All Forum Posts by: David Beard

I feel your pain, Marlan. Sounds like you're dealing with an inept loan officer and/or underwriter, or both, if they pre-approved you at this level and now recanting.

There are requirements to have 6 mths PITI on your subject property remaining in liquid assets (after paying your down payment, closing costs, and funding escrows), but this would be a small amount, certainly way under your 13k, so I'm puzzled. Also, for this purpose, 401-Ks and other retirement assets typically qualify. [Is your 13k what you'll have left AFTER you leave the closing table?]

I would jump down their throats to find out very specifically what FNMA rule they think they're following, and go from there.

MsJerseyDevil (what a name!)

I take it you're a mtg broker or LO. Do you agree that on the conventional side most wholesale lenders and banks require 2 years of landlording experience to qualify any rental income whatsoever?

Also, what is the most common method for computing rental income on a new subject property (for situations where it has tenants in place, and where it is currently vacant)? Also, same question for qualifying income on other properties (not the subject) that have been owned for too short a time frame to have income on a tax return.

And what conventional lenders are you aware of offering loans in 5th-10th financed property level.

Inquiring minds want to know!

It also bugs me that W2 income seems to enjoy an unfair advantage. W2 income is fully exposed to taxes at your marginal tax rate, as well as payroll tax. Rental income is partially shielded from taxes due to depreciation, and there are generally no payroll taxes, so Net Operating Income from rental property could be worth 25-40% more than W2 income (or "active" self-employment income). Is there anything I'm missing in that critique?

Thanks.

Best of luck. You make mention of an FHA financing program, which I take it be only available for owner-occupants. Unless you're referring to where you can point your end-buyers to get financing. Generally investment property requires 25% down, though some Fannie REOs can be financed with 10% down through their Homepath program.

Awesome, Bryan, your enthusiasm is infectious.... and the free sharing of info and ideas is what makes BP so valuable and fun.

Replacement reserves is simply what you're "setting aside" from the rental payments to handle the large "capital expenditures" as they happen. 5% of gross rents is a common set-aside % that in most cases will build sufficiently to handle your major 15-20 year items (roof, furnace, water heater, HVAC, boiler, appliances). Using 5% of Net Income will not be sufficient.

Take a look at this Freddie Mac form:

http://www.freddiemac.com/sell/forms/pdf/998.pdf

It is used by appraisers/underwriters to estimate Net Operating Income for a property. It's helpful to see how lenders/appraisers look at it, particularly the "Replacement Reserves" section. You will need to have some idea of costs to replace things, such as $150/square for a tearoff and re-shingle, $600 for a water heater, etc.

Hi Jonathan -- just a few things that have sunk in for me in my long illustrious (6 mths and counting!) investing career:

You should multiply the Gross Potential Rent by 5% for "Replacement Reserves" and include it when computing your Net Operating Income. You will need to fine tune the 5% by looking at the building mechanicals and roof and estimating remaining life of these items and replacement costs. If replacement is needed in the next couple of years on the roof, for example, and you elect to not do it immediately, I normally include that item in the up-front purchase price (for analysis purposes) and recompute the ROI in that fashion. In this case, you will need to reserve funds (or build funds) to prepare for that replacement.

An advantage of knocking out these "near-obsolete" items up front is that if you're financing with a community bank, the bank will often loan you funds for "purchase+rehab" for all the work you do right around the time of purchase. Then you have a functionally new property that will require less maintenance and be much easier to sell if need be. And.. if you do find yourself needing to sell for some reason at a later point, you may or may not have funds at that time to replace a roof and other items, forcing you to dump an "as-is" property at a loss.

I'd recommend using at least a one-month vacancy factor (8.3%), and be sure to add in the prop mgr's cost of leasing the unit (commonly half month rent). So if the unit turns over every year, prop mgmt could be 10% (normal fee ) for 11 rented months, but 50% in the vacant month. This equates to a PM fee of 13.3% for the year. You'll also have to clean, paint and possibly replace flooring at these turnover points, so make sure you include this in your PM fee or add to maintenance. If it's a multi, don't forget yard maintenance, snow removal, etc., even if you're doing it yourself. (time is money).

If you're buying well under tax-assessed value (usually the case), make sure you research and understand the process for appealing the assessment, and how long this will take. You can save a ton on this. There are services that will handle this for you for a % of the first year savings, or a flat fee.

You'll be buying way under "replacement cost", so determine how much you want to insure (perhaps 50% above your all-in cost), and base your insurance calc at that level (perhaps .40% multiplied by 150% of all-in). Don't let the agent convince you to insure at "replacement costs".

Be sure to add in loan closing costs to your up-front. Some is fixed -- lender fees, appraisals and inspections (these are higher for multi-unit), title search, attorney fee -- and some is variable with your loan amount -- points, title insurance, county fees sometimes), so I like to break it out in that fashion.

On a side note, purchase an extra umbrella liability policy to protect your property equity and personal assets from lawsuits. 1mm should cost $200-250/year.

You can typically use 401-K and IRA funds to demonstrate necessary cash reserves.

John -- thanks for the suppport :) I've recently purchased two 4-unit buildings.

#1 - paid 75K, with 1,900 of mthly gross rents (tenants in place), in good condition, and tenants paying all utilities except water/sewer
#2 - paid 77.5K, with 2,500 of mthly potential gross (bankruptcy sale, 2 units vacant at the moment), also in good condition, w/ landlord paying for common boiler heat, as well as water/sewer. Boiler heat has averaged $275/mth in the last year.
#3 - I'm evaluating this 3-unit bldg, asking price is $55k (I believe could be had for less than $50k), w/ 1,625 of gross rents (tenants in place), landlord paying only water/sewer, building rehabbed to very nice condition.

Taxes are around 2% of assessed value on these.

These deals are readily available in average areas with solid rental demand, and are not in war zones. All have at least 30% gross rent, 15% net rent (some more), including professional prop mgr who doesn't charge extra for unit lease-up (10% flat fee).

On 15% cap rate, borrowing 75% at 6% equates to an ROI of 42% (15% + (9% loan spread * 3.0 leverage factor)). Of course, cash ROI a bit lower depending on amort. term.

I literally have an entire page of prospect properties that will generate 40% ROIs under the 50% rule. In some cases, there is even more upside when I'm able to get the taxes appealed lower, as purchase prices are usually half of assessed value or less. And this factors in zero future appreciation on the property, zero rent appreciation, and doesn't take into account the tremendous tax shield from aggressive depreciation.

So I'd characterize 30% as a slam dunk, 40% as very reasonable, and 50% as doable with intensified effort. And in an area with unemployment below the national average, with a diversified economic base.

If they state that they've been a past drug user and were convicted on that offense, but are now clean, then they are protected.

Of course, if they engage in illegal drug use while a tenant, that is grounds for eviction.

Chris -- thanks, I discovered later that you're correct, the underwriter recanted and indicates that the related party issue is indeed a problem. Believe me, I have no attempt to do anything even remotely questionable, and I was surprised by their initial response.

I've just turned my attention to real estate in the last six months, and have begun to build a portfolio, with five properties, including two 4-unit buildings and the other SFRs. So I'm pretty close to maxing out the conventional channel.

I have submitted my financial information to a regional bank and am lined up to expand with the 5 to 7 year product as soon as I've exhausted conventional financing -- probably the next deal. You're right that they seem eager to lend, and have no problem lending to my LLC with a personal guaranty. The rollover/rate risk does bother me, as rising rates could (in the short term) rapidly outpace your ability to reset rents higher in an inflationary environment.