this is the "cap rate", or net yield.

Debt Service Coverage Ratio (DSCR) - this is NOI divided by your P&I payment. For small residential rental property, you generally want this to be 2.0 or better (I target 2.5). I think you were confusing this with the 50% expense rule. This is where the loan payment comes into play. To protect your cash flow, you generally want your amortization term to be at least 20 years, and preferably 25-30.

Net Cash Flow = NOI minus P&I. This is where some say they want at least $100/unit, but obviously that should be scaled to the value of your investment in the property. If you keep your DSCR above 2.0, AND your Cash ROI above 20-25%, you’ll be fine.

Cash Return on Investment (Cash ROI) = Net Cash Flow divided by Cost. Keep this at 25% or more for $500/mth properties, and you can relax it toward 20% for 1,000/mth properties.

True ROI (ROI) = Net Cash Flow + Principal Amortization, then divide that by the Cost. This is your true economic return, but the Cash ROI is more important in KEEPING YOU AFLOAT should bad things happen.

Fully Indexed Cash Flow â€" if you’re using bank ARM loans, recompute Net Cash Flow assuming the highest possible rate on your Adjustable Rate loan (ARMs, see below), generally 6% higher than the initial note rate for most ARMs. For simplicity, just recalculate everything with the note rate 6 points higher (some banks actually force you to qualify at this higher rate), and see if you still have positive cash flow. The target is (you guessed it) that you still have positive cash flow.

Just put this stuff in a spreadsheet. It’s very simple. You need to specify minimum targets for Gross Potential Rent return (1.5%-2.0%), DSCR (2.0), and Cash ROI (20-25%), Fully Indexed Cash Flow (at least zero). The properties need to pass these tests.
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You can most definitely get 25-30 year amortization loans from both conventional lenders (secondary market, lowest rates but harder to qualify) and in-house bank lenders (banks keep these loans and have much more flexibility in qualifying you, lower fees, quick close, personal relationship with lender; BUT bank will generally not lock the rate for longer than 5-7 years). If you need to use an in-house loan, try to get an ARM that will remain in effect for 30 years.

A standard 5/1 ARM at a small bank would be fixed for 5 years at around 6.50%, then begin floating with annual resets at 1yr Tsy+3.50% for the remaining 25 years, would be limited to a 2% rate change each year, and 6% over the life. So it would never go higher than 12.50% for the 30 year term of the loan. That rate may sound shocking to you, but please consider that in a hyper-inflationary environment, you will be able to increase your rents due to the sharp growth in the renter pool. If you’re levered at 75% and your interest rate eventually goes up 6%, then to keep the same cash flow your cap rate needs to expand by 4.5% (6% * 75%). An increase in your cap rate from 12% to 16.5% is an increase of 37.5%. Thus if you can increase rents by 37.5%, then you have completely preserved your cash flow. And the loan rate can only move up 2% per year, so there is time to gradually push the increases through your leases. And note that to be conservative you should assume that your Fully Indexed Net Cash Flow is still positive with no rent increases whatsoever.

Well, a wholesaler can add value by canvassing lots of REO listings to find the good ones. They identifiy the "good ones" for the investor by visiting the property, preparing an accurate rehab estimate, pulling accurate market comps and market rent rates, utilize their REO broker contacts, etc.

There's a little bit of fatigue and time restrictions on the part of investors who are trying to process numerous new REOs hitting the market every day (often folks who have regular jobs), so there is definitely a role for a good intermediary that is worth a fee.

Glad you got some balanced advice from Mike. Those of in the midwest/southeast can't even wrap our minds around the concept of buying a rental with a <5% cap rate. But we've never seen the kind of appreciation that can occur in places like CA. Still yet, a gamble, no doubt. Compare to successful flippers on here knocking out triple digit ROIs.

I agree with the posters who are indicating that a 30% grosss rent yield (ie.. "2.5% rule") for a SFR in Ohio that needs little or or no rehab, makes sense for most investors.

If you market it effectively and it's truly a decent area (must be to get $900 in rent), then you might be able to sell it as a 2% property (ie.. 12% cap). But in that instance I'd want to see that there is some fair volume of retail O/O sales activity in the area supporting the valuation as another exit option. (Not just a rental area with nothing but foreclosure sales, in other words.).

Good luck with it.