All Forum Posts by: David Beard

I was curious how many of you have property management agreements where the PM has inserted a clause saying they'll be paid a specified % of the sales price if sold during the term of the agreement. Sounds crazy to me, but I've just encountered this.

Has the seller even thrown a price out to you, or are you just working off this $662K number that you came up with. I assume he did tell you he'd finance at 7.5% for 30 years.

Have you looked at getting your own financing? It's probably advantageous for him to seller finance, as he can spread the taxes out via an installment sale, so don't pay more because he'll carry the note. You have good credit and cash, so might be able to get a loan at a local bank.

The 2% rule for C properties (get 2% of purchase price per month in rents) suggests that you shouldn't pay more than 50x monthly potential rent, or $414K. And if there is immediate deferred maintenance, you would need to subtract that off your offering price (or at least half of it, since you'll have new components). If you can't get into this ballpark, move on.

Combined with the 50% expense rule, that gives you a 24% gross return and 12% net return/cap rate. C properties trade in the 10-15% range typically, though you need to run sales comp in your immediate area to validate.

Thanks, Will, what I was getting at:

Why would anyone operate an S-Corp, since it's more administratively burdensome?

Tony,

You can find 15% cap rate (net return after all expenses and vacancy assumption) properties that you can finance at 75% LTV with 6% fixed interest rate. This will yield a 42% return on your investment (cash flow yield a bit lower due to the principal you have to back back to the bank each month), and that is before factoring in potential rent increases and market appreciation (which are likely but we'll leave them out to be conservative).

That is also a pre-tax ROI. There are additional depreciation benefits for taxes that will make the 42% equate to something higher when compared to a flipping business or other investment (could be as much as +60% if you're in a high fed/state tax bracket)

Successful flippers might look for annualized ROIs in the 100% range, though they have to pay payroll taxes, and is a more time consuming effort compared to using property managers for your buy-and-hold rentals.

Well, find out who the prior owner used. As well, call some independent agents that represent multiple carriers and see who's got the best rate for about 100K of coverage with at least 300K of liability.

On taxes, appeal it; you just paid 50K, not worth 101K; get low comps supporting your position.

To clarify further for a flipping business, since this keeps coming up:

* An LLC can elect to be taxed however it likes, including as an S-Corp. That much is clear.
* Thus Jason asserts that the S-Corp has no tax benefit over an LLC, has equal asset protection benefits, and has the disadvantage of being more difficult to maintain. (I think Stephen, the EA posting previously, seems to agree with this.)
* Will has stated (I think) that the S-Corp permits some of the income to be taxed at a more favorable rate. This is because W-2 compensation (has to be at least "reasonable" but that has lots of latitude) can be paid to the owners/managers of the S-Corp that is less than the S-Corp's total earnings. The wages incur payroll taxes. The residual profits (which can be a large percentage of the total earnings) are counted as "dividends" and not subject to payroll taxes. Somewhat offsetting this is that the S-Corp has to pay unemployment taxes due to having "employees".
* This is the big BUT... If the LLC can elect S-corp treatment, doesn't this level the playing field in all regards related to taxes?

The issue is that your taxes and insurance, as you quote them, are **extremely*** high Your insurance should not cost you more than $40/mth. How much coverage are you electing?? They'll try to sell you full replacement cost, which might be $250K; just go with $100K or thereabouts.

Likewise, taxes are 1.5-3.0% of assessed value in most areas in the country. Your tax number must be based on a very high assessment (perhaps the $170K you mention). You will need to appeal it to the tax assessor. Find out if people are generally successful in appealing assessments in your area based on much lower sales prices, and take the necessary steps to get a reduction. Some local govts are getting anal about reducing assessments due to the lost revenue.

Once you normalize taxes and insurance, your deal should make sense.

I posed the following questions recently to my US bank conventional lender:

• If I buy a 4-unit property for cash, do a bit of rehab, then get it leased up to solid tenants, how long of a period has to elapse before I can do a cash-out refinance? "6 mo."
• Same question as above, but what if I financed the 4-unit with a private lender, how long of a period has to elapse before I can do a rate/term refinance? "30 days but 120 days before you do not have to use purchase price as value"
• Same question, except what if the private lender is a related party. Does that matter for being able to do a rate/term refi? "No."

I asked the last question because a friend and I were considering forming a hard money lending entity, wherein I might contribute 25% of the capital, and he 75%. If this entity loans to me on a purchase transaction, then based on the answer I received it appears that I can do a rate/term refi in a shorter time frame after purchase date than if I purchased using my own cash.

Does anyone disagree? And this is in the context of a conventional 30-year fixed conventional loan, not community bank portfolio loans with 5-year fixed rates.

I just heard a similar story. The big mortgage wholesalers (Wells Fargo, etc.)have been inundated with refinance volume. Purchase transactions, which have contractual close dates, receive priority, and refinances have been generally slow. I'm sure the full documentation requirements, and the appraisal reviews, these days have also contributed to the back log on refinances. With rates now spurting up, there are bound to be LOTS of angry borrowers like yourself.

Well said, Ben.