All Forum Posts by: Dave Fagundes

Found this old thread and it's been very helpful. It's worth reiterating that the reason to form an LLC is primarily personal liability protection. If someone sues for a tort related to real property, the amount of damages is limited to the value of the property held by an LLC if it is held in that form. If you own as an individual, then the plaintiff could come after you to satisfy the judgment as well. There are also privacy advantages, since a property title search will turn up only the names of LLCs if property is held in that form. Finally, there are tax advantages since some corporate forms pay lower taxes than individuals; there are other ones that tax professionals can explain.

So in theory if you have an LLC that owns 10 of your investment properties and someone is injured on one of them and sues the LLC, they could collect to the extent of all ten properties' values, not just the one that the suffered the injury on. That seems to be the logic of getting a different LLC for every different investment property.

It seems from the collective wisdom of this thread though that since most owners will have an insurance policy (a requirement for getting financing and sound practice generally), that diminishes the imperative of dividing up liability. And @James Hamling makes a good point that any degree of commingling may allow a smart lawyer to pursue individual liability regardless of LLC status. So the transaction and other costs of the LLC don't seem to warrant

In terms of trusts, you can convey the assets in an LLC to a trust, and hold in using that legal device. This does not do much for liability limitation or taxation, but it may be helpful for estate planning purposes. For example, if you own property in different states from your residence, upon your death there would be an ancillary probate proceeding in every state where you own real property other than the one where you are domiciled. If the property is held in a trust in your state of domicile, it may be possible to avoid this outcome.

Been watching the OKC rental/purchase market for some time now, also interested in investing there. There are a lot of good fundamentals: population growth, several stable industries (federal government, universities), one more volatile industry with major possible upsides (oil/gas), and most important for the real estate investor, attractive price rent ratios, especially as compared to larger urban areas.

The major thing I've seen that gives me pause is that rents seem like they've been pretty much flat for the past several years, presumably following the oil/gas price crash. Whether that trend will continue is hard to say. Rents generally go up, but I'd be hesitant in OKC to assume that you can raise the rent yearly as you can in most other hot housing markets. 

That said, the market in rental properties by contrast seems very hot. I've had a bunch of offers out and they've all been beaten out by above-asking, all-cash offers that were well above what I'd thought were necessary to make the numbers work. 

So OKC is by no means a secret housing market where it's easy to find great ROI, but there are probably more deals out there than in larger cities. The growth potential of the ROI may be more limited, though.

@Brandon S. Houston is a freakishly big area, so the answer to your questions depends on where you're actually talking about. There are different markets and submarkets, and the answer will vary with respect to each of them. In the inner loop, for example, price/rent ratios are so high that it's very very difficult to find a cash flowing SFH or MF place. As others have stated, you'll have better odds looking farther afield. I've found a few promising options in Missouri City, but in each case I've made an offer, the place went for more than I was willing to pay (and, IMO, more than the numbers justified).

The more general point about taxes is well-taken though. Despite TX's rep as a low-tax haven based on lack of state income tax (which is great, of course), the property taxes are killer. Compared to CA, they are higher rates and typically increase every year due to reassessment (while CA has Prop 13, which freezes your tax base at the sales price). This systematically makes cash flow harder to find, esp in a hot market. My only thought here is that prop taxes are county by county, and much of what people think of as "Houston" is actually scattered around different counties. It's possible, though, that some of the surrounding cities where price/rent ratios are lower are in counties with lower tax rates. That said, the only one I know for sure is Ft Bend Cty, where Missouri City is located, which is just as high as Harris and seems to have pretty aggressive yearly reassessment as well.  

Thanks, @Joe Villeneuve. There are a couple stages of estimation here. After you have the past financials and see the property, I agree you can make a very specific assessment of capex. When making an offer, though, you often don't have access to that information so you have to make some kind of estimate to determine whether an offer is a good move. The baseline that the BP webinars usually seem to suggest for this figure is 5%. I've found that estimate way too low, and in two cases it's undershot actual capex by a lot. That could just be these two places, both of which are old. Or it could be that when running numbers to see about making an offer capex should be fixed at a higher level.

Last couple offers I've had out I made because the deals seemed good based on assumptions I made including 5% each for cap ex and repairs. These assumptions were ones I got from watching some of the BP.com webinars about how to use the pricing utilities on the site. 

In both cases, when I got the actual financials, the amount the owners had spent on each property was far greater than 10% of the NOI. In one case the higher numbers were largely due to what seemed to be some serious plumbing issues, plus replacing HVAC in two of the units. In the other case, they were due to roof replacement and a pretty major remodel of one of the units. But even backing out those major costs, the amount of cap ex/repairs were way higher than I'd predicted.

I walked away from both deals. That was the easy part. The harder part is what lessons to learn from these experiences. One possible takeaway is that I'm just going way low on my capex/repair cost estimates. One relevant fact is that both of these properties were older (1938 and 1961), which has to come with higher costs. One idea I'm thinking about is adjusting capex/repair estimates to the age of property, say 5% for each category for anything built 1990 or after, then 1 additional percentage point for each decade before that. 

 Another issue is what to infer from these about future expenses. My thinking is that if the properties cost X amount in a previous year, that meant that they were likely to cost at least X in future years, and probably more as they aged. In one case, the owner tried to convince me that the higher cap ex/repair costs were due to his getting the place ready for the market, and that I should expect lower than average costs going forward because he'd already done the heavy lifting. That is possible, but sure didn't seem likely. 

Would be interested to hear what the experts think of each of these: (1) what's the best way to accurately estimate cap ex/repairs so you can figure out if a deal warrants making an offer in the first place, and (2) any reason to think past financials do not reasonably well predict future costs? Thanks for any thoughts on this.

OP's question is whether RE investors are causing the next recession. The easy answer to that is no, or at least  not really. Buying property, enhancing it, and charging higher rent to reflect its greater value is not sleight of hand, it's creating something of tangible quality that market actors will pay a fair price for.

The 08 crash was the product of a number of sources: originators willing to lend to anyone and re-sell terrible debt; I-bankers who repackaged that debt into CDOs that masked the worthlessness of the underlying debt instruments; financiers whose models relied on fundamental misunderstandings (independence of default) and mispredictions ("housing has never gone down so it never will!"); and yes the good old state, both by failing to regulate and by feeding the frenzy with its own massive contribution to the secondary mortgage market via FNMA and FHLMC.

Have those problems been remedied? To some extent. Mortgage standards tightened for a bit, but every time I hear a "Rocket Mortgage" ad it reminds me of 2006. The CFPB put in place some reasonable constraints but politics has gotten in the way of that agency making much of an impact. And even if bad debt is being originated, we'd also have to know whether it's being packaged into mortgage-backed securities (with related insane instruments like CDOs squared and synthetic CDOs) to know if we're looking at a repeat of 2008.

This is all to say that no, I don't think that investors are the primary driver of any forthcoming recession. They may facilitate supply and drive up demand, but recessions occur regularly and cyclically, while massive ones like the Great Recession are the product of much greater private and public forces than folks who are rehabbing duplexes to earn some side income.

@Aaron Hall I've found much the same to be true in Houston's inner loop, where the price/rent ratios of MF places are just not going to create good cash flows. Part of the problem is that they are priced along the same metrics as SFH property, using price per square foot, rather than in terms of their rental income potential.

Lots of good thoughts here about how to address this challenge. If you have capital, being a hard money lender is a decent option. You can get a high rate of return, I've heard people getting up to 12%, but there are default risks due to micro causes (borrower screws up) and macro causes (housing tanks). 

I've also run numbers on some Midwestern markets--OKC, Kansas City, Minneapolis--and found that the cash flow opportunities there are much more promising than in major coastal urban areas. Another option would be to become an expert in one mid-size midwestern market and invest there.

Or you could just wait. It's tempting to want to get or stay in the game, especially with the constant warnings about analysis paralysis. But I always remind myself of Warren Buffett's two rules of investing: First, don't lose money. Second, don't forget rule #1. All markets are cyclical, and housing has been on such an insane bull run that it's going to turn sometime in the not too distant (with the rest of the market).

@Heather Varnado From what I've seen, EaDo and 3d Ward are very different markets. EaDo is much more industrial (formerly anyhow) that is moving mainly toward mid-rises and other large housing developments. There is probably less expensive housing stock but not sure how much demand for it there will be when it's surrounded by sleek new apartment buildings. Museum Park, for example, has some SFH and MF but they are mostly being acquired by developers to tear down and build fancy new condos, which are probably the highest and best use of the land right now in that particular neighborhood. Bottom line, not sure how good an idea it would be to buy MF in an area that is trending strongly toward different kind of development overall, even if there is something affordable.

In terms of 3d Ward, the prices drop dramatically once you get on the east side of South Freeway. There's an interesting pocket east of Almeda and west of S Freeway that might still be more affordable, though that is really an adjunct to Museum Park so it too may be part of the sweeping trend toward tear-downs and condos, and not that cheap anymore. The big question I've asked in looking in 3d Ward is whether the trend toward development will stay hot, jump over S Fwy, and start picking up that area's values, or whether S Fwy will remain a visible line of demarcation in value. Plus, if there's a housing downturn, it's the frontier of development/gentrification that will suffer first, and most, so there is risk involved in that. But if you're looking for buy-and-hold, then a downturn is less of an issue since (1) rents tend to stay stable or even increase when housing values decrease and (2) if you're doing B&H then you can ride out a downturn. 

Cool looking place. Given the price/rent ratio, I agree w the above that this is not a good place for REI, you'd likely want to sell to families who wanted to live in a good house in a nice area.

One other suggestion for how you pitch this place: Billing it as "Near Rice" may do more to hurt than help your goal of selling it. I don't think anyone who lives in the loop area would regard this as near Rice; it's more than five miles away. So by billing "near Rice" as the main selling point, you may be bringing in mainly folks who are interested in that feature who are then disappointed. I'd suggest highlighting the house's other many great qualities--nice residential neighborhood, near amenities--rather than headlining one thing that is not really a selling point.

Good luck!!

Great comments, all, thanks for the input. As I continue to run numbers on smaller multifamily places in the inner loop, I keep finding the same outcomes others have identified: even if you knock the asking price down a bit, any financing results in negative cash flow, while an all-cash offer yields a return so small you'd be better off putting your money in a mutual fund. 

From what I've seen talking to agents the reason is that the market in MF is priced along the same lines as residential SFHs. Sellers just look at comps and price per square foot, and conclude that they can get about the same as similar places--which is probably true. Problem is that investors think in terms of totally different metrics--cash flow, cap rate, cash on cash. When I talk to realtors about these properties, it's like we're speaking a different language.

The macro trend seems to be that property values in the inner loop have risen at a faster rate than rents, which is typical in a hot market and also one indicator of overpriced residential real estate. Shiller, about as good an authority on US home prices as you're going to get, uses a price-rent ratio of 20 as the threshold for overpriced property (and on a market-wide scale, as a measure of a bubble). All the places I've seen are around or above that number. (Houston's P/R ratio is one of the lowest in the country among major cities, but that doesn't say much about the Inner Loop submarket because the city limits are so spread out.)

So while I like the idea of Inner Loop multifamily in theory--great location, strong long-term value expectations, some diversification of tenants--I'm growing skeptical that now is a good time for this market. Sure, there's always the possibility of finding the rare black swan opportunity on a probate list or something, but in the near term I'm starting to think it makes more sense to think about different markets like larger apartment complexes where the pricing is based on rental income, not SFH "comps", or looking at smaller or more outlying markets where sales and rental values are more in sync.